SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) February 22, 2005
(December 9, 2004)
HOUSTON OPERATING COMPANY
(Exact name of registrant as specified in its charter)
Delaware 000-31553 76-0307819
(State of Incorporation) (Commission File Number (IRS Employer
Identification No.)
67 Federal Road
Building A
Suite 300
Brookfield, CT 06804
(Address of principal executive offices)
Registrant's telephone number, including area code (203) 775-1178
This Amended Report amends the Form 8-K of the Houston Operating Company
(the "Company"), dated December 15, 2004, by providing the financial statements
required under Item 9.01 and corrects certain information previously reported
under Item 2.01 as noted below.
ITEM 9.01 FINANCIAL STATEMENTS AND EXHIBITS
---------------------------------
NETFABRIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
Financial Statements for the years ended December 31, 2003 and 2004 and for the
period from January 1, 2003 (Inception Date) to December 31, 2004 and Report of
Independent Registered Public Accounting Firm
2
NETFABRIC CORPORATION
INDEX
Report of Independent Registered Public Accounting Firm F-2
Financial Statements:
Balance Sheets, December 31, 2003 and 2004 F-3
Statements of Operations, for the years ended
December 31, 2003 and 2004 and for the period
from inception (January 1, 2003) to December 31, 2004 F-4
Statements of Stockholders' Equity (Deficit),
for the years ended December 31, 2003 and 2004
and for the period from inception (January 1, 2003)
to December 31, 2004 F-5
Statements of Cash Flows, for the years ended
December 31, 2003 and 2004 and for the period from
inception (January 1, 2003) to December 31, 2004 F-6
Notes to Financial Statements F-7 - F-18
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
NetFabric Corporation
We have audited the accompanying balance sheets of NetFabric Corporation (a
development stage company) as of December 31, 2003 and 2004, and the related
statements of operations, stockholders' equity (deficit) and cash flows for each
of the years then ended, and for the period from inception (January 1, 2003) to
December 31, 2004. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of NetFabric Corporation as of
December 31, 2003 and 2004, and its results of operations and cash flows for
each of the years then ended, and for the period from inception (January 1,
2003) to December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company is in the development stage, has had net
losses from inception and has a working capital deficiency. These matters raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ J. H. Cohn LLP
Great Neck, New York
February 21, 2005
F-2
NETFABRIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
AS OF DECEMBER 31, 2003 AND 2004
- --------------------------------------------------------------------------------
DECEMBER 31, 2003 DECEMBER 31, 2004
----------------- -----------------
ASSETS
CURRENT ASSETS:
Cash $ 18,053 $ 67,719
Trade accounts receivable - 18,284
Inventory - 72,025
Due from stockholders 90 -
Prepaid expenses 2,354 50,000
-------- --------
Total current assets 20,497 208,028
Property and equipment, net - 171,931
Other assets 5,665 -
Deferred offering costs - 368,683
-------- --------
TOTAL $ 26,162 748,642
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bridge loans, net of unamortized discount $ - $ 749,659
Loans payable to stockholder 10,000 -
Accounts payable and accrued liabilities 248 256,389
Deferred revenue - 18,284
-------- ----------
Total current liabilities 10,248 1,024,332
-------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Common Stock, $.001 par value,
12,500,000 shares authorized, 9,050,000
and 9,750,000 shares issued and outstanding 9,050 9,750
Additional paid-in capital 25,429 1,270,534
Deficit accumulated during the
development stage (18,565) (1,492,295)
Deferred Stock Option Cost - 63,679
-------- ----------
Total stockholders' equity (deficit) 15,914 (275,690)
-------- ----------
TOTAL $ 26,162 $ 748,642
======== ==========
See Notes to Financial Statements
F-3
NETFABRIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2004 AND FOR
THE PERIOD FROM INCEPTION (JANUARY 1, 2003) TO DECEMBER 31, 2004
- --------------------------------------------------------------------------------
2003 2004 FOR THE PERIOD FROM
INCEPTION (JANUARY 1,
2003) TO DECEMBER 31,
2004
--------- ----------- ---------------------
REVENUES $ - $ 612 $ 612
COST OF GOODS SOLD - 3,126 3,126
--------- ----------- -----------
GROSS LOSS - (2,514) (2,514)
--------- ----------- -----------
EXPENSES:
Research and development - 395,452 395,452
Selling expenses 3,500 189,150 192,650
General and administrative expenses 8,720 614,800 623,520
Legal and professional expenses 6,097 88,238 94,335
Interest and bank charges 248 175,365 175,613
Depreciation and amortization - 8,211 8,211
--------- ----------- -----------
