UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
Commission file number:
HOUSTON OPERATING COMPANY
-------------------------
(Name of Small Business Issuer in Its Charter)
Delaware 76-0307819
(State of Incorporation (I.R.S. Employer
or Organization) Identification No.)
67 Federal Road, Building A
Suite 300
Brookfield, CT 06804
(Address and Telephone Number of Principal Executive Offices
and Principal Place of Business)
(203) 775-1178
(Issuer's telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act: NONE.
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.001 par value
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities 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.
[X] YES [ ] NO
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [____]
State issuer's revenues for its most recent fiscal year: $612
The aggregate market value of the voting stock held by non-affiliates per the
closing stock price of December 31, 2004 is $6,921,822.
As of January 22, 2005, 36,652,204 shares of common stock of the issuer were
outstanding.
TABLE OF CONTENTS
PART I .............................................................1
ITEM 1. DESCRIPTION OF BUSINESS........................................1
ITEM 2. DESCRIPTION OF PROPERTY........................................8
ITEM 3. LEGAL PROCEEDINGS..............................................8
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS.............8
PART II ...............................................................9
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................9
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................9
ITEM 7. FINANCIAL STATEMENTS..........................................19
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE...........................19
PART III ..............................................................21
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS
AND CONTROL PERSONS...........................................21
ITEM 10. EXECUTIVE COMPENSATION........................................23
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT................................................26
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................28
ITEM 13. EXHIBITS AND REPORTS..........................................28
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES........................29
SIGNATURES ..............................................................30
PART I
From time to time, including in this annual report on Form 10-KSB, Houston
Operating Company (the "Company" or "we") may publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, future operations, new products, research and development activities
and similar matters. The Private Securities Litigation Reform Act of 1995
provides a safe harbor for forward-looking statements. In order to comply with
the terms of the safe harbor, we note that a variety of factors could cause our
actual results to differ materially from the anticipated results or other
expectations expressed in our forward-looking statements. The risks and
uncertainties that may affect the operations, performance, development and
results of our business include, without limitation, the following: general
economic and business conditions, both nationally and in our markets; our
expectations and estimates concerning future financial performance, financing
plans, acquisitions or mergers, and the impact of competition; our ability to
implement our acquisition and growth strategy; anticipated trends in our
business; advances in technologies; and, other risk factors set forth under
"Risk Factors" beginning on page 15 in this report.
ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS HISTORY
Houston Operating Company ("HOC") was incorporated in Delaware in August of
1989, and has not had operations since before 2002. NetFabric Corporation
("NetFabric") was incorporated in the State of Delaware on December 17, 2002, as
a new corporation and not as a result of a material re-classification, merger,
consolidation, purchase or divestiture. On December 9, 2004, HOC entered into an
Acquisition Agreement with all of the stockholders of NetFabric in a transaction
that was accounted for as a reverse merger whereby NetFabric was treated as the
accounting acquirer. At the closing, which occurred at the same time as the
execution of the Acquisition Agreement, HOC 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 Company's common stock (the
"Acquisition"). In this report, "we," "us," "our company," "the Company," and
"our" refer to Houston Operating Company and its consolidated subsidiary
NetFabric unless the context requires otherwise.
DESCRIPTION OF BUSINESS
The Company develops and sells a family of IP appliances that simplify the
incorporation of any telephone system into a company's IP infrastructure while
reducing the cost of telephone calls. The Company's products deliver
productivity gains to small and medium sized businesses with cost reductions
while maintaining PSTN class reliability and ease of use. The market for the
Company's products is a multi-billion dollar marketplace and the Company, to its
knowledge, is the one of the first companies to introduce customer premises
equipment ("CPE") that transforms the consumer VoIP services from many providers
into one that is reliable enough to be used in a business environment.
Additionally, this CPE provides an applications platform for the distributed
deployment of network services that add substantially to the value of VoIP to
both the end-user and service provider.
THE MARKET
MARKET DESCRIPTION
Companies generally seek to improve productivity and reduce costs. Major
productivity and cost-reduction improvements have been achieved in recent years
through the use of IP data networks.
Some examples of the use of IP data networks to realize productivity
improvements include the coupling and integration of a website to accounting and
other backend systems; the use of a virtual private network to integrate the
data infrastructures of various offices and remote workers; and, the use of IP
data networks to enable e-mail and instant messaging for general communications.
All of these applications and services run on an IP infrastructure that
ensures that different vendors' hardware and software are operationally
compatible. Today's business infrastructure is about inter-operation and is
rapidly moving away from proprietary technology or products.
One major element in practically every company's infrastructure that is not
only proprietary but is usually isolated from the business data system is the
telephone system. We believe that this isolation of the telephone system will
become an increasing liability to companies that do not upgrade, since they will
fail to realize the benefits that would be achieved by integrating the telephone
system with other business data systems.
By integrating a business's telephone system with its data system the
business would obtain more flexible and lower cost communications that can
seamlessly couple branch offices and remote workers. In addition, the business
will be able to easily control call routing from traditional software
applications running anywhere on the network. For example, this use of
traditional software applications could ensure that a company complies with the
new federal "Do Not Call" list and help that company to avoid fines or lawsuits.
Similarly, businesses can tie in the routing of calls with a schedule that is
kept in applications such as Microsoft Outlook. Both of these applications are
simple to implement with an IP based system but are difficult to implement with
legacy products. Another benefit achieved by integrating the telephone system
with data systems is that the telephone system will be able to drive computer
applications through facilities such as speech recognition and speech synthesis.
Interactive voice response systems can be more intelligent and may become an
alternate portal into the company alongside the website.
IP telephony is the vehicle for integrating telephone systems and data
systems. Just as the personal computer was not a "next generation typewriter,"
the IP telephone system is not the next generation of the PBX. Integrating voice
as an application within the corporate information systems will be essential to
remain competitive in the present business environment.
The use of IP telephone systems is well established in large enterprises.
Large enterprises have information technology organizations and can bring the
necessary financial and intellectual resources to bear on the migration to IP
telephony. The solutions from Cisco and others require considerable cost and a
high level of networking expertise to both install and maintain these IP
telephone systems. Despite these issues, large companies have achieved
significant returns on their investment in IP telephony.
