Table of Contents
 
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________
 
FORM 10-QSB
______________
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
 
000-28745
(Commission File No.)
______________
 
NATIONAL SCIENTIFIC CORPORATION
(Name of Small Business Issuer in its Charter)
______________
                                                                                                     

  Texas

 

  86-0837077

  (State or Other Jurisdiction of

 

 (I.R.S. Employer

 Incorporation or Organization)

 

 Identification No.)

     

 

 

 

  14455 N. Hayden, Suite 202

 

 

  Scottsdale, AZ

 

  85260-6947

 (Address of Principal Executive Offices)

 

 (Zip Code)

   
  (480) 948-8324
(Issuers Telephone Number, Including Area Code)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes  x   No o
 
There were 84,335,669 shares of Common Stock, par value $.01 per share, outstanding at August 12, 2004.
 
Transitional Small Business Disclosure Format (Check One):  Yes  o    No x
 
 
     
 
 
 
NATIONAL SCIENTIFIC CORPORATION
 
FORM 10-QSB
 
TABLE OF CONTENTS
 
 
Page
Part I - Financial Information
 
 
 
3
3
4
5
6
7
13
18
 
 
Part II – Other Information
 
 
 
19
Item 2 – Changes in Securities and Use of Proceeds

19

Item 3 – Defaults Upon Senior Securities

19

Item 4 – Submission of Matters to a Vote of Security Holders

19

Item 5 – Other Information

19

Item 6 – Exhibits and Reports on Form 8-K

20

Signatures

21

   
 Exhibit 14 – Code of Ethics  
 Exhibit 31.1 – Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
 Exhibit 32.1 – Certification Pursuant to Section 906 of the Sarbanes-Oxley Act  
 
2  
 
Table of Contents
PART I - FINANCIAL INFORMATION
 
 
(A Development Stage Company)
 
Unaudited Condensed Balance Sheets
June 30, 2004 and September 30, 2003
 
   
 
   
 
 
 
   

June 30, 

 

 

September 30,

 

 

 

 

2004

 

 

2003
 
   
 
 
ASSETS
   
 
   
 
 
Current Assets:
   
 
   
 
 
Cash and cash equivalents
 
$
424,113
 
$
17,903
 
Trade receivables, net of reserve of $28,169 at June 30, 2004 and $8,169 at September 30, 2003
   
15,000
   
28,200
 
Inventory
   
65,224
   
9,700
 
Other assets
   
2,897
   
16,926
 
   
 
 
Total current assets
   
507,234
   
72,729
 
 
   
 
   
 
 
Property and equipment, net
   
24,366
   
32,081
 
Deposits
   
5,031
   
5,031
 
   
 
 
 
 
$
536,631
 
$
109,841
 
   
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
   
 
   
 
 
Current Liabilities:
   
 
   
 
 
Accounts payable
 
$
154,165
 
$
185,725
 
Accrued expenses
   
336,555
   
457,695
 
Deposits
   
– 
   
20,000
 
Notes payable
   
2,500
   
10,000
 
   
 
 
Total current liabilities
   
493,220
   
673,420
 
               
Notes payable, net of current portion
   
43,250
   
43,250
 
   
 
 
Total Liabilities
   
536,470
   
716,670
 
   
 
 
Commitments and contingencies
   
– 
   
– 
 
   
 
 
Shareholders’ equity (deficit):
   
 
   
 
 
Preferred stock, par value $.10; 4,000,000 shares authorized, and no shares issued or outstanding
   
–
   
– 
 
Common stock, par value $.01; 120,000,000 shares authorized, and shares issued 84,335,669 and 70,633,819 outstanding at June 30, 2004 and September 30, 2003 respectively
   
843,357
   
706,338
 
Additional paid-in capital
   
21,632,654
   
20,444,733
 
Accumulated deficit
   
(22,475,850
)
 
(21,757,900
)
   
 
 
Total shareholders’ equity (defecit)
   
161
   
(606,829
)
   
 
 
 
 
$
536,631
 
$
109,841
 
   
 
 
 
The accompanying notes are an integral part of these financial statements
 
3  
 
Table of Contents
 
(A Development Stage Company)
 
Unaudited Condensed Statements of Operations
For the Three and Nine Months Ended June 30, 2004, 2003 and Development Stage
 
   
 
   
 
   
 
   
 
   
 
 

 

 

 

Three Months 

 

 

Three Months

 

 

Nine Months

 

 

Nine Months

 

 

 

 

 

 

 

Ended 

 

 

Ended

 

 

Ended

 

 

Ended

 

 

Development

 

 

 

 

June 30, 2004 

 

 

June 30, 2003

 

 

June 30, 2004

 

 

June 30, 2003

 

 

Stage

 

   
 
 
 
 
 
Revenues
 
$
4,031
 
$
16,047
 
$
78,569
 
$
34,595
   $
1,027,777
 
Cost of Sales
 
 
2,719
   
9,118
   
58,717
   
13,908
   
956,204
 
   
 
 
 
 
 
Gross profit
   
1,312
   
6,929
   
19,852
   
20,687
   
71,573
 
 
   