Net loss before provision for income taxes (18,565) (1,473,730) (1,492,295)
Provision for income taxes - - -
--------- ----------- -----------
NET LOSS $ (18,565) $(1,473,730) $(1,492,295)
========= =========== ===========
See Notes to Financial Statements
F-4
NETFABRIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2004 AND FOR
THE PERIOD FROM INCEPTION (JANUARY 1, 2003) TO DECEMBER 31, 2004
- --------------------------------------------------------------------------------
FOR THE PERIOD FROM
INCEPTION (JANUARY 1,
2003 2004 TO DECEMBER 31, 2004
---------- ------------ ---------------------
OPERATING ACTIVITIES
Net loss $ (18,565) $ (1,473,730) $ (1,492,295)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services - 100,000 100,000
Amortization of non-cash charges for options
issued to non-employees 1,370 60,059 61,429
Amortization of debt discount - 161,062 161,062
Depreciation and amortization - 8,211 8,211
Changes in operating assets and liabilities:
Inventory - (72,025) (72,025)
Trade accounts receivable - (18,284) (18,284)
Prepaid expenses - (50,000) (50,000)
Accounts payable and accrued liabilities 248 256,141 256,389
Deferred revenue - 18,284 18,284
---------- --- -------- ------------
Net cash used in operating activities (16,947) (1,010,282) (1,027,229)
---------- ------------ ------------
INVESTING ACTIVITIES
Purchases of property and equipment - (180,142) (180,142)
---------- ------------ -------------
Net cash used in investing activities - (180,142) (180,142)
---------- ------------ -------------
FINANCING ACTIVITIES
Proceeds from issuance of common stock 25,090 250,000 275,090
Proceeds from (repayment of) note payable
to stockholder 10,000 (10,000) -
Proceeds from bridge loans - 1,000,000 1,000,000
Due from stockholders (90) 90 -
---------- ------------ ------------
Net cash provided by financing activities 35,000 1,240,090 1,275,090
---------- ------------ ------------
NET INCREASE IN CASH 18,053 49,666 67,719
CASH AT BEGINNING OF PERIOD - 18,053 -
---------- ------------ ------------
CASH AT END OF PERIOD $ 18,053 67,719 67,719
========== ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest expense $ - - -
========== ============ ============
Cash paid for income taxes $ - - -
========== ============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Fair value of options issued to non-employees
for services initially deferred $ 9,389 115,719 125,108
========== ============ ============
Imputed discount on bridge loans relating to
warrants issued and beneficial conversion feature $ - 411,403 411,403
========== ============ ============
Value of shares and warrants issued in
connection with financing commitment $ - 368,683 368,683
========== ============ ============
See Notes to Financial Statements
F-5
NETFABRIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31,
2003 AND 2004 AND FOR THE PERIOD FROM INCEPTION (JANUARY 1, 2003) TO DECEMBER
31, 2004
- --------------------------------------------------------------------------------
COMMON STOCK DEFICIT
---------------------- ACCUMULATED TOTAL
ADDITIONAL DURING THE STOCKHOLDERS'
PAID-IN DEVELOPMENT EQUITY
SHARES PAR VALUE CAPITAL STAGE (DEFICIT)
--------- --------- ----------- ------------ -------------
BALANCES AT JANUARY 1, 2003 (INCEPTION) - $ - $ - $ - -
Sale of common stock to founders 9,000,000 9,000 (8,910) - 90
Sale of common stock to investor 50,000 50 24,950 - 25,000
Issuance of options to purchase common stock
to non-employees for services - - 9,389 - 9,389
Net loss - - - (18,565) (18,565)
--------- --------- ----------- ------------ ----------
BALANCES AT DECEMBER 31, 2003 9,050,000 9,050 25,429 (18,565) 15,914
Sale of common stock to investors 500,000 500 249,500 - 250,000
Issuance of common stock to landlord in lieu of rent 200,000 200 99,800 - 100,000
Issuance of options to purchase common stock
to non-employees for services - - 115,719 - 115,719
Allocation of proceeds from bridge loans to equity
instruments - - 411,403 - 411,403
Value of shares and warrants issued in
connection with financing commitment - - 368,683 - 368,683
Net loss - - - (1,473,730) (1,473,730)
Deferred Stock Option Cost 63,679
--------- --------- ----------- ------------ ----------
BALANCES AT DECEMBER 31, 2004 9,750,000 $ 9,750 $ 1,270,534 $ (1,492,295) (275,690)
========= ========= =========== ============ ==========
See Notes to Financial Statements
F-6
NETFABRIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
NetFabric Corporation ("NetFabric" or the "Company"), a Delaware
corporation incorporated on December 17, 2002, began operations in July
2003. As no activities occurred for the period from December 17, 2002
through December 31, 2002, the presentation of the accompanying financials
statements commences on January 1, 2003. The Company develops and markets a
family of Internet Protocol ("IP") appliances that simplifies the