Although IP telephony has been broadly adopted by large enterprises, it has
largely failed to make the same in-roads into our intended market. The lack of
success with the small to medium sized business ("SMB" OR "SMBS") centers is
based upon the absence of an information technology organization and frequently
poor or variable quality wide-area data connections, making the use of IP
telephone systems unreliable. Additionally, capital expenditure and maintenance
issues associated with an IP PBX are often perceived as prohibitively high,
which is due in part to the lack of networking skills in the Value Added
Reseller ("VAR") and the usually small companies that provide telephone systems,
wiring and other services to the SMBS ("Interconnects").
Given these issues, the overwhelming majority of SMBS continue to employ
traditional telephone systems. We believe that SMBS need a solution that retains
the reliability of the installed PSTN system while offering a cost-effective
VoIP solution. Therefore, we have developed and sell a family of telephony IP
appliances that are reliable, cost-effective, and easy to install, and which
provide VARs and Interconnects with the ability to sell new products in the VoIP
space along with their existing telephony services. Our products also appeal to
the SMB because they avoid the large capital costs and risks of a complete
upgrade to an IP telephone system, while receiving the majority of the benefits
of an IP solution and maintaining PSTN reliability.
MARKET SIZE
The size of the US small and medium sized business market for the Company
products is estimated to be in excess of $3.4 billion. The market was estimated
in the following manner:
1) Using US Government's census data to determine business demographics;
2) Making assumptions that the number of extensions per trunk increases as
the size of the company increases;
2
3) Estimating from the number of trunks and average selling price for the
Company products, the potential market size.
The Company will focus its sales and marketing efforts on companies with
fewer than 100 employees ("the Company Market"). Taking the average end-user
price of the Company products and dividing that by the number of PBX trunks
served in the Company Market, the Company can derive the potential revenue
generated per trunk, and thus for the Company Market as a whole. Using this
approach, the US domestic market for the hardware component alone of the Company
products exceeds $3.3 billion.
Total Employees
Employees Number of Firms Employees line/(1)/ Trunks/(1)/ Revenues/(2)/
- --------- --------------- --------- --------- ----------- -------------
1 to 4 2,697,839 5,630,017 1.0 5,630,017 $844,502,550
5 to 9 1,019,105 6,698,077 1.5 4,465,384 $669,807,600
10 to 19 616,064 8,274,541 2.0 4,137,270 $620,590,500
20 to 99 518,258 20,370,447 2.5 8,148,178 $1,222,226,700
Totals 4,851,266 40,973,082 TOTAL SMB MARKET $3,357,127,350
Source: US Government 2001 Business Census: http://www.census.gov/epcd/www/smallbus.html
- --------------------
(1) Company estimate
(2) Assumes an average selling price per trunk of $150. By telephone
"trunk" we mean usually large-bandwidth telephone channels between switching
centers and/or an end-user customer's premises.
It is anticipated that the Company will only penetrate a percentage of this
$3.3 billion market, as not every potential end-user customer is going to
purchase a Company product. In addition to hardware revenue, the Company has
developed and will continue to develop software and service offerings, which the
Company expects will generate additional revenue with higher margins and lower
distribution costs. Also, with the introduction of the Advanced Product Family
the potential revenue per trunk could be higher. This is a result of the
increased functionality that is contained in the Advanced Product Family.
Finally, the Company products may be attractive to large companies that
have multiple or branch offices, as a cost-effective solution for providing
internal communications, which would therefore generate additional revenue for
the Company.
THE COMPANY'S PRODUCTS
FUSION PRODUCT FAMILY
The Company's FUSION product family, which today includes the FUSION 4x4
and FUSION 12x8, (together, the "FUSION Product Family") uses an external VoIP
gateway to facilitate its use with any service provider utilizing any VoIP call
control protocol.
FUSION 4X4 - STANDARD FUNCTIONALITY
The Company's FUSION 4x4 product offers 4 trunks (i.e., lines that come
into a company's premises from the outside network whether from the PSTN or a
VoIP service provider's network) and 4 lines (i.e., connections on the customer
premises station side of the company's network usually coming from the Private
Branch Exchange ("PBX") or Key System). This product also includes an
intelligent call router that uses least cost router algorithms plus
Quality-of-Service ("QoS") measurement. QoS enables the traditional telephone
network to be used as a safety net when the VoIP network is impaired to ensure
that telephone calls will go through so long as PSTN service is available. The
system also ensures that emergency (e.g., 911) calls are automatically routed to
the proper authorities and provides the location of the caller via the PSTN
3
lines an end-user customer maintains. Properly routing emergency calls can be an
issue with VoIP deployments if a customer does not manually register its
geographic location with the proper authorities.
The FUSION 4x4 product also features a "call state server" that generates
"informational events" in the form of IP packets. Local or remote clients can
subscribe to this service which can be used for simple name and number pop-up,
through client record pop-ups in Customer Relationship Management ("CRM") or
other database packages such as Microsoft Outlook.
The FUSION 4x4 also features an integrated time client that uses network
timeservers for accurate call logs. This product also has a fail-safe with power
outage connecting trunk 1 to line 1, trunk 2 to line 2, etc. The FUSION 4x4 uses
network based administration to simplify either local or remote configuration of
the unit.
FUSION 12X8 - STANDARD FUNCTIONALITY
The FUSION 12x8 product contains all of the functionality of the FUSION 4x4
product plus additional capabilities. The FUSION 12x8 product features port
expansion. This product provides additional VoIP lines without sacrificing any
of the current analog connections. The FUSION 12x8 offers 12 trunks into an 8
line PBX. The FUSION 12x8 also features dial plan translation, which allows
calls to be routed automatically to different providers and make the dialed
number correspond to the service provider's parameters. For example, a local
call dialed as 755-1178 is routed over the PSTN telephone network unchanged, but
if it is routed over VoIP, the number is modified by FUSION to 1-203-755-1178
(i.e., includes all 11 digits required by a VoIP provider).
OPTIONAL FEATURES AND APPLICATIONS FOR FUSION
The Company's FUSION Product Family may also include an optional call
validation interface for "Do Not Call" and similar applications. FUSION can
connect to call validation servers across an IP network connection. This feature
allows for enterprise-wide deployment of call control policies to any legacy PBX
or even to discrete telephones.
