-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CvpbYaHOUQljv5HRMpOrNVoObrjKxEJbIAPwx4Pbf0emDA5RpsHtzm8EDZ+aQFkv yh0PQ3FJfUQ/1cO4Jms9+w== 0001231742-06-000805.txt : 20061114 0001231742-06-000805.hdr.sgml : 20061114 20061114170607 ACCESSION NUMBER: 0001231742-06-000805 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061114 DATE AS OF CHANGE: 20061114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NIGHTHAWK SYSTEMS INC CENTRAL INDEX KEY: 0001084475 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATION SERVICES, NEC [4899] IRS NUMBER: 870627349 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-30786 FILM NUMBER: 061216520 BUSINESS ADDRESS: STREET 1: 8200 EAST PACIFIC PLS STREET 2: SUITE 204 CITY: DENVER STATE: CO ZIP: 80231 BUSINESS PHONE: 2103414811 MAIL ADDRESS: STREET 1: 10715 GULFDALE STREET 2: SUITE 200 CITY: SAN ANTONIO STATE: TX ZIP: 78216 FORMER COMPANY: FORMER CONFORMED NAME: PEREGRINE INC DATE OF NAME CHANGE: 20020501 FORMER COMPANY: FORMER CONFORMED NAME: LSI COMMUNICATIONS INC DATE OF NAME CHANGE: 19991117 10QSB 1 nihk10qsb.txt 10-QSB U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to ________ Commission File Number: 0-30786 NIGHTHAWK SYSTEMS, INC ---------------------- (Exact name of small business issuer as specified in its charter) Nevada 87-0627349 ------ ---------- (State or other jurisdiction (I.R.S Employer of incorporation or organization) Identification No.) 10715 Gulfdale, Suite 200 San Antonio, TX 78216 ---------------------- (Address of principal executive offices) 210 341-4811 ------------ (Issuer's telephone number) (Former name, former address and former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEEDING FIVE YEARS Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS As of November 14, 2006 there were 77,066,699 shares of common stock, par value $.001 per share, of the registrant issued and outstanding. Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X] INDEX Part I FINANCIAL INFORMATION Item 1 Financial Statements (unaudited) Condensed consolidated balance sheet as of September 30, 2006 2 Condensed consolidated statements of operations for the three and nine month periods ended September 30, 2006 and 2005 3 Condensed consolidated statement of stockholders' deficit for the nine months ended September 30, 2006 4 Condensed consolidated statements of cash flows for the nine months ended September 30, 2006 and 2005 5 Notes to condensed consolidated financial statements 7 Item 2 Management's Discussion and Analysis or Plan of Operation 11 Item 3 Controls and Procedures 15 Part II OTHER INFORMATION Item 1 Legal Proceedings 16 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 16 Item 3 Defaults Upon Senior Securities 16 Item 4 Submissions of Matters to a Vote of Security Holders 16 Item 5 Other Information 16 Item 6 Exhibits and Reports on Form 8-K 16 Signatures and Certifications 17 -1- NIGHTHAWK SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2006
ASSETS Current assets: Cash $ 121,790 Accounts receivable, net of allowance for doubtful accounts of $1,654 152,057 Inventories 104,625 Prepaids 793,130 ------------ Total current assets 1,171,602 ------------ Furniture, fixtures and equipment, net 19,299 Intangible and other assets 24,200 ------------ $ 1,215,101 ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable $ 221,249 Accrued expenses 384,441 Line of credit 19,792 Notes payable: Related parties 12,716 Other 338,601 ------------ Total current liabilities 976,799 ------------ Long-term liabilities: Convertible debt 2,849,320 ------------ Commitments and contingencies Stockholders' deficit: Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding; liquidation preference $ - Common stock; $0.001 par value; 200,000,000 shares authorized; 74,480,015 issued and outstanding 74,480 Additional paid- in capital 7,919,493 Accumulated deficit (10,604,991) ------------ Total stockholders' deficit (2,611,018) ------------ $ 1,215,101 ============ The accompanying notes are an integral part of these financial statements
-2- Nighthawk Systems, Inc. Condensed Consolidated Statements of Operations
Three months ended September 30, Nine months ended September 30, 2006 2005 2006 2005 ----------------------- --------------------------- Revenue $ 231,710 $ 120,973 $ 625,236 $ 390,567 Cost of goods sold 136,690 91,579 400,983 281,203 ----------------------- --------------------------- Gross profit 95,020 29,394 224,253 109,364 Selling, general and administrative expenses 555,375 476,496 1,866,749 1,626,195 ----------------------- -------------------------- Loss from operations (460,355) (447,102) (1,642,496) (1,516,831) Interest expense: Related parties 346 627 1,677 1,466 Other 145,050 130,224 910,820 619,232 ----------------------- --------------------------- Total interest expense 145,396 130,851 912,497 620,698 ----------------------- --------------------------- Net loss (605,751) (577,953) (2,554,993) (2,137,529) Less: preferred stock dividends (224) (664) ----------------------- --------------------------- Net loss to common stockholders $ (605,751) $(578,177) $(2,554,993) $(2,138,193) ======================= =========================== Net loss per basic and diluted common share $ (0.01) $ (0.01) $ (0.04) $ (0.06) ======================= =========================== Net loss to common stockholders per basic and diluted common share $ (0.01) $ (0.01) $ (0.04) $ (0.06) ======================= =========================== Weighted average common shares outstanding - basic and diluted 74,712,976 40,626,529 67,270,080 37,228,455 The accompanying notes are an integral part of these financial statements.