integration of standard telephone systems with an IP infrastructure. The
Company's products deliver productivity gains and significant cost
reductions, while maintaining Public Switched Telephone Network ("PSTN")
class reliability and ease of use. The Company is in the process of
obtaining patents for the underlying technology. NetFabric provides
progressive upgrades in both the PSTN and Voice Over Internet Protocol
("VoIP")" solutions principally used in the large residential marketplace
and small and medium sized businesses. The Company develops and sells IP
Telephony Service Adaptors ("IP TSA"), products that connect to the trunk
side of existing standard phone systems and provide the functionality of an
IP phone system, at a fraction of the cost with virtually no risk of system
failure. FUSION, the Company's principal product line, uses an external
VoIP gateway to facilitate its use with any service provider utilizing any
protocol.
The Company has not generated significant revenue and is considered to be a
development stage company and as such the financial statements presented
herein are presented in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 7.
On December 9, 2004, (the "Closing Date") Houston Operating Company
("HOOC") entered into an Exchange Agreement with all of the stockholders of
NetFabric (see Note 7) and NetFabric became a wholly-owned subsidiary of
HOOC. This acquisition shall be accounted as a reverse merger acquisition
with NetFabric as the accounting acquirer and HOOC as the accounting
acquiree effective as of December 31, 2004. The financial statements and
notes of NetFabric presented herein represent, without material difference,
its financial position and results of operations immediately prior to
giving effect to the merger with HOOC as of December 31, 2004.
The accompanying financial statements have been prepared on a going concern
basis. As shown in the accompanying financial statements, the Company has
incurred losses in the development stage totaling $1,492,295 and has a
working capital deficit of $795,678 at December 31, 2004. These factors,
among others, indicate that the Company may be unable to continue as a
going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
Management recognizes that the Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to allow the
Company to continue the development of its business plan and satisfy its
F-7
obligations on a timely basis. Management believes that such cash flows
will be funded by additional equity and/or debt financings through the time
in which the Company evolves from the development stage and generates
sufficient positive cash flows from its operations. However there can be no
assurance that management's plans will be able to be achieved.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES USE OF ESTIMATES
The financial statements are prepared in conformity with accounting
principles generally accepted in the United States ("GAAP") and,
accordingly, include amounts that are based on management's best estimates
and judgments. Estimates are used in determining such items as provisions
for bad debts, depreciable/amortizable lives, impairment of long-lived
assets, the fair value of common stock and options issued for services as
well as the allocation of proceeds from the bridge loan to equity
instruments and other reserves. Because of the uncertainty inherent in such
estimates, actual results may differ from these estimates.
REVENUE RECOGNITION
The Company mainly sells its products through distributors and recognizes
revenue when there is an executed agreement between the parties, no further
obligations are required after delivery, the price is defined and the
realization of the receivable is reasonably assured. Through December 31,
2004, revenues and associated gross profit from shipments to the Company's
distributors are deferred until the distributors resell the products to end
consumers. Shipments to distributors are made under agreements allowing
price protection and limited rights to return unsold merchandise. This
policy is a common practice within the industry. Accordingly, NetFabric
receives distribution sales and inventory information regarding its
products from its distributors for the purpose of determining the
appropriate timing of revenue recognition.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company will maintain allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required
payments. These estimated losses will be based upon historical bad debts,
specific customer creditworthiness and current economic trends. If the
financial condition of a customer deteriorates, resulting in the customer's
inability to make payments within approved credit terms, additional
allowances may be required. The Company performs credit evaluations of its
customers' financial condition on a regular basis, and has not experienced
any material bad debt losses to date.