SOFTWARE APPLICATIONS
The FUSION Product Family distinguishes itself by having a range of
applications that run in association with the hardware. This adds versatility
and value in the IP telephony market that is akin to the one enjoyed by the
personal computer in the office software market.
The majority of the Company's software is either browser-based or written
in Java for platform independent deployment, allowing end-user customers to run
Windows, Macintosh or Linux seamlessly with the Company software. The Company's
initial software portfolio comprises a standard software application package
that is shipped with every hardware unit and two optional applications packages,
as described below.
STANDARD SOFTWARE APPLICATION PACKAGE
The standard software application package includes a simple graphical user
interface that allows for configuring the FUSION product within the existing
telephone system to route calls the way the business chooses to route them - for
instance, local calls to the PSTN and long-distance calls to the VoIP provider.
The standard package also includes a network time client that provides accurate
and automatic setting of the internal clock. Network accessible call logs are
also included in the standard package to provide for the listing of all inbound
and outbound calls on either PSTN or VoIP trunks.
The time client is used for accurate record keeping. The call log also
provides information regarding the number of rings occurring before the call is
answered or abandoned which is useful for assessing the performance of customer
support and sales groups of service organizations. The log can be customized by
the end-user and utilized for input to billing packages.
4
CALL STATE CLIENT
The call state client software package includes the features of the
standard software package plus pop up caller ID with name, number and trunk.
This feature identifies the caller and allows the appropriate person to receive
the call or direct the call to voice mail(s) or even email(s). The call state
client package also includes a call monitor, which displays names and/or number
of inbound and outbound calls on any trunk of the PBX and also displays the
length of the call, which is effective for the remote monitoring of branch
offices and customer support facilities. This package also interfaces with CRM
packages for client record pop-up. This package is usually associated with very
high-end systems but is now available at a cost-effective price.
CALL VALIDATION CLIENT
The call validation client software package provides dialogs with an
external database to check whether the current call is allowed to proceed or
whether it should be dropped. This function may be used, for example, by
businesses for the direct implementation of the "Do Not Call" requirement that
is now a federal mandate. The call validation client software allows tracking of
all calls and lists those calls that were blocked. Many companies are required
to track calls in this manner in order to show the efforts they are making to
comply with the law.
PRODUCT STRATEGY
The Company's product strategy assumes that potential end-user customers
will use a VoIP service provider for branch-to-branch and long distance calling.
VoIP service providers have been unable to penetrate the small to medium sized
business market because of perceived issues with cost, reliability, ease of use,
quality of service and potential Emergency 911 problems. The Company's products
solve these and other problems and deliver end-user customers a fast return on
their investment in the Company's products that can be measured in months rather
than years.
The Company's product strategy has two phases, which are described below.
PHASE 1 - THE FUSION PRODUCT FAMILY
Phase 1 of the Company's product strategy involves creating products that
provide reliable access to VoIP services with the use of an external VoIP
gateway. The use of an external gateway obviates the need to have each and every
service provider port their authentication, billing, and monitoring code across
to the Company's products. Furthermore these gateways are either provided for a
nominal fee or even free of charge, and thus the end-user has a very
cost-effective way to work with any service provider. The FUSION Product Family
includes the following:
o Call router
o Call state client
o Call validation client
o Network accessible call logs
These products deliver several benefits to SMB customers. These products
use VoIP to reduce the cost of telephone calls. The use of VoIP is also a method
of better accommodating remote workers and a way of seamlessly integrating
separate branch offices. These products provide access to call state services
for productivity enhancements such as client record pop up, call logs and call
monitoring. In addition, the Company's FUSION Product Family allows for simple
deployment of a broad array of new, easily customized services that couple
telephone and data systems such as the "Do Not Call" register, the "VIP" call
pop-up, and easy to access logs of all incoming and outgoing calls made by the
business.
Production of the FUSION 4x4 began in early 2004 and won a "Best of Show"
award at its introduction at the February 2004 Internet Telephony Conference and
Expo in Miami.
5
PHASE 2 - ADVANCED PRODUCT FAMILY
Phase 2 of the Company's product strategy - the "Advanced Product Family" -
provides a tightly integrated solution coupled with a more sophisticated
applications platform. The Company is presently developing this Advanced Product
Family and intends for this highly integrated unit to be the service provider's
"product of choice" in the deployment of their voice services to SMBS.
PRODUCT SALES AND DISTRIBUTION SALES CHANNELS
The Company primarily employs an indirect sales model that comprises the
following:
o Master Distributors
o Service Providers
o Original Equipment Manufacturers ("OEM")
o Retailers
Master Distributors sell primarily to Value Added Resellers ("VARS") and
Interconnects. Although Master Distributors represent an attractive distribution
channel initially, since the Company believes they represent the easiest
distribution partner group to penetrate, the Company believes they are limited
in their ability to significantly increase sales of the Company's products in
the longer term. The Company currently works with the following Master
Distributors:
o Williams Telecommunications Corp. (www.williamsglobal.com)
("Williams")
o ABP Technology, Inc. (www.abptech.com) ("ABP")
o CoMatrix, Inc. (www.comatrix.com) ("CoMatrix")
Service providers are potentially the largest long-term sales channel for
the Company. The Company is currently in negotiation with a broad range of
service providers from small companies such as Broadvoice, Inc. to national
providers including major long distance carriers and notable Regional Bell
Operating Companies (RBOC"). Ultimately, the Company seeks to have its products
become the standard for major service providers to deploy services to SMB
customers.
OEMs represent another major long-term revenue stream for the Company.
Existing PBX or other telecom equipment vendors might add the Company's products
to their portfolio to rapidly bring VoIP capability to legacy products. This
type of interaction with an OEM is called private labeling and the Company has
already begun to negotiate these types of relationships.
Another type of OEM transaction would be to adapt one or more of the
Company's products to meet certain specific needs, for example, redesigning the
product to fit a particular board size and connector pin configuration so that
the Company's product can plug into the OEM's existing card cage. The Company
expects to be involved in this type of activity in the future, but has no such
relationships today.
The retail channel is becoming a marketing channel for the Small Office
Home Office ("SOHO") market. Companies such as Best Buy Co., Inc and others are
focused on the SOHO market and have invested in their own product installation
and configuration teams. The Company is in discussions with companies in this
market with the expectation that they will represent a major source of revenue
in the future.