-3- Nighthawk Systems, Inc. Condensed Consolidated Statement of Stockholders' Deficit Nine months ended September 30, 2006
Common stock Additional -------------------------- paid-in Accumulated Shares Amount capital deficit Total ------------ ------------ ------------ ------------ ------------ Balances, December 31, 2005 46,477,158 $ 46,477 $ 5,464,436 $(8,049,998) $(2,539,085) Common stock issued for Dutchess puts, including commissions 20,130,857 20,131 1,447,955 1,468,086 Common stock issued as incentive for notes payable 5,353,666 5,354 332,626 337,980 Common stock issued for consulting services 4,925,000 4,925 232,075 237,000 Common stock converted to warrants (3,256,666) (3,257) 3,257 Warrant to purchase common stock issued(notes payable) 48,000 48,000 Conversion of accrued liabilities to common stock 850,000 850 34,150 35,000 Amortization of beneficial conversion feature on notes payable 254,280 254,280 Vesting of options 102,714 102,714 Net loss (2,554,993) (2,554,993) ------------ ------------ ------------ ------------ ------------ Balances, September 30, 2006 74,480,015 $ 74,480 $ 7,919,493 $(10,604,991) $(2,611,018) ============ ============ ============ ============ ============ The accompanying notes are an integral part of these financial statements
-4- Nighthawk Systems, Inc. Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2006 2005 ------------ ------------ Cash flows from operating activities: Net loss $(2,554,993) $(2,137,529) ------------ ------------ Adjustments to reconcile net loss to net cash used in operating activities: Bad debt expense 1,987 1,648 Depreciation and amortization 7,413 4,740 Vesting of options 102,714 - Loan discounts and warrants 133,789 267,929 Beneficial conversion feature 254,281 - Common stock issued for consulting services 177,000 238,031 Common stock issued for interest 88,109 - Shares and warrants issued as incentives on notes payable 233,267 180,007 Note payable issued for consulting 74,550 - Note payable issued for interest - 131,954 Amortization of prepaid consulting expense - 186,310 Changes in assets and liabilities: (Increase) in accounts receivable (70,839) (18,052) (Increase) in inventories (24,747) (51,676) (Increase) decrease in prepaids ( 9,434) 34,482 Decrease in other assets and liabilities ( 4,652) (1,020) Decrease in accounts payable (64,000) (121,805) Increase in accrued expenses 91,601 116,058 ------------ ------------ Total adjustments 991,039 968,606 ------------ ------------ Net cash used in operating activities (1,563,954) (1,168,923) ------------ ------------ Cash flows from investing activities: Purchases of furniture, fixtures and equipment (13,283) (4,348) ------------ ------------ Net cash used in investing activities (13,283) (4,348) ------------ ------------ Cash flows from financing activities: Proceeds from notes payable, related parties - 1,070 Payments on notes payable, related parties (1,678) (1,658) Proceeds from notes payable, other 1,615,000 1,026,133 Payments on notes payable, other (5,500) (20,075) Net proceeds from the sale of common stock, and the exercise of puts and warrants - 112,093 ------------ ------------ Net cash provided by financing activities 1,607,822 1,117,563 ------------ ------------ Net increase (decrease) in cash 30,585 (55,708) Cash, beginning balance. 91,205 61,118 ------------ ------------ Cash, ending balance $ 121,790 $ 5,410 ============ ============
-5- Condensed Consolidated Statements of Cash Flows (continued)
Supplemental disclosures of cash flow information: 2006 2005 ---------- ---------- Cash paid for interest $ 24,409 $ 195,244 ========== ========== Supplemental disclosure of non-cash investing and financing activities: Common shares issued as payments on notes payable, including commissions $1,482,943 $ 169,796 ========== ========== Common shares issued as incentives for notes payable $ 385,980 $ 248,300 ========== ========== Common shares issued for prepaid consulting agreements $ 207,500 ========== Conversion of accrued expenses to common stock $ 35,000 $ 83,226 ========== ========== Conversion of notes payable and accrued interest to common stock Notes payable $ 240,623 Accrued interest 14,362 ---------- Total amount converted $ 254,987 ========== Preferred stock dividends issued in common stock $ 664 ==========
-6- NIGHTHAWK SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2006 AND 2005 (unaudited) 1. ORGANIZATION, GOING CONCERN, RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS ORGANIZATION Nighthawk Systems, Inc. ("the Company") designs and manufactures intelligent wireless power control products that enable simultaneous activation or de-activation of multiple assets or systems on demand. Nighthawk's installed customer base includes major electric utilities, internet service providers and fire departments in over 40 states. Nighthawk's products also enable custom message display, making them ideal for use in traffic control and emergency notification situations. Nighthawk products enable customers to wirelessly extend their reach, allowing them to turn on, off or reboot remotely located equipment at any time, from anywhere. Expensive truck rolls and third-party service contracts are no longer required with Nighthawk products in place. The Company's proprietary, wireless products are ready to use upon purchase, so they are easily installed by anyone, regardless of technical ability, and are also easily integrated into third-party products, systems and processes. They allow for intelligent control by interpreting instructions sent via wireless media, and executing the instructions by 'switching' the electrical current that powers the device, system or process. Nighthawk's intelligent products can be activated individually, in pre-defined groups, or en masse, and for specified time periods with a simple click of a mouse or by dialing a telephone number. GOING CONCERN, RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS The Company incurred a net loss of approximately $2.5 million during the nine month period ended September 30, 2006 and had a stockholders' deficit of approximately $2.6 million as of September 30, 2006. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Although no assurance can be given that such plans will be successfully implemented, management's plans to address these concerns include: - - Raising working capital through additional borrowings. - - Raising equity funding through sales of the Company's common stock. - - Implementation of the Company's sales and marketing plans. In August 2004, the Company signed a financing arrangement with Dutchess Private Equities, II, L.P. ("Dutchess") under which the Company received $250,000 in exchange for a convertible debenture during August 2004. The Company also signed an investment agreement under which Dutchess agreed to purchase up to $10.0 million in common stock from the Company, at the Company's discretion, over the next three years, subject to certain limitations including the Company's then current trading volume. Although the amount and timing of specific cash infusions available under the entire financing arrangement cannot be predicted with certainty, the arrangement represents a contractual commitment by Dutchess to provide funds to the Company. Since entering into the arrangement with Dutchess, the Company has utilized the arrangement to obtain enough cash to cover its operating cash flow deficits on a monthly basis. For more information on transactions with Dutchess during the nine-month period ending September 30, 2006, please see Note 4 - Notes payable. Although no assurance may be given that it will be able to do so, the Company expects to be able to continue to access funds under this arrangement to help it fund near-term and long-term sales and marketing efforts, and to cover cash flow deficiencies. During 2005, the Company hired its first full-time personnel that were dedicated only to developing sales channels and sales opportunities Throughout 2005, the sales staff was responsible for generating new business opportunities for the Company's core products, the NH100 rebooting device and the CEO700 whole house disconnect device. It also launched a new website during 2005 which allows potential customers to send contact information and product inquiries directly to the Company via the Internet. -7- The Company's strategic initiatives for 2006 include: - - Capitalize on existing enterprise sales opportunities - - Cultivate and capitalize on indirect sales channels - - Enhance our marketing effort to support direct and indirect sales channels - - Bundle our products with ancillary products and services to enhance revenue opportunities - - Develop and sell a device that functions on multiple wireless protocols - - Form an advisory board with relevant industry expertise and relationships - - Execute on a strategic acquisition that is scalable and complementary to our existing business The Report of the Company's Independent Registered Public Accounting Firm on the Company's financial statements as of and for the year ended December 31, 2005 includes a "going concern" explanatory paragraph which means that the auditors expressed substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts of liabilities that might be necessary should the Company be unsuccessful in implementing these plans, or otherwise be unable to continue as a going concern. 2. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements, which include the accounts of Nighthawk Systems, Inc. and its subsidiary Peregrine Control Technologies, Inc. (collectively referred to herein as "the Company"), have been prepared in accordance with accounting principles generally accepted in the U.S. for interim financial information. In the opinion of management, all adjustments (consisting of only normal recurring items), which are necessary for a fair presentation have been included. The results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-KSB for 2005 filed with the Securities and Exchange Commission (the "SEC"). 3. SIGNIFICANT ACCOUNTING POLICIES REVENUE RECOGNITION Revenue from product sales is recognized when all significant obligations of the Company have been satisfied. Revenues from equipment sales are recognized either on the completion of the manufacturing process, or upon shipment of the equipment to the customer, depending on the Company's contractual obligations. The Company occasionally contracts to manufacture items, bill for those items and then hold them for later shipment to customer-specified locations. As of September 30, 2006, the Company billed $16,415 for equipment that was being held pending shipping instructions from a customer. Revenue related to airtime billing is recognized when the service is performed. Some customers pre-pay airtime on a quarterly or annual basis and the pre-paid portion is recorded as deferred revenue. Deferred revenue, included in accrued expenses on the balance sheet at September 30, 2006, is approximately $15,869. PROVISION FOR DOUBTFUL ACCOUNTS The Company reviews accounts receivable periodically for collectibility and establishes an allowance for doubtful accounts and records bad debt expense when deemed necessary. -8- CONCENTRATIONS Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. Receivables arising from sales to customers are not collateralized and, as a result, management continually monitors the financial condition of its customers to reduce the risk of loss. At September 30, 2006, the Company had approximately $152,057 in accounts receivable, net of the allowance for doubtful accounts. Approximately $132,669 of this balance was from four customers, $120,602 of which was collected as of November 14, 2006. During the three month period ended September 30, 2006, two customers accounted for approximately 14% and 32% of total revenue, respectively. During the nine month period ended September 30, 2006, one customer accounted for approximately 12% of total revenue. During the three months ended September 30, 2005, two customers accounted for approximately 12% and 20% of total revenue, respectively. During the nine month period ended September 30, 2005, two customers accounted for approximately 14% and 20% of total revenue, respectively. During the three month period ended September 30, 2006 two suppliers accounted for approximately 56% of the Company's purchases of pre-manufactured component materials, during the nine month period ended September 30, 2006, three suppliers accounted for approximately 74% of the Company's purchases of pre-manufactured component materials. INVENTORIES Inventories consist of parts and pre-manufactured component materials and finished goods. Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) method. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of five to seven years. Maintenance and repairs are expensed as incurred and improvements are capitalized. Upon sale or retirement of assets, the cost and related accumulated depreciation or amortization is eliminated from the respective accounts and any resulting gains or losses are reflected in operations. INTANGIBLE ASSETS Intangible assets include patent costs and are stated at cost. If the patents are granted, the Company will then begin to amortize the patents over the shorter of the lives of the patents or the estimated useful lives using the straight-line method. The Company reviews these and any other long-lived assets for impairment whenever events or changes in circumstances indicate their carrying amounts may not be recoverable. Recoverability of an asset to be held and used is measured by a comparison of the carrying amount of the asset to future undiscounted cash flows expected to be generated by the asset. If the asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management does not believe that any impairment of intangible or other long-lived assets exists at September 30, 2006. RESEARCH AND DEVELOPMENT COSTS Research and development costs include materials and equipment costs associated with the formulation, design, construction and testing of new product prototypes. These costs also include contract labor and salaries, wages and other related costs of personnel engaged in the research and development activities. During the three month and nine month periods ended September 30, 2006, the Company incurred approximately $32,500 and $92,500, respectively, in research and development costs related to the development of a two-way wireless product for the utility industry. These costs are included in selling, general and administrative expenses in the accompanying financial statements. INCOME TAXES Deferred tax assets and liabilities are recorded for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the accompanying balance sheets, and for operating loss and tax credit carry forwards. The change in deferred tax assets and liabilities for the period measures the deferred tax provision or benefit for the period. Effects of changes in enacted tax laws on deferred tax assets and liabilities are reflected as adjustments to the tax provision or benefit in the period of enactment. The Company's deferred tax assets have been completely reduced by a valuation allowance because management does not believe realization of the deferred tax assets is sufficiently assured at the balance sheet date. -9- NET LOSS PER SHARE Basic net loss per share is computed by dividing the net loss applicable to common stockholders by the weighted-average number of shares of common stock outstanding for the year. Diluted net loss per share reflects the potential dilution that could occur if dilutive securities were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company, unless the effect of such inclusion would reduce a loss or increase earnings per share. For each of the periods presented in the accompanying financial statements, the effect of the inclusion of dilutive hares would have resulted in a decrease in loss per share. Accordingly, the weighted average shares outstanding have not been adjusted for dilutive shares. USE OF ESTIMATES The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. STOCK-BASED COMPENSATION During the first quarter of fiscal 2006, the Company adopted the provisions of, and accounts for stock-based compensation in accordance with, the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 - - revised 2004 ("SFAS 123R") "Share-Based Payment" which replaced Statement of Financial Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25 ("APA 25"), "Accounting for Stock Issued to Employees". Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The Company elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. RECLASSIFICATIONS Certain amounts reported in the condensed consolidated financial statements for the three and nine month periods ended September 30, 2005 have been reclassified to conform to the September 30, 2006 presentation. 4. NOTES PAYABLE
At September 30, 2006, notes payable consist of the following: Related parties: Note payable, officer; unsecured; interest at prime rate plus 5.5% (13.74% at September 30, 2006); due on demand $ 9,247 Note payable, officer; unsecured; interest at 23.99%, revolving 3,469 ---------- $ 12,716 ========== Other: Convertible note payable to stockholder, 8% interest rate, in default as of the date of this report (1) $ 160,000 Notes payable to stockholder, 8% interest rate, in default as of the date of this report (1) 165,000 Unsecured note with a financial institution, 18.24% interest rate, revolving 13,601 ----------- $ 338,601 =========== Long Term: Convertible debenture, 5% interest rate, due December, 2010 $ 500,000 Convertible debenture, 10% interest rate, due December, 2009 1,303,924 Convertible debenture, 10% interest rate, due March, 2011 137,084 Convertible debenture, 10% interest rate, due April, 2011 165,000 Convertible debenture, 10% interest rate, due May, 2011 92,071 Convertible debenture, 10% interest rate, due June, 2011 205,000 Convertible debenture, 10% interest rate, due July, 2011 135,000 Convertible debenture, 10% interest rate, due August, 2011 126,241 Convertible debenture, 10% interest rate, due September, 2011 185,000 ---------- $2,849,320 ========== 1) Based on recurring discussions with the shareholder, who is a former board member, the Company does not expect to receive a notice of default and to have the notes called by the holder. However, no assurance may be give that this will be the case.