INVENTORY
Inventory consist primarily of finished goods and purchased electronic
components, and are stated at the lower of cost or market. Cost is
determined by using the first-in, first-out method.
F-8
CASH AND CASH EQUIVALENTS
The Company considers all investments purchased with an original maturity
of three months or less to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment, consisting principally of computer equipment and
capitalized purchased software programs, are recorded at cost. Depreciation
and amortization are provided for, using straight-line methods, in amounts
sufficient to relate the cost of depreciable and amortizable assets to
operations over their estimated useful lives. Repairs and maintenance are
charged to operations as incurred.
The Company has adopted statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use". This
statement requires that certain costs incurred or purchasing or developing
software for internal use be capitalized as internal use software
development costs and are included in fixed assets. Amortization begins
when the software is ready for its intended use.
LONG-LIVED ASSETS
Long-lived assets, including property and equipment and intangible assets,
are monitored and reviewed for impairment in value whenever events or
changes in circumstances indicate that the carrying amount of any such
asset may not be recoverable. The determination of recoverability is based
on an estimate of undiscounted cash flows expected to result from the use
of an asset and its eventual disposition. The estimated cash flows are
based upon, among other things, certain assumptions about expected future
operating performance, growth rates and other factors. Estimates of
undiscounted cash flows may differ from actual cash flows due to factors
such as technological changes, economic conditions, and changes in the
Company's business model or operating performance. If the sum of the
undiscounted cash flows (excluding interest) is below the carrying value,
an impairment loss is recognized, measured as the amount by which the
carrying value exceeds the fair value of the asset. Through December 31,
2004, no write-downs of long-lived assets have been recognized.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and accounts
receivable. The Company reduces credit risk by placing its temporary cash
and investments with major financial institutions with high credit ratings.
At times, such amounts may exceed federally insured limits. The Company
reduces credit risk related to accounts receivable by routinely assessing
the financial strength of its customers and maintaining an appropriate
allowance for doubtful accounts.
F-9
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's assets and liabilities that qualify as
financial instruments under Statement of Financial Accounting Standards
("SFAS") No. 107 approximate their carrying amounts presented in the
balance sheets at December 31, 2003 and 2004.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") costs are expensed as incurred. These
expenses include the cost of the Company's proprietary R&D efforts as well
as costs incurred in connection with the Company's third-party
collaboration efforts. The amounts charged to R&D in 2003 and 2004 were $0
and $395,452, respectively.
WARRANTIES
The Company provides a basic limited warranty for its products for one
year. The Company will estimate the costs that may be incurred under its
basic limited warranty and record a liability in the amount of such costs
at the time product revenue is recognized. Factors that affect the
Company's warranty liability include the number of installed units,
historical and anticipated rates of warranty claims and cost per claim. The
Company will periodically assess the adequacy of its recorded warranty
liabilities and adjust the amounts as necessary.
STOCK-BASED COMPENSATION
The Company accounts for stock options granted to employees using the
intrinsic value method in accordance with the provisions of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB Opinion No. 25"), and related interpretations. As such,
compensation expense to be recognized over the related vesting period is
generally determined on the date of grant only if the current market price
of the underlying stock exceeds the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), permits
entities to recognize as expense over the vesting period the fair value of
all stock-based awards on the date of grant. Alternatively, SFAS No. 123
allows entities to continue to apply the provisions of APB Opinion No. 25
and provide pro forma net income (loss) disclosures for employee stock
option grants as if the fair-value-based method defined in SFAS No. 123 had
been applied.