 
   
 
   
 
   
 
   
 
 
Costs and expenses
   
 
   
 
   
 
   
 
   
 
 
Salaries and benefits
   
183,290
   
118,661
   
440,685
   
298,037
   
2,617,481
 
Research and development
   
8,652
   
34,918
   
18,050
   
56,695
   
3,731,185
 
Stock compensation
   
22,178
   
82,082
   
50,471
   
192,062
   
3,131,165
 
Consulting fees, related party
   
– 
   
2,650
   
– 
   
17,650
   
8,175,973
 
Other
   
78,774
   
42,735
   
209,944
   
86,907
   
2,617,247
 
   
 
 
 
 
 
Total costs and expenses
   
292,894
   
281,046
   
719,150
   
651,351
   
20,273,051
 
   
 
 
 
 
 
Loss from operations
   
(291,582
)
 
(274,117
)
 
(699,298
)
 
(630,664
)
 
(20,201,478
)
   
 
 
 
 
 
Other income (expense)
   
 
   
 
   
 
   
 
   
 
 
Interest and other income
   
– 
   
– 
   
– 
   
– 
   
178,972
 
Interest expense
   
(8,178
)
 
1,073
   
(18,652
)
 
(1,050
)
 
(58,664
)
 
 
 
 
 
 
 
 
   
(8,178
)
 
1,073
   
(18,652
)
 
(1,050
)
 
120,308
 
   
 
 
 
 
 
Loss before income taxes
   
(299,760
)
 
(273,044
)
 
(717,950
)
 
(631,714
)
 
(20,081,170
)
Income tax expense
   
– 
   
– 
   
– 
   
– 
   
– 
 
   
 
 
 
 
 
Net loss
 
$
(299,760
)
$
(273,044
)
$
(717,950
)
$
(631,714
)
$
(20,081,170
)
   
 
 
 
 
 
Net loss per common share, basic and diluted
 
$
(0.00
)
$
(0.00
)
$
(0.01
)
$
(0.01
)
 
 
 
   
 
 
 
       
Weighted average number of shares outstanding
   
83,921,036
   
66,936,328
   
76,149,638
   
60,406,542
   
 
 
   
 
 
 
       
                                 
The accompanying notes are an integral part of these financial statements
 
4  

Table of Contents

 

(A Development Stage Company)
 
Unaudited Condensed Statements of Cash Flows
For the Nine Months Ended June 30, 2004, 2003 and Development Stage
 
   
 
   
 
   
 
 
 

 

 

 

 

 

 

 

 

Development

 

 

 

 

2004

 

 

2003

 

 

Stage  

 
   
 
 
 
Cash flows from operating activities:
   
 
   
 
   
 
 
Net loss
 
$
(717,950
)
$
(631,714
)
$
(20,081,170
)
Adjustments to reconcile net loss to net cash used in operating activities:
   
 
   
 
   
 
 
Non cash transactions
   
 
   
 
   
 
 
Depreciation
   
9,789
   
9,694
   
74,985
 
Loss on disposal of assets
   
– 
   
– 
   
30,960
 
Impairment loss on equipment
   
– 
   
– 
   
64,187
 
Stock and options issued for services, net
   
50,471
   
273,775
   
11,633,183
 
Decrease (increase) in inventory
   
(55,524
)
 
4,643
   
(65,224
)
Deferred offering costs
   
– 
   
– 
   
(85,171
)
Decrease (increase) in receivables
   
13,200
   
– 
   
116,631
 
Decrease (increase) in other assets
   
14,029
   
(73,762
)
 
1,012
 
Increase in accounts payable and accrued expenses
   
67,050
   
(54,601
)
 
740,176
 
   
 
 
 
Net cash (used in) operating activities
   
(618,935
)
 
(471,965
)
 
(7,570,431
)
   
 
 
 
Cash flows from investing activities:
   
 
   
 
   
 
 
Acquisition of property and equipment
   
(2,074
)
 
– 
   
(155,766
)
Repayment of loans
   
– 
   
– 
   
200,000
 
Proceeds from the sale of furniture and equipment
   
– 
   
– 
   
6,050
 
Loans issued
   
– 
   
– 
   
(400,000
)
   
 
 
 
Net cash (used in) investing activities
   
(2,074
)
 
– 
   
(349,716
)
   
 
 
 
Cash flows from financing activities:
   
 
   
 
   
 
 
Increase in notes payable
   
– 
   
20,710
   
– 
 
Draws on the line of credit
   
– 
   
– 
   
430,000
 
Loan from (to) officer
   
– 
   
– 
   
65,079
 
Repayment of notes payable
   
(7,500
)
 
(40,039
)
 
(117,500
)
Repayment of line of credit
   
– 
   
– 
   
(430,000
)
Repayment of capital lease obligations
   
– 
   
– 
   
(1,819
)
Proceeds from the exercise of options
   
9,675
   
29,058
   
208,265
 
Proceeds from the exercise of warrants
   
– 
   
– 
   
92,460
 
Proceeds from equity line of credit
   
– 
   
– 
   
414,824
 
Proceeds from the issuance of preferred stock
   
– 
   
– 
   
482,500
 
Deposits for private placement
   
(20,000
)
 
