Halitron (HAON) 10QSB 2006 Q3 Quarterly report (small business)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

Form 10-QSB

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

TEKNIK DIGITAL ARTS, INC.

(Exact name of small business issuer as specified in its charter)

Nevada	68 053 9517
State or jurisdiction of	(I. R. S. Employer Identification No.)
incorporation or organization

P.O. Box 2800-314, Carefree, Arizona 85377
(Address of principal executive offices)

(480) 443-1488

(Issuer’s telephone number)

     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 last 90 days. Yesþ Noo

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

     On August 11, 2006, the registrant had outstanding 8,925,000 shares of Common Stock, par value $0.001 per share.

     Transitional Small Business Disclosure Format: Yeso Noþ

Teknik Digital Arts, Inc. and Subsidiary
Form 10-QSB
For the Quarter Ended June 30, 2006
Table of Contents

PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and September 30, 2005	1
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2006 and 2005	2
Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended June 30, 2006	3
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2006 and 2005	4
Notes to Condensed Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3. Controls and Procedures	14
PART II OTHER INFORMATION
Item 1. Legal Proceedings.	14
Item 6. Exhibits.	15
EX-31.1
EX-32

Part I — FINANCIAL INFORMATION

Item 1. Financial Statements.

TEKNIK DIGITAL ARTS INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

	(Unaudited)
	June 30,			September 30,
	2006			2005
Assets
Current Assets:
Cash and cash equivalents	$	67,654		$	7,060
Accounts receivable		223			—
Prepaid expenses		1,859			28,678
Total Current Assets		69,736			35,738
Property and equipment, net		7,492			7,673
Security deposit		1,000			3,200
Total Assets	$	78,228		$	46,611
Liabilities and Stockhoders’ Equity (Deficit)
Current Liabilities:
Note payable — related party	$	882,500		$	610,350
Notes payable — current portion		—			11,069
Accounts payable		351,254			311,667
Accrued vacation		—			1,154
Capital lease liability — current portion		951			2,283
Accrued interest		41,692			17,667
Total Current Liabilities		1,276,397			954,190
Long-Term Liabilities
Capital lease liability — long term portion		—			380
Notes payable — long term portion		75,000			—
Minority Interest in Joint Venture		37,500			37,500
Total Liabilities and Minority Interest		1,388,897			992,070
Stockholders’ Equity (Deficit):
Common stock — $.001 par value; 50,000,000 shares authorized, 9,425,000 and 9,125,000 shares issued and 8,925,000 and 9,125,000 outstanding, respectively		9,425			9,125
Additional paid-in capital		4,948,085			4,604,010
Accumulated deficit		(6,267,404	)		(5,558,594	)
		(1,309,894	)		(945,459	)
Less: Treasury stock at cost, 500,000 shares		(775	)		—
Total Stockholders’ Deficit		(1,310,669	)		(945,459	)
Total Liabilities and Stockholders’ Equity	$	78,228		$	46,611

See accompanying notes to condensed consolidated financial statements

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TEKNIK DIGITAL ARTS INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three			Three			Nine			Nine
	Months Ended			Months Ended			Months Ended			Months Ended
	June 30,			June 30,			June 30,			June 30,
	2006			2005			2006			2005
Sales	$	201		$	—		$	3,447		$	—
Cost of Sales		265			—			1,981			—
Gross Profit		(64	)		—			1,466			—
General and Administrative Expenses		168,906			170,553			622,052			708,874
Research and Development Costs		509			66,880			38,868			211,476
Loss from Operations		(169,479	)		(237,433	)		(659,454	)		(920,350	)
Other Income (Expense):
Interest Expense		(17,074	)		(9,725	)		(49,356	)		(19,778	)
Miscellaneous Income		—			—			—			2,172
		(17,074	)		(9,725	)		(49,356	)		(17,606	)
Minority Interest Portion of Loss		—			—			—			—
Net Loss	$	(186,553	)	$	(247,158	)	$	(708,810	)	$	(937,956	)
Basic and diluted loss per share (Note 1)	$	(0.02	)	$	(0.03	)	$	(0.08	)	$	(0.11	)
Weighted Average Common Shares Outstanding		8,665,778			8,857,967			8,940,641			8,424,414

See accompanying notes to condensed consolidated financial statements

2

TEKNIK DIGITAL ARTS INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

(UNAUDITED)