-10- On January 9, 2006, Dutchess loaned the Company $245,000. The note had no stated interest rate but had a face amount of $294,000 and matured on January 9, 2007. Dutchess was issued 653,000 incentive shares of unregistered common stock valued by the Company at $45,710 for the note, which was secured by put notices. During the three month period ending March 31, 2006, Dutchess exercised put notices valued at $294,000 to pay off the note and was issued 3,477,247 shares of common stock as a result. On February 8, 2006, Dutchess loaned the Company $205,000 in exchange for a convertible debenture that was due February 8, 2011. Dutchess was issued 615,000 incentive shares of unregistered common stock valued by the Company at $55,350 for the debenture, which was secured by put notices. The debenture contained a clause calling for an early redemption penalty of 20%. During the three month period ending March 31, 2006, Dutchess exercised put notices valued at $246,000 to pay off the debenture and the redemption penalty, and was issued 2,429,107 shares of common stock as a result. The Company recorded the redemption penalty as interest expense, and also recorded $68,333 in interest expense during the period related to the beneficial conversion feature of the debenture. On March 16, 2006, Dutchess loaned the Company $185,000 in exchange for a convertible debenture that is due March 16, 2011. Dutchess was issued 444,000 incentive shares of unregistered common stock valued by the Company at $44,400 for the debenture, which is secured by put notices. The Company recorded $7,196 in interest expense during the nine month period ending September 30, 2006 related to the beneficial conversion feature of the debenture. Additionally, during the nine month period ending September 30, 2006, Dutchess exercised put notices valued at $47,916 to pay down the debenture, and was issued 1,089,480 shares as a result. The debenture contains a clause calling for an early redemption penalty of 20%. On April 19, 2006, Dutchess loaned the Company $165,000 in exchange for a convertible debenture that is due April 19, 2011. Dutchess was issued 366,666 incentive shares of unregistered common stock valued by the Company at $33,000 for the debenture, which is secured by put notices. The Company recorded $5,502 in interest expense during the nine month period ending September 30, 2006 related to the beneficial conversion feature of the debenture. The debenture contains a clause calling for an early redemption penalty of 20%. On May 17, 2006, Dutchess loaned the Company $130,000 in exchange for a convertible debenture that is due May 17, 2011. Dutchess was issued 690,000 incentive shares of unregistered common stock valued by the Company at $48,300 for the debenture, which is secured by put notices. The Company recorded $3,610 in interest expense during the nine month period ending September 30, 2006 related to the beneficial conversion feature of the debenture. Additionally, during the nine month period ending September 30, 2006, Dutchess exercised put notices valued at $37,929 to pay down the debenture, and was issued 1,307,593 shares as a result. The debenture contains a clause calling for an early redemption penalty of 20%. On June 15, 2006, Dutchess loaned the Company $205,000 in exchange for a convertible debenture that is due June 15, 2011. Dutchess was issued 1,010,000 incentive shares of unregistered common stock valued by the Company at $47,470 for the debenture, which is secured by put notices. The Company recorded $4,556 in interest expense during the nine month period ending September 30, 2006 related to the beneficial conversion feature of the debenture. The debenture contains a clause calling for an early redemption penalty of 20%. On July 6, 2006, Dutchess loaned the Company $135,000 in exchange for a convertible debenture that is due July 6, 2011. Dutchess was issued 575,000 incentive shares of unregistered common stock valued by the Company at $28,750 for the debenture, which is secured by put notices. The Company recorded $2,250 in interest expense during the nine month period ending September 30, 2006 related to the beneficial conversion feature of the debenture. The debenture contains a clause calling for an early redemption penalty of 20%. On August 21, 2006, Dutchess loaned the Company $160,000 in exchange for a convertible debenture that is due August 21, 2011. Dutchess was issued 1,000,000 incentive shares of unregistered common stock valued by the Company at $35,000 for the debenture, which is secured by put notices. The Company recorded $1,778 in interest expense during the nine month period ending September 30, 2006 related to the beneficial conversion feature of the debenture. Additionally, during the nine month period ending September 30, 2006, Dutchess exercised put notices valued at $33,759 to pay down the debenture, and was issued 1,009,035shares as a result. The debenture contains a clause calling for an early redemption penalty of 20%. On September 27, 2006, Dutchess loaned the Company $185,000 in exchange for a convertible debenture that is due September 27, 2011. In addition to the debenture, which is secured by put notices, Dutchess was issued a warrant to purchase 1,200,000 shares of common stock for $0.001 per share. The Company has valued the warrant, which it considers to be equivalent to 1,200,000 shares of common stock, at $48,000. See note 5 below. The debenture contains a clause calling for an early redemption penalty of 20%. In addition to the activity discussed about, during the nine month period ending September 30, 2006, Dutchess exercised puts valued at $737,832 to pay off four notes and one debenture, plus all related interest, that had been outstanding at December 31, 2005, and exercised puts valued at $59,573 to pay down a debenture that had been outstanding at December 31, 2005. Dutchess was issued 14,661,608 shares as a result of these transactions. The Company recorded $121,039 in interest expense on these notes and debentures during the period, as well as $83,908 in interest expense related to the beneficial conversion feature of the debenture. During the three and nine month periods ended September 30, 2006, the Company recognized a total of $54,680 and $254,281, respectively, in interest expense related to the beneficial conversion feature of debentures outstanding during the period. During the three and nine month periods ended September 30, 2006, the Company also recognized $8,533 and $75,667, respectively, in commissions due to a third party as a result of puts exercised by Dutchess during the period. -11- Subsequent to September 30, 2006, Dutchess has exercised four puts valued at $65,432 in order to pay down the debentures issued in May, 2006 and August 2006. The Company issued Dutchess 1,888,000 shares of common stock as a result. On October 6, 2006, Dutchess loaned the Company $105,000 in exchange for a convertible debenture that is due October 6, 2011. In addition to the debenture, which is secured by put notices, Dutchess was issued a warrant to purchase 650,000 shares of common stock for $0.001 per share. The Company has valued the warrant, which it considers to be equivalent to 650,000 shares of common stock, at $19,250. The debenture contains a clause calling for an early redemption penalty of 20%. On October 25, 2006, Dutchess loaned the Company $330,000 in exchange for a convertible debenture that is due October 25, 2011. In addition to the debenture, which is secured by put notices, Dutchess was issued a warrant to purchase 1,250,000 shares of common stock at $0.001 per share. The Company has valued the warrant, which it considers to be equivalent to 1,250,000 shares of common stock, at $62,500. The debenture contains a clause calling for an early redemption penalty of 20%. 