10,000
   
– 
 
Proceeds from issuance of common stock
   
1,045,044
   
470,000
   
7,196,833
 
   
 
 
 
Net cash provided by financing activities
   
1,027,219
   
489,729
   
8,340,642
 
   
 
 
 
Net (decrease) increase in cash and cash equivalents
   
406,210
   
17,764
   
420,495
 
Cash and cash equivalents, beginning of period
   
17,903
   
1,405
   
3,618
 
   
 
 
 
Cash and cash equivalents, end of period
 
$
424,113
 
$
19,169
 
$
424,113
 
   
 
 
 
Supplementary Disclosure of Cash Flow Information:
   
 
   
 
   
 
 
Cash paid for interest
 
$
10,493
 
$
1,050
   
35,967
 
   
 
 
 
Cash paid for income taxes
 
$
– 
 
$
– 
 
$
50
 
   
 
 
 
                     
                     
The accompanying notes are an integral part of these financial statements 
 
5  
 
Table of Contents
 
(A Development Stage Company)
 
Unaudited Condensed Statement of Changes in Shareholders' Equity (Deficit)
For the Nine Months Ended June 30, 2004
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
 

 

 

Common Stock

 

 

Preferred Stock

 

 

 

 

 

 

 

 

 

   
 
                   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Additional

 

 

 

 

 

 

 

 

 

 

Number of 

 

 

Par

 

 

Number of

 

 

Par

 

 

Paid-In

 

 

Accumulated

 

 

 

 

 

 

 

Shares 

 

 

Value

 

 

Shares

 

 

Value

 

 

Capital

 

 

Deficit

 

 

Total

 

 

 
 
 
 
 
 
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance, September 30, 2003
   
70,633,819
 
$
706,338
   
– 
 
$
– 
 
$
20,444,733
 
$
(21,757,900
)
$
(606,829
)
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Exercise of options
   
107,500
   
1,075
   
– 
   
– 
   
16,985
   
– 
   
18,060
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Stock issued for services
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Price per share ranged
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
$0.14
   
47,646
   
476
   
– 
   
– 
   
5,527
   
– 
   
6,003
 
$0.155
   
33,000
   
330
   
– 
   
– 
   
4,274
   
– 
   
4,604
 
$0.150
   
55,186
   
552
   
– 
   
– 
   
7,726
   
– 
   
8,278
 
$0.160
   
24,252
   
243
   
– 
   
– 
   
3,249
   
– 
   
3,492
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Common stock options granted
   
–
   
–
   
–
   
–
   
19,709
   
–
   
19,709
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Debt equity swap
   
1,500,000
   
15,000
   
–
   
–
   
135,000
   
–
   
150,000
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Private placement of common stock
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Shares issued for:
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
$0.10
   
1,100,000
   
11,000
   
–
   
–
   
99,000
   
–
   
110,000
 
$0.11
   
10,334,266
   
103,343
   
–
   
–
   
831,701
   
–
   
935,044
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Stock retainage program
   
500,000
   
5,000
   
–
   
–
   
64,750
   
–
   
69,750
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Net loss
   
–
   
–
   
–
   
–
   
–
   
(717,950
)
 
(717,950
)
 
 
 
 
 
 
 
 
 
Balance, June 30, 2004
   
84,335,669
 
$
843,357
   
–
 
$
–
 
$
21,632,654
 
$
(22,475,850
)
$
161
 
 
 
 
 
 
 
 
 
 
   
   
The accompanying notes are an integral part of these financial statements
 
 
6  
 
Table of Contents
NATIONAL SCIENTIFIC CORPORATION
(A Development Stage Company)
 
NOTES TO FINANCIAL STATEMENTS

1.      Basis of Presentation
 
The accompanying financial statements have been prepared by National Scientific Corporation (“NSC” or the “Company” or “We”), without audit, and reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods. The statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) that are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the nine months ended June 30, 2004 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, 2003, and the Company’s quarterly report on Form 10-QSB for the fiscal periods ended December 31, 2003 and March 31, 2004.
 
2.     Issuance of Common Stock
 
During the three months ended June 30, 2004, 55,186 shares of common stock were issued for services at an average market price per share price of $0.15 and 24,252 shares of common stock were issued for board services at an average market price per share of $0.16.
 
On March 15, 2004, the Company commenced a private placement of units consisting of its common stock and warrants to purchase its common stock. On June 14, 2004, the Company completed this private placement. Each investor received the Company’s common stock and a five-year warrant to purchase three quarters of a share of common stock for each share purchased. The Company issued 10,334,266 shares of its common stock and warrants to purchase an aggregate of 7,750,700 shares of common stock. After deducting commissions and other expenses relating to the private placement, the Company received aggregate net proceeds of approximately $972,864. Additional disbursements by the Company related to the private placement further reduced the net proceeds to $935,044. The Company also issued seven-year warrants to purchase an aggregate of 2,308,497 shares of its common stock at a price of $0.10 per share to the placement agent.