													Total
					Additional		Treasury						Stockholders’
	Common Stock				Paid-in		Stock			Accumulated			Equity
	Shares		Amount		Capital		at Cost			Deficit			(Deficit)
Balance at September 30, 2005		9,125,000	$	9,125	$	4,604,010	$	—		$	(5,558,594	)	$	(945,459	)
Treasury stock, 500,000 shares (Unaudited)		—		—		—		(775	)					(775	)
Warrants issued for compensation (Unaudited)		—		—		129,375					—			129,375
Stock issued for compensation (Unaudited)		50,000		50		44,950					—			45,000
Issuance of common stock for litigation settelement (Unaudited)		250,000		250		169,750					—			170,000
Net Loss for the nine months ended June 30, 2006 (Unaudited)		—		—		—		—			(708,810	)		(708,810	)
Balance at June 30, 2006 (Unaudited)		9,425,000	$	9,425	$	4,948,085	$	(775	)	$	(6,267,404	)	$	(1,310,669	)

See accompanying notes to condensed consolidated financial statements

3

TEKNIK DIGITAL ARTS INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Nine			Nine
	Months Ended			Months Ended
	June 30,			June 30,
	2006			2005
Increase/(Decrease) in Cash and Cash Equivalents:
Cash flows from operating activities:
Net Loss	$	(708,810	)	$	(937,956	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation		1,006			917
Common stock and warrants issued for compensation and consulting		174,375			346,062
Common stock issued for litigation settlement		170,000			—
Changes in Assets and Liabilities:
Accounts receivable		(223	)		—
Prepaid expenses		26,819			(27,091	)
Security deposit		2,200			(1,000	)
Accounts payable		39,587			114,607
Accrued vacation		(1,154	)		—
Other accrued expenses		—			(1,637	)
Accrued interest — related party		24,025			(7,660	)
Net cash used by operating activities		(272,175	)		(513,758	)
Cash flows from investing activities:
Purchase of fixed assets		(1,600	)		(3,239	)
Net cash used in investing activities		(1,600	)		(3,239	)
Cash flows from financing activities:
Proceeds from note payable — related party		272,150			488,150
Proceeds from debt payable		75,000			19,166
Payments of note payable		(11,069	)		—
Payments related to capital lease		(1,712	)		(1,331	)
Net cash provided by financing activities		334,369			505,985
Net change in cash and cash equivalents		60,594			(11,012	)
Cash and cash equivalents at beginning of period		7,060			11,995
Cash and cash equivalents at end of period	$	67,654		$	983

See accompanying notes to condensed consolidated financial statements

4

TEKNIK DIGITAL ARTS INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

	Nine		Nine
	Months Ended		Months Ended
	June 30,		June 30,
	2006		2005
Supplemental Information:
Interest paid	$	25,331	$	23,958
Income taxes paid	$	—	$	—
Non-cash Investing and Financing Activities
Common Stock and warrants issued for compensation and consulting	$	174,375	$	1,111,500
Common Stock issued for litigation settlement	$	170,000	$	—
Capital lease obligation	$	—	$	4,565
Fixed assets exchanged for treasury stock	$	775	$	—

See accompanying notes to condensed consolidated financial statements

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1
Summary of Significant Accounting Policies, Nature of Operations and Use of Estimates

Presentation of Interim Information:

The condensed consolidated financial statements included herein have been prepared by Teknik Digital Arts Inc. (“we”, “us”, “our” or “Company”) without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) and should be read in conjunction with our Form 10KSB filed for the year ended September 30, 2005 as filed with the SEC under the Securities and Exchange Act of 1933. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted, as permitted by the SEC, although we believe the disclosures, which are made are adequate to make the information presented not misleading. Further, the condensed consolidated financial statements reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly our financial position at June 30, 2006 and the results of our operations and cash flows for the periods presented. The September 30, 2005 consolidated balance sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Interim results are subject to variations and the results of operations for the nine months ended June 30, 2006 are not necessarily indicative of the results to be expected for the full year.

Nature of Corporation

Teknik Digital Arts, Inc. (the “Company”) was organized under the laws of the State of Nevada on January 29, 2003. The principal business purpose of the Company is to publish interactive video games and instructional software for play on mobile telephones, personal computers and video game consoles.