F-10
The Company has elected to continue to apply the provisions of APB Opinion
No. 25 and provide the pro forma disclosures required by SFAS No. 123. If
compensation expense for stock options awarded to employees had been
determined in accordance with SFAS No. 123, the Company's pro forma net
loss would have been as follows:
Year ended, December 31,
2003 2004
-------- -----------
Pro forma net loss, as reported $(18,565) $(1,473,730)
Stock-based employee compensation expense
determined under fair value method - 128,486
-------- -----------
Pro forma net loss, as adjusted $(18,565) $(1,602,216)
-------- -----------
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants: For the year ended December 31, 2003, dividend
yield of 0%, risk-free interest rate of 2.27%, volatility of 100% and
expected life of approximately five years. For the year ended December 31,
2004, dividend yield of 0%, risk-free interest rate of 3.50%, volatility of
100% and expected life of approximately five years. The estimated value of
the options is amortized over their vesting periods of one to four years
for pro forma disclosure only.
In accordance with SFAS No. 123, the Company will also recognize the cost
of shares, options, warrants and other equity instruments issued to
nonemployees as consideration for services as expense over the periods in
which the related services are rendered by a charge to compensation cost
and a corresponding credit to additional paid-in capital. Generally, cost
will be determined based on the fair value of the equity instruments at the
date of issuance, estimated based on the Black-Scholes option-pricing
model, which meets the criteria set forth in SFAS No. 123, and the
assumption that all of the options or other equity instruments will
ultimately vest. The effect of actual forfeitures will be recognized as
they occur.
INCOME TAXES
Deferred income tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Deferred tax assets
are reduced by a valuation allowance if it is more likely than not that the
tax benefits will not be realized. The ultimate realization of deferred tax
assets depends upon the generation of future taxable income during the
periods in which those temporary differences become deductible.
COMPREHENSIVE INCOME (LOSS)
SFAS No. 130, "Reporting Comprehensive Income," establishes standards for
reporting and presentation of comprehensive income (loss) and its
components in a full set of financial statements. The statement requires
additional disclosures in the financial statements for certain items; it
does not affect the Company's financial position or results of operations.
The Company had no items for Comprehensive Income during 2003 and 2004.
F-11
RECENT ACCOUNTING PRONOUNCEMENTS ISSUED, NOT ADOPTED
In February 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity" ("SFAS No. 150"). The
provisions of SFAS No. 150 are effective for financial instruments entered
into or modified after May 31, 2003, and otherwise are effective at the
beginning of the first interim period beginning after June 15, 2003, except
for mandatorily redeemable financial instruments of nonpublic entities. The
Company has not issued any financial instruments with such characteristics.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN No.
46R"), which addresses how a business enterprise should evaluate whether it
has a controlling financial interest in an entity through means other than
voting rights and accordingly should consolidate the entity. FIN No. 46R
replaces FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities", which was issued in January 2003. Companies are required to
apply FIN No. 46R to variable interests in variable interest entities
("VIEs") created after December 31, 2003. For variable interests in VIEs
created before January 1, 2004, the Interpretation is applied beginning on
January 1, 2005. For any VIEs that must be consolidated under FIN No. 46R
that were created before January 1, 2004, the assets, liabilities and
noncontrolling interests of the VIE initially are measured at their
carrying amounts with any difference between the net amount added to the
balance sheet and any previously recognized interest being recognized as
the cumulative effect of an accounting change. If determining the carrying
amounts is not practicable, fair value at the date FIN No. 46R first
applies may be used to measure the assets, liabilities and noncontrolling
interest of the VIE. The Company does not have any interest in any VIE.
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004),
"Share-Based Payment", which amends FASB Statement No. 123 and will be
effective for public companies for interim or annual periods beginning
after June 15, 2005. The new standard will require entities to expense
employee stock options and other share-based payments. The new standard may
be adopted in one of three ways - the modified prospective transition
method, a variation of the modified prospective transition method or the
modified retrospective transition method. The Company is evaluating how it
will adopt the standard and evaluating the effect that the adoption of SFAS
123(R) will have on our financial position and results of operations.
F-12
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4. This statement amends the guidance in
ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4,
previously stated that "...under some circumstances, items such as idle
facility expense, excessive spoilage, double freight, and rehandling costs
may be so abnormal as to require treatment as current period charges..."