 
  7   
 
Table of Contents
 
3.     Stock Options and Warrants
 
The Company from time to time issues stock options for the purchase of common stock to directors, officers, employees and consultants. The Company adopted a qualified stock option plan for its executives, consultants, and employees in December 2000.
 
During the three months ended June 30, 2004, 20,000 non-qualified stock options were granted under the 2000 Stock Option Plan at an average exercise price of $0.16, and 150,000 non-qualified stock options were granted under the same plan at an average exercise price of $0.125. Also during the same period 107,500 non-qualified stock options were exercised at $0.09 per share.
 
The Company adopted Financial Accounting Standards Board APB Opinion No. 25, Accounting for Stock Issued to Employees, 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 grant. As no options were granted to employees, there was no compensation recognized for the fiscal quarter ended June 30, 2004. Under the terms of the Company's stock options granted to certain directors, officers, employees and consultants, the Board of Directors, at its sole discretion, will determine when certain options granted shall be fully vested and exercisable. On June 30, 2004, 3,307,257 outstanding stock options were vested, and fully exercisable, and 5,000 were not vested.
 
In accordance with The Statement of Financial Accounting Standards (SFAS) 148, Accounting for Stock-Based Compensation , the fair value of option grants is estimated on the date of grant using the Black-Scholes option-pricing model for proforma footnote purposes with the following assumptions used for grants in all years; dividend yield of 0%, risk-free interest rate of 5%, and expected option life of ten years. Expected volatility was assumed to be 50% as of the date of issue.
 
 
   

  Number of

 Weighted Average

       

 

 Shares

 Exercise Price

   
 
 
               
 Options Outstanding, September 30, 2003      3,329,757   $     0.90  
 Add:  Granted
     340,000      0.14  
 Deduct:  Exercised
    (107,500 )   (0.09 )
 Deduct:  Forfeited
    (250,000 )   (0.15 )
   
   
 Options Outstanding, June 30, 2004      3,312,257   $ 0.91  
   
   
 

 

8  
 
Table of Contents
 
         Had the Company fully adopted SFAS 148, the Company’s net income and earnings per share would approximate the following pro forma amounts:

 

 

 

Three Months 

 

 

Three Months

 

 

Nine Months

 

 

Nine Months

 

 

 

 

Ended 

 

 

Ended

 

 

Ended

 

 

Ended

 

 

 

 

June 30, 2004 

 

 

June 30, 2003

 

 

June 30, 2004

 

 

June 30, 2003

 

   
 
 
 
 
                           
Net (loss) income:
   
 
   
 
   
 
   
 
 
As reported
 
$
(299,760
)
$
(273,044
)
$
(717,950
)
$
(631,714
)
Pro forma
   
(299,760
)
 
(273,044
)
 
(717,950
)
 
(643,050
)
 
   
 
   
 
   
 
   
 
 
Basic (loss) earnings per share
   
 
   
 
   
 
   
 
 
As reported
 
$
– 
 
$
– 
 
$
(0.01
)
$
(0.01
)
Pro forma
   
– 
   
– 
   
(0.01
)
 
(0.01
)
 
During the three months ended June 30, 2004, the Company issued warrants in conjunction with its March 15, 2004 private placement offering (see Issuance of Common Stock above). The table below summarizes all outstanding warrants obligations of the Company as of June 30, 2004:
 
 

 

9  
 
 
          The warrants outstanding as of June 30, 2004 were as follows:
 
 
   

Number 

 

 

 

 

 

 

 

 

 

 

of 

 

 

Exercise

 

 

 

 

 

 

 

Shares 

 

 

Price

 

 

Expires
 
   
 
 
 
                     
Outstanding at September 30, 2001
   
1,500,000
 
 
$0.12
   
1/02
 
Exercised
   
(770,500
)
 
 
   
 
 
Expired
   
(729,500
)
 
 
   
 
 
New Issues
   
412,201
 
 
$1.67

 

 

5/04
 
   
     
Outstanding at September 30, 2002
   
412,201
   
 
   
 
 
New Issues
   
4,800,000
 
 
$0.30

 

 

12/04

 

 
   
200,000
 
 
$0.50

 

 

12/04
 
 
   
1,000,000
 
 
$0.35

 

 

6/06
 
 
   
1,000,000
 
 
$0.50

 

 

6/06

 

   
     
Outstanding at September 30, 2003
   
7,412,201
   
 
   
 
 
Expired
   
(412,201
)
 
 
   
 
 
New Issues
   
275,000
 
 
$0.50

 

 

6/06
 
 
   
275,000
 
 
$0.75

 

 

6/06
 
 
   
640,000
 
 
$0.13

 

 

1/07
 
 
   
500,000
 
 
 
$0.10

 

 

3/11
 
 
   
4,414,739
 
 
$0.11

 

 

4/09

 

 
   
3,335,961
 
 
$0.11

 

 

4/09

 

 
   
1,808,497
 
 
$0.10

 

 

4/11
 
   
     
Outstanding at June 30, 2004
   
18,249,197
   
 
   
 
 
   
     