Reclassifications

Certain balances as of September 30, 2005 and for the periods ended as of June 30, 2005 have been reclassified in the accompanying condensed consolidated financial statements to conform to the current year presentation. These reclassifications had no effect on previously reported net income or stockholders’ equity.

Liquidity

The Company has generated an accumulated net loss of $6,267,404 (unaudited) from the date of inception January 29, 2003 through June 30, 2006. Our primary sources of liquidity are proceeds from borrowings from a related party note and, to a lesser extent, proceeds from the sale of equity securities.

Revenue Recognition

The Company will derive its revenues from the sale of interactive entertainment software through the Company website and distributors. Revenues are recognized at the time the sale is made through the Company website or by the distributors. As of June 30, 2006 the Company has begun to generate revenues associated with some of the mobile phone applications.

Software Development Costs

The Company capitalizes software development costs in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” Capitalization of software development costs begins upon the establishment of technological feasibility of the product. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors including, but not limited to, anticipated future gross product revenue, estimated economic life, and changes in software and hardware technology. Amortization of capitalized software development costs begins when the products are available for general release to customers and is computed on a product-by-product basis using straight-line amortization with useful lives of five years or, if less, the

6

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 1
Summary of Significant Accounting Policies, Nature of Operations and Use of Estimates (Continued)

Software Development Costs (Continued)

remaining estimated economic life of the product. Amounts related to software development costs during the current year were expensed as the time between when technological feasibility and product marketability were indeterminate and therefore no costs were capitalized. Amounts related to internal software development that could be capitalized under this statement were immaterial.

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48, “An Interpretation of FASB Statement No. 109,” which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 reflects the benefit recognition approach, where a tax benefit is recognized when it is “more likely than not” to be sustained based on the technical merits of the position. This Interpretation is effective for fiscal years beginning after December 15, 2006. The adoption of this FSP is not expected to have a material effect on the Company’s consolidated financial statements.

In April 2006, the FASB issued FASB Staff Position (FSP) FIN No. 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”, that will become effective beginning the third quarter of 2006. FSP FIN No. 46(R)-6 clarifies that the variability to be considered in applying FASB Interpretation 46(R) shall be based on an analysis of the design of the variable interest entity. The adoption of this FSP is not expected to have a material effect on the Company’s consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets,” which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This new Statement amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities as of the beginning of an entity’s fiscal year that begins after September 15, 2006, with earlier adoption permitted in certain circumstances. The Company does not expect SFAS No. 156 will have a material effect on its financial statements.

Consolidated Statements

The consolidated financial statements include the accounts of the Company and its subsidiary, Playentertainment-Teknik, LLC. All significant intercompany balances and transactions have been eliminated in consolidation. The Company owns 50% of the membership interest of the LLC, however, the financial statements of the subsidiary has been consolidated as the management and operations of Playentertainment-Teknik, LLC is substantially controlled by Teknik Digital Arts, Inc.

Use of Estimates

The preparation of 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.

Loss Per Share

Basic loss per share of common stock was computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period.

Diluted loss per share is computed based on the weighted average number of shares of common stock and dilutive securities outstanding during the period. Dilutive securities are options that are freely exercisable into common stock at

7

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 1
Summary of Significant Accounting Policies, Nature of Operations and Use of Estimates (Continued)

Loss Per Share (Continued)

less than the prevailing market price. Dilutive securities are not included in the weighted average number of shares when inclusion would increase the earnings per share or decrease the loss per share. As of June 30, 2006, options to purchase 200,000 shares and warrants to purchase 3,837,500 shares of common stock were not included in the determination of diluted loss per share as their effect was anti-dilutive.

Stock-Based Compensation

Prior to January 1, 2006, the Company accounted for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”). Accordingly, compensation expense, if any, was measured as the excess of the underlying stock price over the exercise price on the date of grant. The Company complied with the disclosure provisions of Statement of Financial Accounting Standards Board No. 123 (“SFAS 123”) “Accounting for Stock Based Compensation” as amended by SFAS 148 “Accounting for Stock-Based Compensation-Transition and Disclosure,” which required pro-forma disclosure of compensation expense associated with stock options under the fair value method.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards Board No. 123(R), “Share–Based Payment,” using the modified prospective-transition method. Under this transition method, compensation expense recognized for the six months ended June 30, 2006 includes: (a) compensation expense for all share-based payments granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated and (b) compensation expense for all share-based payments granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123 (R). Results for prior periods have not been restated. The fair value of option grants is estimated as of the date of grant utilizing the Black-Scholes option-pricing model and amortized to expense over the options’ vesting period.