5. STOCKHOLDERS' DEFICIT COMMON STOCK During the nine month period ending September 30, 2006, the Company issued 4,925,000 unregistered shares of common stock to consultants for services to be performed. The Company recognized $177,000 in expense related to these contracts during the period, and has recorded an additional $60,000 in prepaids related to one of the contracts as of September 30, 2006. The Company also issued 850,000 unregistered shares of common stock to a consultant for $35,000 in services rendered in 2004 and 2005. During the nine month period ended September 30, 2006, the Company issued options to purchase 200,000 shares to employees, 250,000 shares to a consultant and 4,000,000 shares to its board members. The Company recognized $96,738 and $102,714 respectively, in non-cash compensation expense for the three and nine month periods ending September 30, 2006 for the vesting of these and previously issued options. Effective September 25, 2006, the Company approved the exchange of 3,256,666 shares of its outstanding common stock previously issued to Dutchess for warrants to purchase an equal number of shares of Company common stock for $0.001 per share. As a result of the exchange, the Company reduced the number of its shares outstanding by 3,256,666. However, because the exercise price of the warrants is minimal, and Dutchess has seven years to exercise the warrants, the Company has continued to value and account for the warrants as if they were incentive shares that were originally issued with the associated debentures. As such, the warrants issued in exchange for common stock continue to be expensed as interest expense at the same value and over the same period as the shares they were exchanged for. Any warrants issued with debentures to Dutchess subsequent to September 25, 2006 that have minimal exercise prices and long lives have also been valued at the fair value of the Company's common stock, are being accounted for by the Company as incentive shares, and expensed as interest expense over the lives of the associated debentures. All debentures associated with these warrants have been recorded at their full face values in the accompanying financial statements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION FORWARD-LOOKING STATEMENTS Discussions and information in this document, which are not historical facts, should be considered forward-looking statements. With regard to forward-looking statements, including those regarding the potential revenues from increased sales, and the business prospects or any other aspect of Nighthawk Systems, Inc.'s business, actual results and business performance may differ materially from that projected or estimated in such forward-looking statements. Nighthawk Systems, Inc. ("the Company") has attempted to identify in this document certain of the factors that it currently believes may cause actual future experience and results to differ from its current expectations. Differences may be caused by a variety of factors, including but not limited to, adverse economic conditions, entry of new and stronger competitors, inadequate capital and the inability to obtain funding from third parties. The following information should be read in conjunction with the unaudited condensed consolidated financial statements included herein which are prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. GENERAL The Company designs and manufactures intelligent remote monitoring and power control products that are easy to use, inexpensive and can remotely control virtually any device from any location. Our proprietary, wireless products are ready to use upon purchase, so they are easily installed by anyone, regardless of technical ability, and are also easily integrated into third-party products, systems and processes. They allow for intelligent control by interpreting instructions sent via paging and satellite media, and executing the instructions by 'switching' the electrical current that powers the device, system or process. Our intelligent products can be activated individually, in pre-defined groups, or en masse, and for specified time periods with a simple click of a mouse or by dialing a telephone number. Our products have been uniquely designed and programmed to be simple and ready to use upon purchase by anyone, almost anywhere, at affordable prices. As such, it is the Company's goal to have its products become commonplace, accepted and used by businesses and consumers alike in their daily routines. We save consumers and businesses time, effort and expense by eliminating the need for a person to be present when and where an action needs to be taken. By utilizing existing wireless technology, we give our users the flexibility to move their application from place to place, without re-engineering their network. Currently, most commercial control applications utilize telephone lines, which tether the system to a single location and have associated installation and monthly charges. Our products make companies more profitable by eliminating installation costs and monthly charges for telephone lines, and allow for remote control of unmanned or remote locations that may operate on traditional electrical power, or solar or battery generated power. Applications for our intelligent products include, but are not limited to: - - Rebooting remotely located computer equipment - - Remote switching of residential power - - Managing power on an electrical grid - - Activation/deactivation of alarm and warning devices - - Displaying or changing a digital or printed message or warning sign - - Turning pumps on or off - - Turning heating or cooling equipment on or off Companies both large and small are seeking ways to save money and lower the risk of liability by replacing processes that require human intervention with processes that can be controlled remotely without on-site human intervention. Today, the remote control of industrial or commercial assets and processes is performed mainly through the use of telephone-line based systems. Opportunities exist for companies that provide intelligent wireless solutions, as telephone lines are expensive and limited in availability and function. Nighthawk's products are wireless, and can be designed to work with a variety of wireless media. The number of applications for wireless remote control is virtually limitless. The Company has identified primary markets (Utility, IT Professional, Traffic Control), as well as secondary markets (Irrigation, Outdoor Advertising, Oil/Gas, Security) for its products. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. REVENUE RECOGNITION Revenue from product sales is recognized when all significant obligations of the Company have been satisfied. Revenues from equipment sales are recognized either on the completion of the manufacturing process, or upon shipment of the equipment to the customer, depending on the Company's contractual obligations. The Company occasionally contracts to manufacture items, bill for those items and then hold them for later shipment to customer-specified locations. As of September 30, 2006, the Company billed $16,415 for equipment that was being held pending shipping instructions from a customer. Revenue related to airtime billing is recognized when the service is performed. Some customers pre-pay airtime on a quarterly or annual basis and the pre-paid portion is recorded as deferred revenue. Deferred revenue, included in accrued expenses on the balance sheet at September 30, 2006, is approximately $15,869. STOCK-BASED COMPENSATION We believe that stock-based compensation is a critical accounting policy that affects our financial condition and results of operations. Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation defines a fair-value based method of accounting for stock-based employee compensation plans and transactions in which an entity issues its equity instruments to acquire goods or services from non-employees, and encourages but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for employee stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and related interpretations. In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123R "Share-Based Payment", which addresses the accounting for share-based payment transactions. SFAS 123R eliminates the ability to account for share-based compensation transactions using APB 25, and instead, generally requires that such transactions be accounted and recognized in the statement of operations based on their fair value. SFAS No. 123R will be effective for small business issuers as of the beginning of the first interim or annual reporting period that begins after December 15, 2005. SFAS No. 123R offers the Company alternative methods of adopting this standard. The Company has not yet determined which alternative method it will use. Depending upon the number and terms of options that may be granted in future periods, the implementation of this standard could have a material impact on the Company's financial position and results of operations. -12- COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005 The components of revenue and their associated percentages of total revenues, for the three months ended September 30, 2006 and 2005 are as follows:
Three months ended September 30, 2006 2005 $ Change % Change ------------------- ------------------- ---------- -------- Revenues: Rebooting products $ 57,847 25% $ 30,563 25% $ 27,284 47% Logic boards 94,555 41% 14,774 12% $ 79,781 84% Utility products 55,804 24% 51,895 43% $ 3,909 7% Emergency notification products 5,960 2% 10,975 9% $ (5,015) -46% Airtime sales 10,628 5% 9,729 8% $ 899 8% Other product 5,025 2% 1,840 2% $ 3,185 63% Freight 1,891 1% 1,197 1% $ 694 37% ----------- ---------- ----------- Total revenues $ 231,710 100% $ 120,973 100% $ 110,737 92% =========== ========== ===========
Revenues for the three-month period ended September 30, 2006 were $231,710 as compared to $120,973 for the corresponding period of the prior year, an increase of 92% between periods. With the exception of emergency notification products, sales of Company's core products increased between the periods presented. Although the Company's revenues failed to increase for the fifth consecutive quarter, the Company actually closed on significantly more contracts during the three months ending September 30, 2006 than it had closed on in any of the previous eight quarters. Lead times on required parts that stretched beyond September 30, 2006 prevented the Company from completing, shipping and billing for all orders taken during the three month period ending September 30, 2006. A sustained sales and marketing effort, which began in 2005 and was enhanced in 2006 with the hiring of new sales and marketing personnel, has allowed the company to stay in regular contact with and grow its customer base. A large portion of the Company's revenues were generated during the current year quarter by existing customers who ordered for the second or third time. A single customer contributed approximately half of the logic board revenues during the three month period ended September 30, 2006. This electric utility customer purchased the Company's PT1000 logic board with specialized firmware, placed in a customer enclosure, in order to control capacitor banks. An almost equally large portion of revenues was generated by customers who were placing their initial orders. Sales of the Company's emergency notification products declined slightly between the periods presented. The Company is not yet providing significant sales and marketing dollars towards these products as the market for such products is still developing. The products, sold mainly to firehouses for in-station alerting, were first sold by the Company in the latter stages of 2005. Airtime revenues increased slightly between the periods presented due to the addition of new customers between the periods presented. Cost of goods sold includes parts and pre-manufactured components used to assemble our products as well as allocated overhead for production personnel and facilities costs. Cost of goods sold increased by $45,111 or 49% to $136,690 for the three months ended September 30, 2006 from $91,579 for the corresponding period of the prior year but decreased as a percentage of revenues between the periods from 76% in 2005 to 59% in 2006. As a result, the Company's gross margin increased between the periods from 24% to 41%. This improvement in gross margins is attributable to the increase in products produced during the 2006 period as compared to the 2005 period, which led to volume discounts for parts and in-house production efficiencies. The increase in revenues assisted in covering fixed overhead charges at the Company's assembly facility in Denver, Colorado. Selling, general and administrative expenses for the three months ended September 30, 2006 increased by $78,879 or 17% to $555,375 from $476,496 for the three-month period ended September 30, 2005. During the current year period presented, the Company incurred $80,000 in non-cash expenses associated with the granting of options, which immediately vested, to purchase 4.0 million shares of common stock to the Company's two board members. Shares underlying these options have not been registered by the Company with the Securities and Exchange Commission. Excluding these expenses, selling, general and administrative expenses remained relatively flat between the periods presented. Interest expense increased $14,545 or 11% between the three-month periods presented. During 2005, the Company borrowed funds on a monthly basis from Dutchess under short-term notes. While the Company has continued to borrow funds from Dutchess on a monthly basis, and the amount of debt outstanding at September 30, 2006 has increased in comparison to the amount outstanding one year earlier, all amounts outstanding throughout the third quarter of 2006 are under debentures that mature four to five years from their date of issuance. Any associated expenses for loan discounts and incentive shares on these notes are amortized over the life of the note, resulting in smaller amounts of interest expense recorded by the Company on a monthly basis. -13- The net loss to common shareholders for the three-month period ended September 30,2006 was $605,751 compared to $578,177 for the three-month period ended September 30, 2005, an increase of 5%. Although the Company produced approximately $66,000 more gross margin dollars in the current year period than in the prior year period, that increase was slightly more than offset by the $80,000 non-cash expense associated with the option award to the Company's directors discussed above, as well as the slight increase in interest expense recognized between the periods presented. The net loss per common share for each of the quarters presented was ($0.01). COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005 The components of revenue and their associated percentages of total revenues, for the nine months ended September 30, 2006 and 2005 are as follows:
Nine months ended September 30, 2006 2005 $ Change % Change ------------------- ------------------- ---------- -------- Revenues: Rebooting products $ 139,563 22% $ 73,168 19% $ 66,395 48% Logic boards 130,930 21% 54,441 14% $ 76,489 58% Utility products 267,329 43% 131,040 33% $ 136,289 51% Emergency notification products 44,126 7% 10,975 3% $ 33,151 75% Hydro 1 - 76,975 20% (76,975) n/a Airtime sales 27,755 4% 37,519 9% $ ( 9,764) -26% Other product 10,069 2% 3,137 1% $ 6,932 69% Freight 5,464 1% 3,312 1% $ 2,152 39% ---------- ----------- ---------- Total revenues $ 625,236 100% $ 390,567 100% $ 234,669 60% ========== =========== ==========
Revenues for the nine-month period ended September 30, 2006 were $625,236 as compared to $390,567 for the corresponding period of the prior year, an increase of 60% between periods. Sales of all of the Company's core products increased at least 48% between the periods presented. During the nine months ended September 30, 2005, one customer, who purchased the Company's Hydro 1 product, represented approximately 20% of the Company's total revenue. This sale was made as part of a stated-funded project in New Mexico, and the Company has not marketed or sold Hydro 1's since that time. The Company does not consider the Hydro 1 to be a core product that it markets and sells on an ongoing basis. A sustained sales and marketing effort, which began in 2005 and was enhanced in 2006 with the hiring of new sales and marketing personnel, has allowed the company to stay in regular contact with and grow its customer base. Sales to both new and existing customers contributed significantly to revenues during the first nine months of fiscal 2006. As a result, the company's dependence on a few large customers has decreased, with only one customer accounting for just slightly more than 10% of revenues generated during the nine month period ending September 30, 2006. Airtime revenues decreased 26%, or $9,764 between the two periods presented. Recurring monthly airtime revenues from the Company's largest customer declined significantly in July 2005 when that customer lost its own remote monitoring contract with a customer, and airtime access to more than 2,400 rebooting units was canceled. However, the Company has continued to add new customers during this time period, and as a result airtime revenues generated during the three month period ending September 30, 2006 exceeded airtime revenues generated during the same fiscal quarter of 2005. Cost of goods sold includes parts and pre-manufactured components used to assemble our products as well as allocated overhead for production personnel and facilities costs. Cost of goods sold increased by $119,780 or 43% to $400,983 for the nine months ended September 30, 2006 from $281,203 for the corresponding period of the prior year, but decreased as a percentage of revenues between the periods from 72% in 2005 to 64% in 2006. As a result, the Company's gross margin increased between the periods from 28% to 36%. This improvement in gross margins is attributable to the increase in products produced during the 2006 period as compared to the 2005 period, which led to volume discounts for parts and in-house production efficiencies. The increase in revenues assisted in covering fixed overhead charges at the Company's assembly facility in Denver, Colorado. In addition, the gross margin for the nine month period ended September 30, 2005 was high relative to the number of products produced during the period because of the one-time sale of the higher margin Hydro 1 units produced during that period. Selling, general and administrative expenses for the nine months ended September 30, 2006 increased by $240,554 or 15% to $1,866,749 from $1,626,195 for the nine-month period ended September 30, 2005. This increase was due primarily to the recognition of approximately $177,000 in noncash expenses from unregistered stock issuances to public relations firms, as well as the recognition of $80,000 in non-cash expense associated with the vesting of options to purchase 4.0 million shares of stock which were granted to the Company's two board members. The Company also incurred approximately $90,000 in fees for research and development efforts on new devices capable of bi-directional communication. These expenses were offset to some degree by decreases in legal fees incurred by the Company between the periods presented. Interest expense increased $291,799 or 47% between the nine-month periods presented. The increase was due to interest expense related to the Dutchess notes and debentures, several which were paid off during the first quarter of 2006 prior to their maturity date. When this occurs, the Company expenses any unamortized discount associated with the debt being paid off, as well as any unamortized beneficial conversion expense, any unamortized expense associated with incentive shares issued with the debt, any early redemption penalties. During the first quarter of 2006, the Company recognized interest expense of approximately $153,000 related to the beneficial conversion feature of debentures, as well as approximately $192,000 in interest expense related for the value of incentive shares issued to Dutchess in exchange for money loaned to the Company. The Company also recognized approximately $77,000 in interest expense during the period in early redemption penalties on debentures that were paid off during the period. During the second and third quarters of 2006, monthly interest expense incurred actually declined, as most short term notes from Dutchess had either been paid off or had been rolled into long term debentures. These longer term arrangements allow the Company to expense loan discounts and incentive shares over longer periods of time, resulting in lower monthly interest accruals than shorter term notes. The net loss to common shareholders for the nine-month period ended September 30,2006 was $2,554,993 compared to $2,138,193 for the nine-month period ended September 30, 2005, an increase of 19%. Increased revenues and gross profit dollars were more than offset by increases in expenses associated with public relations firms, the non-cash expense associated with the options awarded to the Company's two board members, and the amount of interest expense recorded during the first quarter of 2006 associated with the early payoff of notes held by Dutchess. The net loss per common share for the nine month period ended September 30, 2006 was ($0.04) as compared to (0.06) for the previous year's period presented. The improvement was the result of the increase in the weighted average number of shares outstanding from period to period, primarily due to the issuance of shares to Dutchess during the first quarter of 2006 which were utilized to reduce the amounts outstanding under notes and debentures held by Dutchess. LIQUIDITY AND CAPITAL RESOURCES The Company's financial statements for the nine months ended September 30, 2006 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company incurred a net loss of approximately $2.6 million during the nine-month period ended September 30, 2006 and had a stockholders' deficit of approximately $2.6 million as of September 30, 2006. The Report of Independent Registered Public Accounting Firm on the Company's financial statements as of and for the year ended December 31, 2005 includes a "going concern" explanatory