 
10  
 
Table of Contents
 
4.      Net Loss Per Share
 
Net loss per common share is based upon the weighted average shares outstanding. Outstanding stock options and warrants are treated as common stock equivalents, but are anti-dilutive, for purposes of computing diluted net loss per common share. The following is a summary of the computation of net loss per common share (amounts in dollars except shares):

 
 
Nine months ended June 30
   
 
 

 

 

2004

 

 

2003

 

   
 
 
Basic net income (loss) per common share:
   
 
   
 
 
Net income (loss)
 
$
(717,950
)
$
(631,714
)
   
 
 
Basic per share amount
 
$
(0.01
)
$
(0.01
)
   
 
 

5.      Borrowings
 
          On June 11, 2003, the Company issued a three-year interest free convertible note of $43,250, with no payments required of the Company until the end of the three-year period, to its then-Director Mr. Lou Ross for past services rendered (See 10-KSB report for the year ended September 30, 2003). The Company can pay this note at any time before the three-year period elapses with either cash or its common restricted stock or a combination of cash and stock, at its sole discretion. Currently this note represents the only long-term debt of the Company. Mr. Ross retired from the Company’s board on September 30, 2003.\
 
In January of 2004, the Company entered into a financing program with a U.S. investment fund entity that wants to remain confidential, as described in our previous recent quarterly filings. The terms of this program included a six-month Note payable at maturity in July 2004 for $160,000, at an effective annual interest rate of 13%. The transaction also included 640,000 warrants good for three years to purchase the Company’s restricted stock, at $0.13 during the first and second year of the warrant’s lifetime, and $0.15 during the third and final year of the warrant’s lifetime. These warrants include anti-dilution provisions, as well as registration rights in the event that the Company was to file an appropriate registration statement with the SEC during the next three years. This $160,000 Note was repaid in full on May 10, 2004.
 
During March 2004, an Officer of the Company raised approximately $36,000 using his personal credit from a group of shareholders in consideration of short-term personal promissory notes to assist the Company with very short-term cash requirements. The notes carried effective annual interest rates of less than 10%, plus minor processing fees. These notes were subsequently repaid in full on April 13, 2004.

 
11  
 
 
On March 15, 2004, the Company commenced a private offering of restricted common stock units through a placement agent. The offer consisted of one share of common stock and a warrant to purchase three quarters of a share of common stock. On June 14, 2004, we completed this private placement with aggregate gross proceeds of approximately $1.1 million and issued 10,334,266 shares of restricted common stock and warrants to purchase 7,750,700 shares of our common stock at an exercise price of $0.11 per share. The warrants have a term of five years, and include certain registration rights. After deducting commissions and other expenses relating to the private placement, we received aggregate net proceeds of approximately $972,864. Additional disbursements by the Company related to the private placement further reduced the net proceeds to $935,044. The Company intends to use part of the proceeds of the private placement to finance the continued development and marketing of Wi-Fi and RFID related Location Tools™ products. In addition, we plan to use part of the proceeds for expanded marketing and sales efforts, for further commercialization of our other Location Tools™ product line, and for other corporate purposes. The Units were sold to accredited investors pursuant to an exemption from the registration requirements of the Securities Act of 1933 (the “Act”) and applicable state exemptions from registration. The securities offered have not been registered under the Act and they may not be offered or sold in the United States or any state in the absence of an effective registration statement or an applicable exemption from registration requirements. On June 24, 2004, we filed a Form SB-2 with the Securities and Exchange Commission related in connection with this private placement (See Subsequent Events below).
 
6.     Subsequent Events
 
On June 24, 2004, we filed a Form SB-2 with the Securities and Exchange Commission in conjunction with our March 15, 2004, private offering of restricted common stock units. This Registration was declared effective by the Securities and Exchange Commission on July 7, 2004. We filed a prospectus related to this registration statement on July 12, 2004. Copies of these filings can be found at www.sec.gov , or by requesting them in writing from the Company.
 
 
12  
 
Table of Contents
 

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 and Nine Months Ended June 30, 2004 Compared to Three and Nine Months Ended June 30, 2003
 
National Scientific Corporation is focused on the research and development of devices and designs that are intended to enhance the performance of various products commonly used in the semiconductor and electronics industries in general, and in location services devices in particular. We primarily design products that we believe will have a broad application and acceptance in the commercial electronic component marketplace. We currently hold U.S. Patents on eight devices and designs. We plan to continue to develop our existing patented technologies as well as develop new performance-enhancing devices and designs for use in the semiconductor and electronics industries when appropriate funding is available.
 
The Company remained focused on primarily semiconductor development from 1996 to approximately February of 2002. In February of 2002, we began to focus specifically on applications of electronic devices in the location services market. We also began to decrease our focus on semiconductor intellectual property, due primarily to difficult market conditions in the semiconductor area. We plan to continue our focus on wireless location devices for the foreseeable future. Much of our efforts since February 2002 have been devoted to licensing and developing technologies related to location services. We expect to continue product development in 2004, and to develop new sales channels and new customers for our location services products. The Company’s embedded systems Location Tools™ strategy began to yield small amounts of revenue late in the fiscal year ended September 30, 2002. This small revenue stream increased to $63,579 for the fiscal year ended September 30, 2003.
 