As of June 30, 2006 the Company had 200,000 options outstanding and exercisable. The options had no intrinsic value as of June 30, 2006, as the exercise price of all outstanding and exercisable options is greater than the trading price of the Company’s common stock at June 30, 2006. All options were 100% vested as of March 31, 2005 and therefore will result in no future compensation expense to the Company. The options have a weighted average remaining life of 1.31 years and a weighted average exercise price of $1.00.

The fair value of option grants is estimated as of the date of grant utilizing the Black-Scholes option-pricing model with the following weighted average assumptions for all grants: expected life of options of 3 years, risk-free interest rate of 2%, volatility at 0-90%, and a 0% dividend yield. The value of the options outstanding at June 30, 2006 was $234,000, determined on the respective dates of grant.

As a result of adopting SFAS 123(R), the Company’s net loss for the three and nine month periods ended June 30, 2006 is unchanged from the net loss that would be reported if it had continued to account for share-based compensation under APB 25 as all options granted by the Company were fully vested as of December 31, 2005. The effect of recording stock-based compensation expense for the three and nine months ended June 30, 2006 were as follows:

	(Unaudited)		(Unaudited)
	Three		Nine
	Months Ended		Months Ended
	June 30, 2006		June 30, 2006
Stock based compensation expense by type of award:
Stock options	$	—	$	—
Total stock based compensation expense	$	—	$	—
Tax effect on stock based compensation expense	$	—	$	—
Net effect on net income available to common shareholders	$	—	$	—
Effect on earnings per share:
Basic	$	—	$	—
Diluted	$	—	$	—

8

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 1
Summary of Significant Accounting Policies, Nature of Operations and Use of Estimates (Continued)

Stock-Based Compensation (Continued)

The following table illustrates the effect on the Company’s net loss and loss per share for the three months ended December 31, 2005 if the Company had applied the fair value recognition provisions of SFAS 123 to options granted under the Company’s stock option plans, prior to the adoption of SFAS 123(R):

	(Unaudited)
	Three
	Months Ended
	December 31,
	2005
Net loss:
As reported	$	(279,071	)
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		—
Pro forma net loss	$	(279,071	)
Basic loss per share:
As reported	$	(0.03	)
Pro forma	$	(0.03	)
Diluted loss per share:
As reported	$	(0.03	)
Pro forma	$	(0.03	)

Note 2
Related Party Transactions

The Company had an uncollateralized line of credit of $1,000,000 with a related party as of September 30, 2005 with the principal and interest due March 1, 2006. On March 1, 2006, the outstanding balance on the line of credit was converted to a note, which bears interest at the rate of 7% per annum with principal and interest due on March 1, 2007. As of June 30, 2006 and September 30, 2005, the Company’s balance on the related party note payable and line of credit was $882,500 and $610,350 respectively.

As of June 30, 2006 and September 30, 2005, there was interest accrued on the note of $41,447 and $17,667, respectively.

Note 3
Notes Payable

During the three months ended June 30, 2006, the Company entered into an agreement to issue convertible debt. Under the terms of the agreement, the Company intends to offer a maximum of $1,500,000 of debt during the period commencing May 5, 2006 to July 31, 2006. The notes will accrue interest at a rate of 8% per annum with principal and interest due on June 1, 2008. The note holder may convert the note and accrued interest at any time prior to June 1, 2008, into shares of the Company’s common stock at a purchase price per share of $.75, subject to any subsequent issuances of convertible debt at a more favorable conversion rate. In addition, the placement agent was issued 250,000 common stock warrants upon commencement of the agreement to purchase the stock at a price of $.75 per share. The Company will issue additional warrants to the placement agent to purchase.5 shares of common stock at $.75 per share for each $1.00 of Notes sold up to an additional 250,000 shares of common stock. As of June 30, 2006, the placement

9

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Notes Payable (Continued)

agent has raised $75,000 entitling them to an additional 37,500 of common stock warrants. The fair value of warrant grants is estimated as of the date of grant utilizing the Black-Scholes option-pricing model with the following weighted average assumptions for the aforementioned grants: expected life of warrants of 3 years, risk-free interest rate of 5.09%, volatility at approximately 109%, and a 0% dividend yield. This resulted in the warrants having been valued at $129,375 or approximately $0.45 per warrant.