paragraph which means that the auditors expressed substantial doubt about the Company's ability to continue as a going concern. Although no assurance can be given that such plans will be successfully implemented, management's plans to address these concerns include: - - Raising working capital through additional borrowings. - - Raising equity funding through sales of the Company's common stock. - - Implementation of the Company's sales and marketing plans to generate additional cash flows from operations. In August 2004, the Company signed a financing arrangement with Dutchess Private Equities, II, L.P. ("Dutchess") under which the Company received $250,000 in exchange for a convertible debenture during August 2004. The Company also signed an investment agreement under which Dutchess agreed to purchase up to $10.0 million in common stock from the Company, at the Company's discretion, over the next three years, subject to certain limitations including the Company's then current trading volume. Although the amount and timing of specific cash infusions available under the entire financing arrangement cannot be predicted with certainty, the arrangement represents a contractual commitment by Dutchess to provide funds to the Company. Since entering into the arrangement with Dutchess, the Company has utilized the arrangement to obtain enough cash to cover its operating cash flow deficits on a monthly basis. During the nine-month period ended September 30, 2006, net cash used in operating activities was approximately $1.6 million. This net cash flow deficit was covered by proceeds of $1,615,000 from the issuance of a note and debentures to Dutchess during the period. Major cash outlays during the period were approximately $506,000 for payroll/employee benefits, $344,000 for public relations efforts, $304,000 for inventory, $148,000 for consulting expense, $122,000 for sales and marketing efforts, and $90,000 for product development. The amount of net cash used in operating activities of the Company has decreased each successive quarter throughout 2006 as the Company's sales levels have increased at a faster rate than it has incurred expenses related to sales production. Net cash used from operations during the first, second and third fiscal quarters of 2006 was $605,116, $586,453 and $372,384, respectively. In an effort to further reduce expenses, subsequent to September 30, 2006, Dutchess and the Company agreed to terminate their consulting arrangement and to discontinue the advanced funding of the Company through the issuance of notes. By doing so, the Company will no longer incur $10,000 in monthly consulting fees or fees and interest previously incurred with the issuance of new notes and debentures. Beginning in January 2007, the Company is expecting to access funds from Dutchess through the periodic issuances of puts under its existing investment agreement with Dutchess. The Company issued 19,370,736 shares to Dutchess during the nine-month period ended September 30, 2006 which was used to pay down $1,513,348 in debt during the period. Each note or debenture issued by the Company to Dutchess is secured by put notices, which allow Dutchess to exercise puts in order to pay down on the notes and debentures if they want to. Until the Company is able to generate positive cash flows from operations in an amount sufficient to cover its current liabilities and debt obligations as they become due, it will remain reliant on borrowing funds from or selling equity to Dutchess or other parties to meet those obligations. Although the amount and timing of specific cash infusions available under the entire financing arrangement cannot be predicted with certainty, the arrangement represents a contractual commitment by Dutchess to provide funds to the Company. -14- ITEM 3. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures: The Company's management, including the Company's principal executive officer and principal accounting and financial officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the three-month period ended September 30, 2006, the period covered by the Quarterly Report on Form 10-QSB. Based upon that evaluation, the Company's principal executive officer and principal financial and accounting officer have concluded that the disclosure controls and procedures were effective as of September 30, 2006 to provide reasonable assurance that material information relating to the Company is made known to management including the CEO. There were no changes in the Company's internal control over financial reporting that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. However, on September 23, 2005, the Company's Principal Accounting and Financial Officer, Daniel P. McRedmond, resigned as the Company's Corporate Controller. As a result, the Company's Chief Executive Officer, H. Douglas Saathoff, will serve as the Company's Principal Operating and Principal Accounting and Financial Officer until Mr. McRedmond's successor is hired. -15- PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES The Company is in default on two loans from Mr. Revesz, a former board member, as of the date of this report and is in discussions to extend the maturity dates on those notes. In April 2004, the Company reached an agreement with Tomas Revesz under which, in return for an additional $25,000 in borrowings and the extension of the maturity dates of three notes to July 31, 2004, the Company granted the creditor a secured position in the assets of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS (a) Exhibits 31.1 Certification of H. Douglas Saathoff, Chief Executive Officer and Principal Accounting and Financial Officer, pursuant to Rule 13A-14 or 15D-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certification pursuant to the 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. None -16- SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NIGHTHAWK SYSTEMS, INC. (Registrant) Date: November 14, 2006 By: /s/ H. Douglas Saathoff --------------------------- H. Douglas Saathoff, Chief Executive Officer, Principal Accounting and Financial Officer -17- EX-31.1 2 ex311.txt EXHIBIT 31.1 Exhibit 31.1 I, H. Douglas Saathoff, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of Nighthawk Systems, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared; and b) evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal controls over financial reporting. Date: November 14, 2006 By: /s/ H. Douglas Saathoff ---------------------------- H. Douglas Saathoff Chief Executive Officer and Principal Accounting and Financial Officer EX-32.1 3 ex321.txt EXHIBIT 32.1 Exhibit 32 Section 1350 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ("Section 906"), H. Douglas Saathoff, the Chief Executive Officer and the Principal Accounting and Financial Officer of Nighthawk Systems, Inc., certifies that (i) the Quarterly Report on Form 10-QSB for the period ended September 30, 2006 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the information contained in such report fairly presents, in all material respects, the financial condition and results of operations of Nighthawk Systems, Inc. A signed original of this written statement required by Section 906 has been provided to Nighthawk Systems, Inc. and will be retained by Nighthawk Systems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. Date: November 14, 2006 By:/s/ H. Douglas Saathoff ---------------------------------- H. Douglas Saathoff, Chief Executive Officer and Principal Accounting and Financial Office -----END PRIVACY-ENHANCED MESSAGE-----