13  
 
 
Revenues increased roughly seven fold to $38,230 in the quarter ended December 31, 2003, compared to $5,455 for the quarter ending December 31, 2002, and were $36,308 for the quarter ended March 31, 2004, compared to $13,093 for the quarter ended March 31, 2003. During the quarter ended June 30, 2004 revenues dropped to $4,031 compared to $16,047 for the quarter ended June 30, 2003. Revenues for the nine months ended June 30, 2004 were $78,569 compared to $34,595 for the nine months ended June 30, 2003. This increase in revenue for the nine-month period ending June 30, 2004 over the comparable nine-month period of the previous fiscal year was related to sales of the Company’s Gotcha!® products. The decrease in sales in the three-month period ending June 30, 2004 compared to the prior quarter was related to decreased shipments and sales of Gotcha!® from the Company to its primary distributor, Futurecom Global, and potentially due to seasonal variations on the sell through of this product, which the Company believes may be more popular as a gift item during the winter holiday period.
 
As of June 30, 2004, the Company’s cash and cash equivalents totaled approximately $424,113 and total current assets were approximately $507,234. During the first week in January 2004, the Company secured a net loan of approximately $130,000 to assist with short-term cash requirements. This loan was repaid in full in May of 2004 (See Liquidity and Capital Resources below). On March 15, 2004, the Company commenced a private offering of restricted common stock of units through a placement agent. Cash proceeds to the Company totaled approximately $972,864 after costs. However, additional disbursements by the Company related to the private placement reduced the net proceeds to $935,044. NSC has recently initiated product-marketing efforts after several years of research and development and has negative operational cash flow and has never been profitable. The Company has long-term debt of $43,250 as of June 30, 2004. Total liabilities at June 30, 2004 were $536,470.
 
         Total operating expenses for the nine months ended June 30, 2004 increased to approximately $719,150 from $651,351 in the comparable period ended June 30, 2003. In order to advance the company’s product development timeline and sales requirements, in April 2004 the Company added several new personnel as permanent employees and also as contractors in the area of sales and marketing, as well as in product engineering and development.
 
Salaries and benefits increased from approximately $298,037 for the nine months ended June 30, 2003 to approximately $440,685 for the nine months ended June 30, 2004.
 
Stock compensation decreased to approximately $50,471 during the first nine months of fiscal year 2004 compared to $192,062 during the first nine months of fiscal year 2003. The most significant factor in the decrease is a result of a reduction in Director’s compensation.
 
14  
 
 
          Research and development costs decreased from approximately $56,695 for the nine months ended June 30, 2003 to approximately $18,050 for the nine months ended June 30, 2004. This trend which started in the first three quarters of fiscal year 2004 is expected to reverse during the last quarter of the fiscal year, as research funding increases 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. This has included increased attendance at trade shows, radio advertising, Internet advertising and promotion through website listings, on-site customer product demonstrations, and other marketing related activities intended to foster customer acquisition. The Company marketed some of its products in December 2003 and again in February 2004 on cable television’s Home Shopping Network and in April 2004 on the QVC cable television shopping channel. The Company has also spent and plans to continue to spend resources on the development of strategic partnerships with other technology firms to assist 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.
 
Other costs and expenses increased to approximately $209,944 during the first nine months of fiscal year 2004 compared to $86,907 during the first nine months of fiscal year 2003. The 2003 total was reduced by one time event of approximately $150,000 after the Company came to a definitive settlement agreement with a service firm resulting in the elimination of approximately $150,000 of short-term liability previously owed by the company (See Form 10-QSB for the period ended March 31, 2003).
 
The Company expects to continue to increase its focus on sales and marketing of its Location Tools™ products for the foreseeable future. This includes significantly increased attendance at trade shows and other product marketing events during the most recent quarters, as well as recent additional investment in product promotion through new outreach programs with the trade press, using new outside public relations resources. Partly as a result of these efforts and others, revenues have begun to be generated from operations. It is thus possible that the Company may emerge from its development stage status at sometime during the coming year.
 
Liquidity and Capital Resources
 
At June 30, 2004, our liquidity included cash and cash equivalents of $424,113 compared to $17,903 at September 30, 2003. Our total cash used in operating activities from developmental stage inception in 1998 through June 30, 2004 was $7,570,431. We have an accumulated deficit of $22,475,850 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, though the sale of our products.
 
15  
 
 
In January of 2004, the Company entered into a financing program with a U.S. investment fund entity that wants to remain confidential. The terms of this program include a six-month Note payable at maturity in July 2004 for $160,000, at an effective annual interest rate of 13%. The transaction also included 640,000 warrants good for three years to purchase the Company’s restricted stock, at $0.13 during the first and second year of the warrant’s lifetime, and $0.15 during the third and final year of the warrant’s lifetime. These warrants include anti-dilution provisions, as well as registration rights in the event that the Company was to file an appropriate registration statement with the SEC during the next three years. This $160,000 Note was repaid in full in May of 2004.
 