As of June 30, 2006 the Company’s balance on the note payable was $75,000 and there was interest accrued on the note of $245.

Note 4
Going Concern

As discussed in the prior Form 10-KSB, the Company has incurred operating losses and negative cash flows from its operations to date. Realization of a major portion of the assets is dependent upon the Company’s ability to meet its future financing requirements, and the success of future operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

Note 5
Subsequent Events

On August 1, 2006, the Company entered into a joint venture agreement with Powergrid Fitness, Inc. to exclusively develop, manufacture, and market physically interactive video game controllers, software, and leagues using the Powergrid Fitness patented isometric-based controller technology.

The Company owns 50% of the joint venture and is obligated to contribute $50,000 as an initial capital contribution. Under the terms of the joint venture, the Company will be allocated 50% of the net profits/losses attributable to the operations of the joint venture.

The agreement entitles Powergrid the right to convert its membership interest into common stock of the Company beginning August 1, 2007 and after the joint venture is profitable. The conversion option is an amount equal to Powergrid’s membership interest conversion value divided by the prior 90-day average market price per share of the Company’s common stock. The membership conversion value shall be equal to ten (10) times the share of the net pre-tax earnings of the joint venture for the most recent fiscal year allocated to Powergrid. However, the membership conversion value is not to exceed 50% of the outstanding common stock.

The Joint venture will be accounted for under the consolidated method of accounting as the Company is the managing member and has substantial control of the joint venture.

10

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

Special Note Regarding Forward-Looking Statements

This report contains “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. In making such statements, we must rely on estimates and assumptions drawn in light of our experience and our perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate under the circumstances. These estimates and assumptions are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond our control. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed or implied in any forward-looking statements made by us, or on our behalf.

In particular, the words “expect,” “anticipate,” “estimate,” “may,” “will,” “should,” “intend,” “believe,” and similar expressions are intended to identify forward-looking statements. In light of the risks and uncertainties inherent in all forward-looking statements, you should not consider the inclusion of forward-looking statements in this report to be a representation by us or any other person that our objectives or plans will be achieved.

Risks and uncertainties that could cause actual results to differ from our forward-looking statements include those discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report.

We undertake no obligation to update our forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

The “Teknik Digital Arts” family of related marks, images and symbols are our properties and trademarks. All other trademarks, tradenames and service marks appearing in this report are the property of their respective holders. References to “Teknik Digital Arts,” “we,” “us,” “our,” or similar terms refer to Teknik Digital Arts Inc. together with its consolidated subsidiary.

Overview

Teknik Digital Arts, Inc. publishes interactive video game and instructional software for play on mobile telephones, personal computers and video game consoles. We have developed a prototype game and order processing system for personal computers and have launched mobile phone video games we have developed based on highly visible, exclusively-licensed consumer content. We plan to continue to license highly visible consumer content, such as popular motion pictures, television shows, characters, and sports figures, and develop mobile phone, personal computer and console entertainment applications based on these licensed properties.

In December 2005, we released a mobile phone game based on the television showFear Factor.We also launched a mobile phone game around professional golfer Phil Mickelson that was released in December 2005. We have developed a proprietary mobile media player that is used for the instructional series developed by Mickelson’s short game teacher, Dave Pelz, and his swing coach, Rick Smith. The Company’s prior agreements with Phil and Chris Simms Football and Cal Ripken Baseball have been mutually terminated, and development of the Phil Weber and Joe Johnson Basketball application has been postponed.

We work with video game software developers to develop products across the mobile phone, personal computer and console game system platforms. We intend to leverage our licensed brand names to form strategic partnerships that we believe will enable us to create truly distinctive digital content.

Customers will order and download mobile phone games through their mobile phone carriers, who will charge customers through their monthly phone bills and retain a percentage of these fees before remitting the balance to us. Customers may also order and download mobile phone games through our website. Electronic distribution of both our personal computer and mobile phone applications relieves us of the typical distribution challenges, such as packaging, shipping and the management of physical inventories.

As of June 30, 2006, we had two full time employees, including one in sales and marketing and one in finance, general and administrative. We intend to hire additional employees as needed. We also retain independent contractors to provide various services, primarily in connection with our software development and sales activities.