SFAS No. 151 requires that those items be recognized as current-period
charges regardless of whether they meet the criterion of "so abnormal." In
addition, this statement requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. The provisions of SFAS 151 shall be applied
prospectively and are effective for inventory costs incurred during fiscal
years beginning after June 15, 2005, with earlier application permitted for
inventory costs incurred during fiscal years beginning after the date this
Statement was issued. The adoption of SFAS No. 151 is not expected to have
a material impact on the Company's financial position and results of
operations.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. The guidance in APB Opinion No.
29, Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value
of assets exchanged. The guidance in that Opinion, however, included
certain exceptions to that principle. This Statement amends Opinion 29 to
eliminate the exception for nonmonetary exchanges of similar productive
assets that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. SFAS No. 153 is effective
for nonmonetary exchanges occurring in fiscal periods beginning after June
15, 2005. The adoption of SFAS No. 153 is not expected to have a material
impact on the Company's financial position and results of operations.
3. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consists of the following at December 31,
2004:
2004
---------
Equipment $14,452
Purchased software 75,440
Software development 90,250
---------
180,142
Less: Accumulated depreciation
and amortization 8,211
---------
$171,931
=========
F-13
4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31, 2003 and 2004:
2003 2004
------------------ -------------------
Trade accounts payable $248 $185,638
Accrued professional fees - 49,273
Accrued interest payable - 13,796
Advances from customers - 7,682
------------------ -------------------
$248 $256,389
================== ===================
5. BRIDGE LOANS
On July 22, 2004, NetFabric entered into a Financing Agreement which was
amended on December 2, 2004 (the "Financing Agreement") with Macrocom
Investors, LLC, ("Macrocom") whereby Macrocom provided a loan to NetFabric
in the amount of $500,000 ("Loan") for a period of 180 days from the
original date of the Financing Agreement ("Due Date") at an annual simple
interest rate of 5%. On the Due Date, the Company has the option to repay
the principal in cash or in kind by issuing 1,000,000 shares of Post
Closing Stock, as defined (effectively, shares of HOOC after giving effect
to the reverse acquisition - see Note 7). In either event, the interest on
the Loan is payable in cash on the Due Date. The Company must issue to
Macrocom 250,000 shares of Post Closing Stock as additional consideration
for the Loan. In January 2005, in accordance with the terms of the
Financing Agreement, the Company elected to repay the principal by issuing
1,000,000 shares of Post Closing Stock.
On October 14, 2004, NetFabric and Macrocom entered into a loan agreement
which was amended on December 2, 2004 (the "Loan Agreement"), whereby
Macrocom agreed to loan an additional $500,000 to NetFabric ("Second
Loan"), due 180 days from the original date of the Loan Agreement ("Second
Due Date") at an annual simple interest rate of 5%. On the Second Due Date,
at the option of Macrocom, Macrocom can convert the principal of the Second
Loan into 1,000,000 shares of Post Closing Stock or demand repayment of the
principal in cash. In either event, the interest on the Second Loan is
payable in cash on the Second Due Date. In addition, NetFabric agreed to
issue to Macrocom 250,000 shares of Post Closing Stock as additional
consideration for the Second Loan.
F-14
Since the actual issuance and availability of Post Closing Stock at the
time of the Financing and Loan Agreements was contingent upon the
consummation of a specified type of merger with a then unidentified entity,
the Post Closing Stock issued as additional consideration was initially
valued based on the estimate of the value of the entity that would result
after such a merger. The Company allocated the proceeds of each loan to the
computed relative value of the debt and equity components of each bridge
loan. The initial amount allocated to the equity component was recorded as
a debt discount at the date of issuance of the respective notes and will be
amortized to interest expense using the effective interest method over the
stated terms of the respective notes. At the time of the resolution of the
contingency regarding the issuance of the Post Closing Stock relating to
the Financing Agreement and Loan Agreement, a final value was computed for
the additional consideration, and the debt discount recorded was revised
and is being amortized over the remaining terms of the respective notes. In
addition, the Loan Agreement, as a result of the debt discount and the
conversion feature had a beneficial conversion feature embedded in the
security, which beneficial conversion feature had a value that was also
contingent upon the consummation of a specified type of merger. A further
discount to the debt was recorded for the value of the beneficial
conversion feature upon the resolution of the contingency when the Post
Closing Stock became available for possible conversion. As a result of
these transactions, total debt discounts for the bridge loans, including
the value of the beneficial conversion feature, of $411,403 were recorded,
of which $161,062 was amortized into interest expense during the year ended
December 31, 2004 and $250,341 is recorded as a discount on the debt and
offset against the carrying value as of December 31, 2004, which remaining
discount will be amortized into interest expense over the remaining terms
of the respective notes.