Also, the Company presently employs two direct sales representatives, and
may add more in the future if this direct sales channel proves effective.
DISTRIBUTORS
The Company has a written agreement with Williams, whereby Williams
purchases and resells the Company's products to end-users and VARS, and for use
in conjunction with its own customer product offerings. Under the terms of the
agreement, Williams orders products directly from the Company. The Company ships
those products as directed by Williams and invoices Williams on a net 30 day
6
basis. Williams offers a full range of products and services and also resells to
1,000 dealers in Canada and 500 dealers in the US.
The Company currently has a non-binding verbal distribution agreement with
ABP, whereby ABP purchases and resells the Company products to VARS and small
service providers. Under the terms of that agreement, ABP orders products
directly from the Company. The Company ships those products as directed by ABP
and invoices ABP on a net 30 day basis. The Company chose ABP for its expertise
in IP networking, specifically VoIP products. ABP is currently a distributor for
companies such as AudioCodes, Ltd. and SNOM technology AG and would have the
capability to bundle the Company's products for more complete solutions. More
importantly, ABP is actively seeking products that are easy to sell and have
mass-market appeal. ABP covers North, Central and South America through
approximately 200 VARS.
The Company currently has a non-binding verbal distribution agreement with
CoMatrix, whereby CoMatrix purchases and resells the Company products to
Interconnects, integrators and VARS. Under the terms of that agreement, CoMatrix
orders products directly from the Company. The Company ships those products as
directed by CoMatrix and invoices CoMatrix on a net 30 day basis. The Company
selected CoMatrix as a distributor for its products because CoMatrix is largely
focused on the traditional telephony Interconnect. The Company's product is the
first IP appliance CoMatrix has successfully installed at an end-user customer
site. CoMatrix works with approximately 4,000 VARS and Interconnects and plans
major mailing efforts and training sessions for its customers regarding IP
telephony. The Company believes it will be important to these VARS that a Master
Distributor or super-VAR such as CoMatrix, perceived as understanding the
telephone business, endorses the Company's IP products.
TRAINING THE SALES, DISTRIBUTION AND INSTALLATION CHANNELS
In support of the Company's sales and distribution channels, the Company
has instituted a comprehensive training program that is delivered via the
Company's extranet. The extranet is augmented by live training delivered over
WebEx on-demand web meetings applications. The Company intends to efficiently
train large numbers of VARS, Interconnects and other personnel involved in the
sales, distribution and installation of products. In 2005, the Company intends
to further augment this program with the introduction of official Company
certification programs.
MANUFACTURING AND COMPONENT SUPPLY
The Company uses Kimchuk, Inc. (www.kimchuk.com) ("Kimchuk") for its
manufacturing operations. The Company's relationship with Kimchuk is not
formalized in a written agreement, but is determined by the parties on a
manufacturing lot-by-lot basis. That is, the Company provides Kimchuk with a
non-binding rolling 90-day forecast of its manufacturing needs. Each month, the
Company communicates by purchase order to Kimchuk the products and number of the
Company units Kimchuk should manufacture for the Company for the month. When
Kimchuk has manufactured those units and placed them in its inventory, Kimchuk
invoices the Company on a net 30 day basis. The price of the units to the
Company is also determined by the parties on a lot-by-lot basis.
DEPENDENCE ON SPECIFIC CUSTOMERS
The Company anticipates that its revenue will be more dependent on critical
sales channels rather than specific end-user customers. The Company is creating
a relatively small number of business relationships with major service providers
and equipment vendors. The revenue that will ensue from these relationships is
expected to form a large percentage of the Company's total revenue.
COMPETITION
The Company believes its approach in using CPE to elevate consumer grade
VoIP services to business class service is unique. The Company believes it is
also unique in providing an applications platform for the improved distribution
of a host of telephony related services. Thus, the Company is not aware of any
direct competition to its products. However there are a number of companies that
7
have VoIP gateways and that can intelligently route calls between the PSTN and
VoIP.
The most notable of these is Quintum Technologies, Inc. ("Quintum"). The
Quintum product is principally focused on the traditional VoIP gateway
application, namely the construction of an internal enterprise VoIP telephone
system. Quintum can reroute to the PSTN during the telephone call, whereas the
Company cannot. However, Quintum requires installation of its proprietary
hardware at both ends of the call, which prohibits its use with the majority of
the current VoIP service providers. Also, the Quintum product does not contain
an applications platform. Other notable companies with routing capabilities to
the PSTN would include B.O.S. Better Online Solutions, Ltd. ("BOScom") and
Multi-Tech Systems, Inc ("MultiTech").
Other than Quintum, BOScom, MultiTech and similar companies with solutions
that can deliver hybrid PSTN/VOIP solutions, there is also the general adoption
of pure IP telephone systems, which have the potential to provide similar
capabilities to those of the Company products. However, the Company believes
that this migration will not occur during the coming decade.
INTELLECTUAL PROPERTY
The Company has two patents pending on the technology used in its products.
The first patent application, filed in March 2003, provides details regarding
the way in which IP appliances can be used, administered or otherwise controlled
from a web page contained elsewhere in the Internet. This process essentially
provides a new means for rich graphics, instant updates, ease-of-use and product
branding that does not exist today. This technology is broad in scope and could
be applied to any IP appliance, not just the Company's IP devices.
The second patent application, filed in June 2003, provides details
regarding a new call routing technique that provides much lower costs, with
increased product robustness. This technology is at the heart of the FUSION 4x4
Product Family.
EMPLOYEES
As of December 31, 2004, the Company directly employs approximately 12
people in the United States of America. Our employees are not represented by
labor unions or collective bargaining agreements. We have not experienced any
work stoppages anywhere, and consider our relations with our employees to be
good.
ITEM 2. DESCRIPTION OF PROPERTY
DESCRIPTION OF PROPERTY
The Company's headquarters are located at 67 Federal Road, Building A,
Suite 300, in Brookfield, CT. The Company leases office space under a two-year
operating lease with Silvermine Investors, LLC ("Silvermine"), which expires on
December 31, 2005 (the "Lease"). Under the terms of the Lease, the Company has
paid one dollar and issued 200,000 shares of common stock to Silvermine as
consideration for use of the office space during the term of the Lease. Prior to
2004, the Company operated rent-free from the primary residence of Jeff
Robinson, co-founder and current CEO and Chairman, and the offices of Fred
Nazem, co-founder and former Chairman and CEO.