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We are not subject to any collective bargaining agreements and we believe that our relationship with our employees is good.

Summary Plan of Operations

Presently, we require approximately $40,000 to $50,000 per month to fund our recurring operations. This amount may increase as we expand our development efforts to include additional product offerings. Our cash needs are primarily attributable to insurance costs, payroll related expenses, as well as professional fees associated with being a public company. As of the date of this report, we have funded our working capital requirements from past borrowings under our revolving line of credit, which has been converted to a note as of March 1, 2006, and, to a lesser extent, from the sale of equity securities. We currently anticipate that if our capital requirements increase and we are, therefore, required to raise additional capital, we will raise such additional funds through the sale of equity or debt securities and from the exercise of outstanding warrants. The amount of funds raised, if any, will determine what additional projects we will be able to undertake. No assurance can be given that we will be able to raise additional capital, when needed or at all, or that such capital, if available, will be on terms acceptable to us. In addition, no assurance can be given that our outstanding warrants will be exercised, if ever, at a time when we may need such funds for our operations.

Over the next 12 months, we plan to continue to devote research and development resources to our planned mobile phone product offerings as well as the development of our physically interactive gaming software.

Revenue

During the three months ended June 30, 2006 the Company generated a small amount of revenue related to our mobile phone game applications. Our business model contemplates that we will derive revenue from two sources: one-time fees charged in connection with the initial sale of our products and monthly subscriptions. We plan to generate revenue from the sale of applications for mobile phones, personal computers and console game systems.

Expenses

We intend to continue to develop our products both internally and through third parties. We expect that our research and development expenses will increase as we expand our product offerings. As the Company grows, we may need to hire additional employees in connection with the animation and software development efforts of new products.

We will incur operational costs associated with customer support and maintaining our web presence. In the future, we believe much of the customer support for our online products may be handled online via chat messaging or e-mail. Some expense may be incurred in the future to offer customer service via phone but this will not be a requirement for our core market. Initial customer service for our mobile products will be provided by the carriers. We intend to maintain our website and application servers in a professional hosting environment. The expenses incurred to maintain a professional web presence consist of hosting space, including security, redundant power supply, and fire suppression, as well as access to redundant broadband networks, personnel to conduct preventive and emergency site maintenance, and backup/disaster recovery systems.

Sales and marketing expenses will consist primarily of salaries and related expenses for our direct sales force and marketing personnel, commissions to independent sales staff, marketing programs and advertising campaigns. Management intends to use its experience and connections within the software industry to promote and market our products. We expect our sales and marketing expenses will increase materially when operations increase and we expand our product offerings and launch an international presence.

General and administrative expenses consist primarily of salaries and related expenses for finance and other administrative personnel, facilities and occupancy charges, professional fees as well as amounts related to a legal settlement as discussed in the period ended March 31, 2006 10-QSB. We expect our general and administrative expenses to increase as we expand our staff, build our infrastructure, grow our business and incur costs associated with being a public company.

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We have incurred significant expenses from inception through June 30, 2006 primarily attributable to charges incurred during our development stage. Since our inception, we have incurred a net loss of $6,267,404 (unaudited). Approximately $4,112,000 (unaudited) of expenses have been attributable to non-cash charges taken since inception related to stock issuances for compensation, consulting and stock and warrants issued in relation to software development costs as well as a legal settlement.

Comparisons of the three months ended June 30, 2006 and 2005

Our general and administrative expenses decreased approximately 1% from $170,553 for the three months ended June 30, 2005 to $ 168,906 for the three months ended June 30, 2006. The decrease is primarily attributable to a decrease in payroll related expenses as well as a decrease in professional fees incurred by the Company during the three months ended June 30, 2006. Research and development costs decreased approximately 99% from $66,880 for the three months ended June 30, 2005 to $509 for the three months ended June 30, 2006. This decrease is primarily attributable to the Mickelson game being completed in December 2005, combined with more resources and up-front costs being required in the early development phases of product development in the three months ended June 30, 2005.

Comparisons of the nine months ended June 30, 2006 and 2005

Our general and administrative expenses decreased approximately 12% from $708,874 for the nine months ended June 30, 2005 to $622,052 for the nine months ended June 30, 2006. The decrease is primarily attributable to a decrease in payroll related expenses and professional fees during the nine months ended June 30, 2006. Research and development costs decreased approximately 82% from $211,476 for the nine months ended June 30, 2005 to $38,868 for the nine months ended June 30, 2006. This decrease is primarily attributable to the Mickelson game being completed in December 2005, combined with more resources and up-front costs being required in the early development phases of product development in the nine months ended June 30, 2005.