In addition to the bridge loan transactions described above, Macrocom has
also entered into a commitment to purchase common stock of HOOC subsequent
to the Closing Date, under certain terms. Under this arrangement, Macrocom
received 250,000 shares of Post Closing Stock and a six-month warrant to
purchase 2,000,000 shares of Post Closing Stock at a purchase price of
$1,500,000, provided that the closing price of the merged entity's common
stock on the day immediately preceding the exercise of the warrant is less
than $2.00 per share. The value of the additional consideration paid to
Macrocom as part of this financing commitment, totaling $368,683, has been
recorded as deferred offering costs as of December 31, 2004 on the
accompanying balance sheet, and will be offset against the proceeds of the
additional purchases of common stock as they occur in 2005.
Under the terms of the Financing Agreement, NetFabric also agreed, at its
cost, to file a registration statement for the registration of the Macrocom
stock with the Securities and Exchange Commission as soon as practicable
but no later than 90 days following the Closing Date. If the registration
statement relating to the Macrocom stock is not effective within 180 days
of the Closing Date for reasons not beyond NetFabric's control, NetFabric
will pay Macrocom liquidated damages of 45,000 shares of the common stock
of the Company for each month or any portion thereof, until such
registration statement is effective.
F-15
6. INCOME TAXES
A reconciliation of the statutory U.S. federal income tax rate to the
Company's effective tax was as follows:
For the year ended
December 31, 2003 December 31, 2004
---------------------- ----------------------
Statutory U.S. rate 34.0% 34.0%
State income taxes, net of federal benefit 4.0% 4.0%
Effect of valuation allowance (38.0%) (38.0%)
---------------------- ----------------------
Total income tax expense (benefit) 0.0% 0.0%
---------------------- ----------------------
Significant components of the Company's deferred tax assets at December 31,
2003 and 2004 are as follows:
December 31, 2003 December 31, 2004
---------------------- ----------------------
Tax effect of operating loss carryforwards $8,400 $672,000
Effect of valuation allowance (8,400) (672,000)
---------------------- ----------------------
Net deferred tax assets $0 $0
---------------------- ----------------------
At December 31, 2004, the Company had net operating loss ("NOL")
carry-forwards of approximately $1.5 million which expire through 2024,
subject to certain limitations. A full valuation allowance has been
established because of the uncertainty regarding the Company's ability to
generate income sufficient to utilize the tax losses during the
carry-forward period.
7. STOCKHOLDERS' EQUITY
In May 2004, the Company effected a 3.3 for 1 stock split of its common
shares. All per share information in the accompanying financial statements
and notes has been retroactively adjusted to reflect this event.
In December 2003, the Company sold 50,000 shares of the Company's common
stock along with a warrant to purchase 50,000 shares of common stock, at an
exercise purchase price of $0.50 per share, resulting in aggregate proceeds
of $25,000. The warrants are immediately exercisable and terminate on the
earlier of (i) the fifth anniversary of the issue date or (ii) the
consummation of a Qualified Public Offering, as defined.
F-16
The Company sold an additional 500,000 shares of common stock at various
dates through April 20, 2004. In connection with the sale of certain of
these shares to other investors the Company issued 300,000 warrants on the
same terms and conditions as described in the preceding paragraph. In 2004,
the Company also issued 200,000 shares of common stock (valued at $100,000)
as payment for certain expenses.