ITEM 3. LEGAL PROCEEDINGS
LEGAL PROCEEDINGS
The Company is currently not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None.
8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
A. Our Common Stock is quoted on the NASD's Over-the-Counter Bulletin Board
under the trading symbol "HOOC" The Company was formed in Delaware in August
1989, and has been quoted on the NASD's Over-the-Counter Bulletin Board since
March of 2001. The following table sets forth the range of high and low closing
sales prices (based on transaction data as reported by The NASDAQ SmallCap
Market and the NASD's Over-the-Counter Bulletin Board) for each fiscal quarter
during the periods indicated.
HIGH LOW
---- ---
YEAR ENDING DECEMBER 31, 2004
First Quarter $0.20 $0.20
Second Quarter $0.20 $0.20
Third Quarter $0.20 $0.20
Fourth Quarter $3.40 $0.20
YEAR ENDED DECEMBER 31, 2003
First Quarter $0.35 $0.35
Second Quarter $0.35 $0.35
Third Quarter $0.35 $0.20
Fourth Quarter $0.20 $0.20
YEAR ENDED DECEMBER 31, 2002
First Quarter $0.51 $0.51
Second Quarter $0.51 $0.51
Third Quarter $0.40 $0.35
Fourth Quarter $0.35 $0.35
At December 31, 2004, the number of stockholders of record was
approximately 434 (excluding beneficial owners and any shares held in street
name or by nominees).
We have not paid any dividends upon our common stock. The payment of common
stock dividends, if any, in the future rests within the discretion of our board
of directors and will depend, among other things, upon our earnings, capital
requirements and financial condition, as well as other relevant factors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
REVIEW OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the consolidated
financial statements and accompanying notes and the other financial information
appearing elsewhere in this report and reports included herein by reference. The
following discussion contains forward-looking statements that reflect our plans,
estimates and beliefs. Our actual results could differ materially from those
discussed in the forward-looking statements.
Our auditors have indicated in their report dated March 30, 2005 that
because the Company is in the development stage, has had net losses from
inception and has working capital and net capital deficiencies. Their report
indicates that these matters raise substantial doubt about the Company's ability
to continue as a going concern. Our plan with regard to this matter is discussed
elsewhere in this document. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
9
CORPORATE HISTORY
Houston Operating Company was incorporated in Delaware in August of 1989,
and has not had operations since before 2002. NetFabric was incorporated in the
State of Delaware on December 17, 2002, as a new corporation and not as a result
of a material re-classification, merger, consolidation, purchase or divestiture.
On December 9, 2004, HOC entered into an Acquisition Agreement with all of the
stockholders of NetFabric in a transaction that was accounted for as a reverse
merger whereby NetFabric was treated as the accounting acquirer. At the closing,
which occurred at the same time as the execution of the Acquisition Agreement,
HOC 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 Company's common stock.
BUSINESS AND PLAN OF OPERATION
The Company, headquartered in Brookfield, CT, is a provider of hardware and
services to the burgeoning sector of the telecom industry that utilizes the
Internet for telephone and data communications. Specifically, the company offers
distributed Voice over Internet Protocol (VoIP) platforms, as well as Services
over IP (SoIP) solutions, that provide small to mid-sized Businesses (SMBs) and
Enterprise Branch Offices (EBOs) with a flexible migration path to an all-IP
infrastructure. The large and very lucrative market of more than 4.9 million
SMBs and EBOs that the Company targets is sometimes referred to collectively in
this document as "Small Offices."
The Company develops and markets small office Customer Premises Equipment
(CPE) in the form of integrated telephony services platforms that provide
businesses with a flexible VoIP migration path from a legacy PBX to IP
softswitch. The Company will build and deploy the server side of the advanced
Services over IP that enable its distributed edge devices to deliver to Small
Offices the improved business efficiencies, competitive advantages and
significant cost savings of IP that previously were only available to larger
enterprises.
The Company's initial product offering, the FUSION line of Intelligent Call
Directors, allows Small Offices to combine the power of VoIP services with the
reliability of their existing phone system as the latter is used often as a back
up. With FUSION, small offices can reap the benefits of IP services without
costly forklift upgrades to their telecom infrastructure.
IP phone systems inherently network with other IP devices, whereas
traditional phone systems are standalone entities. There is tremendous power and
utility in having the phone system be an integral part of the information
systems of a company. Applications can now incorporate telephony as an element
of their functionality in the same way they might incorporate access to a
database or a website or any other informational system in a business. There is
inherent flexibility and increased efficiency in essentially all systems within
the Company speaking the same language.
The Company's products, coupled with its SoIP offerings and VoIP transport
from Service Providers, will transition the Company's sales strategy over time
from product marketing to application license marketing which we believe will
create a steady and predictable stream of monthly recurring revenue. Services
could include unified ordering and inventory systems, distributed phone systems,
find me/follow me, click to talk and call control applications for example.
The Company markets and sells its products to SMBs through Value Added
Resellers (VARs), Service Providers and OEM relationships, and will sell to
Fortune 500 Enterprise Branch Office (EBO) customers, through a direct
consultative sales organization.
The Company's target markets are the SMBs and EBOs -- initially businesses
with key/hybrid telecom systems with fewer than 40 stations. The target market
represents 66% of the key/hybrid market with over 4 million systems installed in
the US. In 2003, the SMB market in the U.S. for IP Telephony services generated
about $300M. By 2009, this market is expected to explode to almost $4.5B.
Although VoIP deployment within large enterprise and residential markets is
moving forward rapidly, the adoption of VoIP for use in Small Offices has, until
now, been lagging. Given that this is a huge market that could benefit
10
significantly from the inherent cost-savings, flexibility and productivity gains
of VoIP, offering a product that allows Small Offices to migrate to VoIP without
the risks of a forklift equipment upgrade is extremely attractive to the Company
partners.
The Small Office market requires a total VoIP solution that is simple to
understand, purchase and transition into their business operations. The Company
kept these requirements in mind when building its initial product, FUSION, which
allows the business owner to keep his legacy telecom equipment, doesn't change
anything about the way that employees use their phones and, most importantly,
doesn't jeopardize the quality and reliability they have come to expect from
their phone system.