During March 2004, an Officer of the Company raised approximately $36,000 using his personal credit from a group of shareholders in consideration of short-term personal promissory notes to assist the Company with very short-term cash requirements. The notes carried effective annual interest rates of less than 10%, plus minor processing fees. These notes were subsequently repaid in full in April 2004.
 
On March 15, 2004, the Company commenced a private offering of restricted common stock units through a placement agent. The offer consisted of one share of common stock and a warrant to purchase three quarters of a share of common stock. On June 14, 2004, we completed this private placement with aggregate gross proceeds of approximately $1.1 million and issued 10,334,266 shares of restricted common stock and warrants to purchase 7,750,700 shares of our common stock at an exercise price of $0.11 per share. The warrants have a term of five years, and include certain registration rights. After deducting commissions and other expenses relating to the private placement, we received aggregate net proceeds of approximately $972,864. Additional disbursements by the Company related to the private placement further reduced the net proceeds to $935,044. The Company intends to use part of the proceeds of the private placement to finance the continued development and marketing of Wi-Fi and RFID related Location Tools™ products. In addition, we plan to use part of the proceeds for expanded marketing and sales efforts, for further commercialization of our other Location Tools™ product line, and for other corporate purposes. The Units were sold to accredited investors pursuant to an exemption from the registration requirements of the Securities Act of 1933 (the “Act”) and applicable state exemptions from registration. The securities offered have not been registered under the Act and they may not be offered or sold in the United States or any state in the absence of an effective registration statement or an applicable exemption from registration requirements. On June 24, 2004, we filed a Form SB-2 with the Securities and Exchange Commission related in connection with this private placement.
 
We believe that our current cash position as of June 30, 2004, including cash funds arising from the exercise of outstanding options, and secured plant assets from legal settlements, from equity placement sales and other capital raising efforts, 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.
 
16  
 
Table of Contents
 
Cash used in operations was approximately $618,935 for the nine months ended June 30, 2004 compared with approximately $471,965 for the nine months ended June 30, 2003. The increase in cash used in operations resulted from fewer salary deferrals, the addition of several new permanent employees and contractors to support the Company’s drive, in the area of sales, marketing, product engineering and development, to take its technology expertise and products to market.
 
Other Results of Operations
 
In March 2004, the Company learned that its common stock was listed on the Berlin Stock Exchange, even though the Company's officers or directors never applied for such a listing. The Company’s board does not believe this unsolicited listing on the Berlin Stock Exchange is in the current best interest of its shareholders, and directed its corporate counsel in May 2004 to request a removal of this listing until such a time as it can be demonstrated to the Company Board’s satisfaction that such a listing is in the best interest of the Company’s current and prospective shareholders. The Company advises investors looking to purchase shares of National Scientific Corporation to consider only purchasing their shares for the foreseeable future from the NASDAQ Over The Counter Bulletin Board under the trading symbol NSCT. The Company has further indicated it may take action to evaluate steps that would require all brokers to request physical delivery of certificates to legitimize the exchange of shares on all future trades.
 
The Company also announced in May 2004 that it had reached agreements with its marketing partners KMH Products and Verify Systems, to the effect that the Company would take a much more active and direct leadership role in the sales and marketing of the Company’s products with those partners. In April of 2004 the Company executed an agreement with KMH Products to allow the Company to take a direct role in the marketing of its Gotcha!® product via the KMH product website. In May 2004, the Company agreed to license the marketing materials and software tools of Verify Systems and assume the primary sales effort for these products ourselves. The material terms of this agreement require that Verify Systems give us an unlimited and indefinite license to use their software products, in exchange for a cash payment of $6,000 and a royalty of 5% of sales of their software products over the next two years.
 
On May 11, 2004 we shipped our version 1.1 Wi-Fi tag, called Wi-Fi Tracker™, to NASA (National Aeronautics and Space Administration), per their request, for evaluation with several other technologies for possible use on the International Space Station and other future space exploration vehicles. On June 30, 2004, the Company shipped its version 1.2 Wi-Fi tag to an additional development partner, Ekahau.
 
In June 2004 we announced a new Wi-Fi enabled version of our IBUS™ school bus passenger authentication system, which tracks the location of buses and logs students boarding or disembarking from the bus. This latest product offering allows school districts to more effectively track and identify school bus passengers.
 
Also in June 2004 we were granted the U.S. registered trademark for Gotcha!®, NSC’s child safety monitor product, by the U.S. Patent and Trademark Office.

 
17  
 
Other Subsequent Events
 
On June 24, 2004, we filed a Form SB-2 with the Securities and Exchange Commission in conjunction with our March 15, 2004, private offering of restricted common stock units. This Registration was declared effective by the Securities and Exchange Commission on July 7, 2004. We filed a prospectus related to this registration statement on July 12, 2004. Copies of these filings can be found at www.sec.gov , or by requesting them in writing from the Company.
 
On June 30, 2004, the Company shipped the first of its version 1.2 level WiFi tags to a development partner. On August 2, 2004 the Company announced the completion and availability of its version 1.2 Wi-Fi developer tag kits. On August 5, 2004, the Company commenced shipping a limited number of these devices to prospective developers.
 