On December 9, 2004, (the "Closing Date") HOOC entered into an Exchange
Agreement (the "Acquisition Agreement") with all of the stockholders (the
"Stockholders") of NetFabric. At the Closing, which occurred at the same
time as the execution of the Acquisition Agreement, HOOC acquired all of
the issued and outstanding capital stock of NetFabric from the Stockholders
in exchange for an aggregate of 32,137,032 newly-issued shares of the
HOOC's common stock. After the Closing and certain related transactions,
the merged entity had approximately 33,902,204 shares of common stock
outstanding. Since the Stockholders of NetFabrics received the majority of
the shares of the merged entity and HOOC had no significant assets and
liabilities or operations prior to the merger, the merger will be
accounted for as a reverse acquisition in which NetFabrics will be the
acquirer for accounting purposes. Since NetFabrics will be the accounting
acquirer, the merger, which will be accounted for, effectively, as of the
close of business on December 31, 2004, will not have any effect on the
recorded assets and liabilities of NetFabrics or its revenues and
expenses.
8. STOCK-BASED COMPENSATION
From time to time, the Company issues stock-based compensation to its
officers, directors, employees and consultants. The maximum term of options
granted is generally 10 years and generally options vest over a period of
one to four years. However, the Board of Directors of the Company may and
has approved other vesting schedules. The Company has issued options to
employees and non-employees under stock option agreements. Options may be
exercised in whole or in part.
The exercise price of the stock options granted is the fair market value of
the Company's common stock as determined by the Board of Directors on the
date of grant, considering factors such as the sale of stock, results of
operations, and consideration of the fair value of comparable private
companies in the industry. Accordingly, no charges were recognized.
During the years ended December 31, 2003 and 2004 the Company recognized
nonemployee compensation expense of $1,370 and $60,059 as a result of
issuing options, respectively, which is included in general and
administrative expenses on the accompanying statements of operations. The
unamortized value of such stock issuances totaling $8,019 and $63,679 at
December 31, 2003 and 2004, respectively, are included in prepaid expenses
(for the current portion) and other assets (for the noncurrent portion) on
the accompanying balance sheets. Such amounts will be amortized into
expense over the respective vesting periods of the options.
F-17
The following is a summary of the Company's stock option activity for the
years ended December 31, 2003 and 2004:
Options Weighted Average Weighted Average
Exercise Price Fair Value
------------------- ------------------ ------------------
Options outstanding January 1, 2003 - $ - $ -
Options granted 25,000 0.50 0.50
Options exercised - - -
Options cancelled - - -
------------------- ------------------ ------------------
Outstanding, December 31, 2003 25,000 $0.50 $0.50
Options granted 1,191,250 0.50 0.50
Options exercised - - -
Options cancelled - - -
------------------- ------------------ ------------------
Outstanding, December 31, 2004 1,216,250 $0.50 $0.50
=================== ================== ==================
Exercisable, December 31, 2004 343,750 $0.50 $0.50
=================== ================== ==================
Exercisable, December 31, 2003 - $0.50 $0.50
=================== ================== ==================
The options outstanding at December 31, 2004 have an exercise price of
$0.50 per share and have a weighted average remaining contractual life of
approximately 9.25 years. No options have been exercised to date.
On the Closing Date all NetFabric outstanding stock options were exchanged
for options in HOOC at an exchange ratio consistent with the ratio in the
exchange of common stock.
9. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office space under an operating lease, which covers a
period from January 1, 2004 through December 31, 2005, subject to certain
renewal options. In accordance with the terms of the lease agreement, the
Company issued 100,000 shares of common stock to the landlord in lieu of
rent payments for the entire lease period. The value of one half of such
shares of $50,000, representing one half of the lease period, was recorded
as rent expense for the year ended December 31, 2004. The remaining value
of $50,000 was recorded as prepaid rent expense and will be charged to the
statement of operations in 2005.
Litigation
From time to time, in the normal course of business, the Company may be
involved in certain litigation and/or proceedings. The Company is not aware
of any matters pending that could have a material adverse effect on the
Company's financial condition or results of operations.
The July 22, 2004 Agreement
The July 22, 2004 Agreement required the Company to provide Macrocom with
1,000,000 shares of post-closing stock in HOOC in connection with Macrocom
providing a public shell company. The parties to this contract orally
agreed to waive such requirement, however a final agreement has not been
executed. Accordingly, the merged entity could be required to issue
additional shares.
F-18
SIGNATURE
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 hereunto duly authorized.
Dated: February 22, 2005
HOUSTON OPERATING COMPANY
By: /s/ Jeff Robinson
------------------------------
Name: Jeff Robinson
Title: Chief Executive Officer
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