[GRAPHIC OMITTED]
The VAR channel that serves this market requires a solution that is easy to
sell, install and support. By definition, the Company designed its products to
be simple to explain, install, configure and support so as to attract the
largest number of partners selling to the Small Office market. In addition, the
Company started early to build relationships with major VoIP Service Providers
so that the transport service could be bundled with FUSION and fast ROI
scenarios could easily be demonstrated to the business customer.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2004 COMPARED TO DECEMBER 31, 2003
As previously noted, the December 9, 2004 Acquisition has been accounted
for as a reverse merger whereby NetFabric was treated as the accounting
acquirer. Accordingly, the historical financial statements of NetFabric have
been presented for all periods required. As NetFabric had no operations prior to
2003, the only period presented for comparison below is the period for the year
ended December 31, 2004 as compared to December 31, 2003.
NetFabric began operations in January 2003 and is still a development stage
company. Therefore, NetFabric had no revenue and minimal expenses in 2003, and
$612 of revenue and $1,502,260 of expenses in 2004.
A summary of the results of operations for the years ended December 31,
2004 and 2003 is as follows:
2004 2003
---- ----
Revenues $612 $0
Cost of Goods Sold 3,126 0
Expenses 1,499,746 18,565
Net Loss 1,502,260 18,565
Net loss per share,
basic and diluted $0.05 $0.00
Weighted average number of shares
outstanding basic and diluted 31,362,838 29,678,950
11
Our operating activities to date have consisted primarily of developing our
VoIP telephony products for the marketplace. This included the acceleration of
research and development activities, hiring of additional Company personnel
(primarily for research and development, but also sales and marketing
personnel), development of sales and marketing programs, and filing of product
patents.
Revenue. For the twelve months ended December 31, 2004, we generated $612
in revenue compared to $0 for the twelve months ended December 31, 2003. The
Company is still in the stages of early product development and does not plan to
generate significant revenue from its various product lines until the fourth
quarter of 2005.
Total Expenses. Total expenses for the twelve months ended December 31,
2004 were $1,499,746 compared to $18,565 for the twelve months ended December
31, 2003. This is related to the Company accelerating its research and
development and marketing and sales activities in 2004. The expenses incurred
for 2004, and as compared to 2003, are set forth in greater detail below and in
the accompanying consolidated financial statements attached.
Research and Development expenses for the twelve months ended December 31,
2004 were $395,452 compared to $0 for the twelve months ended December 31,
2003. These expenses mainly represented the product development costs for the
FUSION 4x4 and the 12x8 voice routers including associated engineering wages.
General and Administrative expenses for the twelve months ended December
31, 2004 were $638,330 compared to $8,720 for the twelve months ended December
31, 2003. This is primarily due to the Company hiring significant new personnel
in management, marketing, and sales among others. In addition, the Company began
maintaining office space in early 2004, and incurred costs associated with this
activity, such as telecom, office supplies and insurance.
Selling expenses for the twelve months ended December 31, 2004 were
$189,150 compared to $3,500 for the twelve months ended December 31, 2003. This
is related primarily to the Company's personnel, participation in certain
industry and trade shows as well as the development and production of marketing
materials and FUSION evaluation units.
Legal and professional fees for the twelve months ended December 31, 2004
were $93,238 compared to $6,097 for the twelve months ended December 31, 2003.
These expenses related to patent protection filings, legal and accounting costs
associated with the preparation of financial statements, and related to the
Acquisition.
Interest and bank charges of $175,365 for the twelve months ended December
31, 2004, represented interest accrued on bridge loans as well as the
amortization of discounts on such loans arising from the allocation of a portion
of the proceeds to the value of equity issued in connection with the loan
agreements.
Net Loss. For the year ended 2004, we had a net loss of $1,502,260 as
compared to a net loss of $18,565 for 2003. The loss increased as we began
full-fledged operations in 2004, and increased our employee headcount, operating
expenses and legal and professional fees. Net loss per common share increased
from $0.00 for 2003 to $0.05 for 2004.
LIQUIDITY AND CAPITAL RESOURCES. As of December 31, 2004 we had cash of
approximately $68,000. Our operating activities used approximately $1,014,000 of
cash for the year ended 2004 as opposed to approximately $17,000 for the same
period in 2003. The primary reason for this increase was the Company's net loss
for the year ended 2004 of approximately $1,500,000. In addition, during 2004,
the Company purchased approximately $180,000 of equipment and raised
approximately $1,240,000 from various bridge loans and stockholder financing.
During 2003, there were no fixed asset purchases and our financing activities
were insignificant. As a result of the above activities, the Company had an
increase in cash of approximately $50,000 for the year ended 2004.
Macrocom has completed its financing of the Company as required under the
terms of the Financing Agreement. In addition, Macrocom has the right to request
repayment in cash of the principal and interest from its second bridge loan to
the Company of $500,000, due April 10, 2005, and the Company may not have the
cash on hand to make such payments. In any event, the Company will require
additional financing for its business, and may not be able to finance its
immediate business plans. Such financing may not be available to the Company on
12
favorable terms, if at all. In addition, the Company's business strategy calls
for growth internally as well as through acquisitions. To this end, the Company
has decided to invest substantial funds to increase its sales and marketing
resources in order to grow revenues. In order to implement this strategy, the
Company will require additional funding for personnel, capital expenditures and
other expenses, as well as for working capital purposes. Financing may not be
available to the Company on favorable terms, if at all. If adequate funds are
not available on acceptable terms, then the Company may not be able to meet its
business objectives for expansion. No commitments to provide additional funds
have been made by management or other stockholders. Accordingly, there can be no
assurance that any additional funds will be available to the Company to allow it
to cover its expenses as they may be incurred. Irrespective of whether the
Company's cash assets prove to be inadequate to meet the Company's operational
needs, the Company might seek to compensate providers of services by issuances
of stock in lieu of cash.