In August of 2004, the Company began a program of seeking research funding through federal sources for military and non-military related applications of its wireless locations products.
 
Item 3.      Controls and Procedures
 
The Company's Chief Executive Officer and Acting Chief Financial Officer, Michael A. Grollman, and President, Graham L. Clark, after reviewing and evaluating the Company’s disclosure controls and procedures within 90 days prior to the filing of this quarterly report have concluded that the Company’s disclosure controls and procedures contained no significant deficiencies or material weakness. There have been no significant changes in the Company's internal controls that could significantly affect these controls subsequent to the date of their evaluation, including corrective actions.
 
The Company’s management believes that upon significant future growth in the number of accounting transactions processed, perhaps within the next year, additional review and enhancement of internal controls will be required. 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 effective levels of internal control.

 
18  
 
PART II - OTHER INFORMATION
 
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, 2003. 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 .
 
During the nine months ended June 30, 2004, 102,832 restricted common shares were issued for services at average market prices ranging from $0.14 to $0.15. During the same period 57,252 shares were issued for board services at average market prices ranging from $0.155 to $0.16.
 
On December 1, 2000, the Board of Directors instituted a Stock Option Plan (2000 Plan). The Board is of the opinion that it is in the best interest of NSC to reserve not less than 7,000,000 Common Shares to provide adequate Common Shares for the issuance to qualified individuals under the 2000 Plan to encourage them to remain in the service of NSC and to promote its business and growth strategy.
 
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.
 
19  
 
 
Item 6.       Exhibits and Reports on Form 8-K .
 
(a)     Exhibits.

 Exhibit  
 Number   Description
   
 14  Code of Ethics
 31.1  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 31.2
 Certification Pursuant to 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.
 
On  April 15, 2004, the Company filed a Report on Form 8-K relating to the initial closing on a private placement of units.
 
 
20  
 
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
      NATIONAL SCIENTIFIC CORPORATION
       
 
 
 
 
Date: August 16, 2004
 
By: 
/s/ Michael A. Grollman
 
 
 
Director, Chairman, Chief Executive Officer, and
Acting Chief Financial Officer

 
 
 
 
 
 
By: 
/s/ Graham L. Clark
 
 
 
Director, President, and Secretary

 
 
 
 
 
 
By: 
/s/ Gregory Szabo
 
 
 
Director

 
  21  
 

EXHIBIT 14

CODE OF ETHICAL CONDUCT FOR
SENIOR FINANCIAL OFFICERS AND MANAGERS
ADOPTED BY THE BOARD OF DIRECTORS
ON JULY 28, 2004

This Code of Ethical Conduct (this "CODE") of National Scientific Corporation (the "COMPANY") provides principles to which the chief executive officer, chief financial officer and all other senior financial managers set forth on Schedule A hereto (the "FINANCIAL MANAGERS") are expected to adhere and advocate. In carrying out his or her responsibilities to the Company, each Financial Manager should, to the best of his or her knowledge and ability, adhere to, promote and advocate the following principles and responsibilities governing his or her professional and ethical conduct and:

1. Conduct his or herself with honesty and integrity and avoid actual or apparent conflicts of interest between his or her personal and professional relationships and disclose to the Chairman of the Audit Committee and the General Counsel of the Company any material transaction or relationship that reasonably could be expected to give rise to such a conflict.

2. Provide full, fair, accurate, timely and understandable disclosure in internal reports as well as documents filed with or submitted to the Securities and Exchange Commission or used in public communications by or on behalf of National Scientific Corporation and its subsidiaries and affiliates.

3. Comply with applicable rules and regulations of federal, state and local governments and other private and public regulatory agencies, including but not limited to the Securities and Exchange Commission.

4. Act in good faith, responsibly, with due care, competence and diligence and without knowingly misrepresenting material facts or allowing his or her independent judgment to be subordinated.

5. Respect the confidentiality of information acquired in the course of his or her work except when authorized or otherwise legally obligated to make disclosure.

6. Promptly report to the Chairman of the Audit Committee AND the General Counsel any breach of this Code of which he or she becomes aware.

SCHEDULE A (TO EXHIBIT 14)

FINANCIAL MANAGERS

Michael Grollman
Graham Clark

EXHIBIT 31.1

NATIONAL SCIENTIFIC CORPORATION

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Michael A. Grollman, certify that:

1. I have reviewed this quarterly report on Form 10-QSB of National Scientific Corporation;

2. Based on my knowledge, this quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 

Date:  August 16, 2004


/s/ Michael A. Grollman
--------------------------------------------------------------------------------
Michael A. Grollman
Director, Chairman, Chief Executive Officer, and Acting Chief Financial Officer

2

EXHIBIT 32.1

NATIONAL SCIENTIFIC CORPORATION

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of National Scientific Corporation (the "Company") on Form 10-QSB for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael
A. Grollman, Director, Chairman, Chief Executive Officer, and Acting Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. 

Date:  August 16, 2004


/s/ Michael A. Grollman
--------------------------------------------------------------------------------
Michael A. Grollman
Director, Chairman, Chief Executive Officer, and Acting Chief Financial Officer