Liquidity and capital resources

Our primary sources of liquidity are proceeds from past borrowings under a revolving line of credit and, to a lesser extent, proceeds from the sale of equity securities. Our line of credit had a term of one year (renewable annually on March 1), and was being provided by a related party, CodeFire Acquisition Corp., or CAC, which holds 10.64% of our issued common stock. The line of credit had a limit of $1,000,000 as of September 30, 2005 with the principal and interest due March 1, 2006. On March 1, 2006, the outstanding balance of $832,850 on the line of credit was converted to a note, which bears interest at the rate of 7% per annum, with principal and interest due March 1, 2007. As of June 30, 2006 and September 30, 2005, the Company’s balance on the related party note payable and line of credit was $882,500 and $610,350 respectively.

As of June 30, 2006 and September 30, 2005, we had cash and cash equivalents amounting to $67,654 and $7,060, respectively, and prepaid expenses of $1,859 and $28,678, respectively. Our liquidity needs are primarily to fund working capital requirements, including general and administration and developmental expenses. The largest use of our funds has been salaries and related expenses as well as costs associated with being a public company.

As of June 30, 2006, we had total current liabilities of $1,276,397 and had total current assets of $69,736, with our current liabilities exceeding our current assets by $1,206,661. As of September 30, 2005, we had total current liabilities of $954,190 and had total current assets of $35,738, with our current liabilities exceeding our current assets by $918,452.

Management believes that the Company will be able to continue to borrow additional funds from CAC, these borrowings, combined with future sales of equity or debt securities, will provide the Company with its immediate financial requirements to enable it to continue as a going concern. In addition, as of June 30, 2006, the Company is in the process of raising additional funds by issuing convertible debt instruments. As of June 30, 2006, the Company has raised approximately $75,000 associated with the convertible debt instruments. The raising of additional capital in public or private markets will primarily be dependent upon prevailing market conditions and the demand for the Company’s products and services. No assurances can be given that the Company will be able to raise additional capital, when needed or at all, or that such capital, if available, will be on terms acceptable to the Company. In the

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event we are unable to raise additional funds, we could be required to either substantially reduce or terminate our operations.

Although we are currently able to pay our debts as they become due, if our expenses exceed our borrowing capability, and we cannot raise money through the sale of equity or debt securities, we may not have sufficient cash to satisfy our liquidity needs for the upcoming twelve months. As a result of the operating losses and negative cash flows incurred since our inception in January 2003, our independent auditor has included an explanatory paragraph in its report on our financial statements for the year ended September 30, 2005, expressing substantial doubt regarding our ability to continue as a going concern. This means that the auditor questions whether we can continue in business. Investors in our securities should carefully review the report prepared by our auditor included in Form 10-KSB at September 30, 2005. Our ability to continue in the normal course of business is dependent upon our access to additional capital, as discussed above, and the success of our future operations. The success of our future operations is dependent on our ability to deploy our products and applications, generate significant revenue from the sale of our products and product applications and licensing of related products and services and establish and maintain broad market acceptance for our products.

Off-Balance sheet arrangements

We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, we have not entered into any derivative contracts nor do we have any synthetic leases.

Item 3. Controls and Procedures.

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its Chief Executive Officer/Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Disclosure controls and procedures are designed to ensure that information required to be disclosed in the periodic reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based upon that evaluation, the Chief Executive Officer/Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the quarterly period covered by this report. No change in the internal control over financial reporting occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is from time to time involved in legal proceedings arising from the normal course of business. There are no lawsuits outstanding as of the date of this report.

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Item 6. Exhibits.

     (a) The following exhibits are filed herewith pursuant to Regulation S-B.

Exhibit Index

Exhibit
No.	Description
31.1	Section 302 Certification of President, Chief Executive Officer and Chief Financial Officer
32	Section 906 Certification

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	TEKNIK DIGITAL ARTS, INC.
Dated: August 14, 2006
	By	/s/ John R. Ward
	John R. Ward President, Chief Executive Officer, and Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit
No.	Description
31.1	Section 302 Certification of President, Chief Executive Officer and Chief Financial Officer
32	Section 906 Certification

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