CRITICAL ACCOUNTING POLICIES
Basis of Preparation of Consolidated Financial Statements
The consolidated financial statements include the accounts of HOC and its
wholly-owned subsidiary. All significant intercompany transactions and balances
have been eliminated. The preparation of the consolidated financial statements
in conformity with generally accepted accounting principles in the United States
of America ("GAAP") 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 consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. The accounting estimates that require management's most
difficult and subjective judgments include 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, the Company 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.
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 2004 and 2003 were $395,452 and $0,
respectively.
13
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.
Earnings (Loss) per Share
The Company calculates earnings (loss) per share in accordance with SFAS
No. 128, "Earnings per Share." SFAS No. 128 computes basic earnings (loss) per
share by dividing the net income (loss) by the weighted average number of shares
of common stock outstanding during the period. Diluted earnings (loss) per share
is computed by dividing the net income (loss) by the weighted average number of
shares of common stock outstanding during the period plus the effects of any
dilutive securities. Diluted earnings (loss) per share considers the impact of
potentially dilutive securities except in periods in which there is a loss
because the inclusion of the potential common shares would have an anti-dilutive
effect. The Company's potentially dilutive securities include common shares
which may be issued upon exercise of its stock options, exercise of warrants or
conversion of convertible debt.
Diluted earnings (loss) per share for the years ended December 31, 2004 and
2003 exclude potential common shares of approximately 6,162,526 and 247,208,
respectively, primarily related to the Company's outstanding stock options,
warrants and convertible debt, because the assumed issuance of such potential
common shares is antidilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
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
14
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.
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 APB 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.
RISK FACTORS
Our business faces risks. These risks include those described below and may
include additional risks of which we are not currently aware or which we
currently do not believe are material. If any of the events or circumstances
described in the following risks actually occurs, our business, financial
condition or results of operations could be adversely affected. These risks
should be read in conjunction with the other information set forth in this
report.
THE COMPANY MAY BE UNABLE TO FUND FUTURE GROWTH
Macrocom has completed its financing of the Company as required under the
terms of the Financing Agreement. In addition, Macrocom has the right to request
repayment in cash of the principle and interest from its second bridge loan to
the Company of $500,000, due April 10, 2005. In any event, The Company will
require additional financing for its business, and may not be able to finance
its immediate business plans. Such financing may not be available to the Company
on favorable terms, if at all. In addition, The Company's business strategy
calls for growth internally as well as through acquisitions. To this end, the
Company has decided to invest substantial funds to increase its sales and
marketing resources in order to grow revenues. In order to implement this
strategy, the Company will require additional funding for personnel, capital
expenditures and other expenses, as well as for working capital purposes.
Financing may not be available to the Company on favorable terms, if at all. If
adequate funds are not available on acceptable terms, then the Company may not
be able to meet its business objectives for expansion. No commitments to provide
additional funds have been made by management or other stockholders.
Accordingly, there can be no assurance that any additional funds will be
available to the Company to allow it to cover its expenses as they may be
15
incurred. Irrespective of whether the Company's cash assets prove to be
inadequate to meet the Company's operational needs, the Company might seek to
compensate providers of services by issuances of stock in lieu of cash.
THE COMPANY HAS A HISTORY OF LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE
The Company has a history of net losses and from January 1, 2003 (date of
inception) through December 31, 2004 has a deficit accumulated during the
development stage of $1,520,825. Further, developing the Company's business
strategy and expanding the Company's services will require significant
additional capital and other expenditures. Accordingly, if the Company is not
able to raise capital or increase its revenue, it may never generate sufficient
cash to achieve or sustain profitability.
THE COMPANY'S GROWTH MAY BE LIMITED IF IT IS UNABLE TO ATTRACT AND RETAIN
QUALIFIED PERSONNEL
The Company believes that its success depends largely on its ability to
attract and retain highly-skilled and qualified technical, managerial and
marketing personnel. The market for highly skilled engineering, sales, marketing
and support personnel is highly competitive as a result of the limited
availability of technically-qualified personnel with the requisite understanding
of the markets which the Company serves. The inability to hire or retain
qualified personnel may hinder the Company's ability to implement its business
strategy and may harm its business.
THE COMPANY IS EXPOSED TO THE GENERAL CONDITION OF THE TELECOMMUNICATIONS MARKET
The Company's business is subject to global economic conditions, and in
particular, market conditions in the telecommunications industry. The Company's
operations may be adversely affected by the continued declines in capital
spending from telecommunications service providers. If global economic
conditions worsen, or if the prolonged slowdown in the telecommunications
industry continues, then the Company may experience adverse operating results.
THE COMPANY'S NEED TO INVEST IN RESEARCH AND DEVELOPMENT COULD HARM THE
COMPANY'S OPERATING RESULTS
The Company's industry is characterized by the need for continued
investment in research and development. If the Company fails to invest
sufficiently in research and development, the Company's products may become less
attractive to potential customers, resulting in a material adverse effect on the
Company's results of operations and financial condition. As a result of the
Company's need to maintain or increase its spending levels in this area, the
Company's operating results could be materially harmed if the Company's revenue
falls below expectations. In addition, as a result of the need for research and
development and technological innovation, the Company's operating costs may
increase in the future.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST THE COMPANY, EVEN WITHOUT
MERIT, COULD REQUIRE THE COMPANY TO ENTER INTO COSTLY LICENSES OR DEPRIVE THE
COMPANY OF THE TECHNOLOGY IT NEEDS
The Company's industry is technology intensive. As the number of
competitors in the Company's target markets increases and the functionality of
the products produced by such competitors further overlaps, third parties may
claim that the technology the Company develops or licenses infringes on their
proprietary rights. Any claims against the Company or any of its subsidiaries
may affect the Company's business, results of operations and financial
conditions. Any infringement claims, even those without merit, may require the
Company to pay damages or settlement amounts or require the Company to develop
non-infringing technology or enter into costly royalty or licensing agreements
to avoid service implementation delays. Any litigation or potential litigation
may result in product delays, increased costs or both. If successful, a claim of
product infringement could completely deprive the Company of the technology it
needs.
16
DEFECTS IN THE COMPANY'S PRODUCTS MAY ADVERSELY AFFECT THE COMPANY'S SALES AND
EXPOSE THE COMPANY TO COSTLY LEGAL CLAIMS
The Company's business strategy calls for the development of new products
and product enhancements which may from time to time contain defects or result
in failures that the Company did not detect or anticipate when introducing such
products or enhancements to the market. In addition, the markets in which the
Company's products are used are characterized by a wide variety of standard and
non-standard configurations and by errors, failures and bugs in third-party
platforms that can impede proper operation of the Company's products. Despite
product testing by the Company, defects may still be discovered in some new
products or enhancements after the products or enhancements are delivered to
customers. The occurrence of these defects could result in product returns,
adverse publicity, loss of or delays in market acceptance of the Company's
products, delays or cessation of service to the Company's customers or legal
claims by customers against the Company.
To the extent that contractual provisions limit the Company's exposure to
legal claims are unenforceable or such claims are not covered by insurance, a
successful products liability claim could have a material adverse effect on the
Company's business, results of operations and financial condition.
THE COMPANY'S DEPENDENCE ON CONTRACT MANUFACTURERS AND SUPPLIERS MAY RESULT IN
PRODUCT DELIVERY DELAYS
The Company currently uses contract manufacturers to manufacture its
products. the Company's reliance on contract manufacturers involves a number of
risks, including the absence of adequate capacity, the unavailability of, or
interruptions in access to necessary manufacturing processes and reduced control
over delivery schedules. If the Company's manufacturers are unable or unwilling
to continue manufacturing the Company's products and components in required
volumes, the Company will have to identify one or more acceptable alternative
manufacturers. Furthermore, the use of new manufacturers may cause significant
interruptions in supply if the new manufacturers have difficulty manufacturing
products to the Company's specifications. Further, the introduction of new
manufacturers may increase the variance in the quality of the Company's
products. In addition, the Company relies upon third-party suppliers of
specialty components, some of which are single-sourced and intellectual property
used in its products. It is possible that a component needed to complete the
manufacture of the Company's products may not be available at acceptable prices
or on a timely basis, if at all. Inadequate supplies of components, or the loss
of intellectual property rights, may affect the Company's ability to deliver
products to its customers. Any significant interruption in the supply of the
Company's products could result in the reduction of product sales to customers,
which in turn could permanently harm the Company's reputation in the industry.
THE COMPANY'S PRODUCTS MAY NOT ACHIEVE ACCEPTANCE IN THE MARKETPLACE
The Company intends to offer a line of VoIP products and services targeted
at the small and medium sized business market. The markets for these products
are relatively new, unpredictable and rapidly evolving. Lack of acceptance in
the marketplace for these new products could have a material adverse effect on
the Company's business, results of operations and financial condition.
IF THE COMPANY MUST MAKE DESIGN CHANGES TO ITS PRODUCT LINES, THEN THE COMPANY'S
SALES ARE LIKELY TO SUFFER, AND THE COMPANY MAY BE EXPOSED TO LEGAL CLAIMS
The Company's business strategy calls for the development of new products
and product enhancements which may from time-to-time be subject to design
changes that the Company did not anticipate when introducing such products or
enhancements to the market. In addition, the markets in which the Company's
products are used are characterized by a wide variety of standard and
non-standard configurations and by errors, failures and bugs in third-party
platforms that can impede proper operation of the Company's products. Despite
product testing by the Company, design changes may still be required in some new
products or enhancements after the products or enhancements are delivered to
customers. The need for these changes could result in product returns, adverse
publicity, loss of or delays in market acceptance of the Company's products,
delays or cessation of service to the Company's customers or legal claims by
customers against the Company.
17
To the extent that contractual provisions that limit the Company's exposure
to legal claims are unenforceable or such claims are not covered by insurance, a
successful products liability claim could have a material adverse effect on the
Company's business, results of operations and financial condition.
THE COMPANY NEEDS TO DEVELOP NEW PRODUCTS AND ENHANCEMENTS IN ORDER TO PREVENT
THE RISK OF OBSOLESCENCE
The Company's industry is characterized by the need for continued
investment in new products and enhancements and upgrades to its existing product
line. If the Company fails to produce new and improved functionality, then the
Company's products could become less attractive to potential customers, which
could have a material adverse effect on the Company's results of operations and
financial condition.
THE COMPANY IS DEVELOPING ITS ACCOUNTING AND REPORTING CONTROLS AND HAS LIMITED
RESOURCES
HOC only has two employees responsible for the accounting and reporting
functions for the HOC. In addition, both the Chief Financial Officer and Vice
President of Finance are part time employees of the Company. As a result, the
Company currently has limited segregation of duties regarding the Company's
accounting and reporting functions. Management recognizes this limited
segregation of duties as a potential deficiency in the Company's internal
controls and is implementing procedures to mitigate this deficiency. HOC will
undertake additional remedial measures in the first half of 2005.
THE COMPANY MAY BE AFFECTED BY GOVERNMENT REGULATION
The government has thus far avoided introducing regulation into the VoIP
industry. On October 19, 2004, Michael Powell, former Chairman of the FCC,
stated his intention to wrest control of VoIP from the states and make it
subject to federal control, with initial proposals that would contain as few
VoIP regulations as possible. On November 9, 2004, the FCC in a 4 to 1 vote did
take jurisdiction over IP telephony away from the states. Powell called the
Commission's vote to exempt Vonage Holdings Corporation's VoIP telephone service
from Minnesota telephone taxes and certification standards "a landmark
decision". It therefore appears that in the near future the industry will be
unregulated at the state level and minimally regulated at the federal level.
However, if government regulation is imposed that affects VoIP deployment or
reduces or eliminates the cost savings of VoIP, this could materially detract
from the commercial viability of the Company's products.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE
The market price of our common stock may experience significant volatility
as a result of a number of factors, many of which are outside of our control.
Each of the risk factors listed in this "Risk Factors" section, and the
following factors, may affect our operating results:
o our quarterly results and ability to meet analysts' and our own
published expectations;
o our ability to continue to attract and retain customers;
o the amount and timing of operating costs and capital expenditures
related to the maintenance and expansion of our businesses,
operations and infrastructure;
o patents issued or not issued to us or our competitors;
o announcements of technological innovations, new services or service
enhancements, strategic alliances, mergers, acquisitions,
dispositions or significant agreements by us or by our competitors;
o commencement or threat of litigation or new legislation or regulation
that adversely affect our business;
o general economic conditions and those economic conditions specific
to the Internet and Internet advertising;
18
o our ability to keep our products and services operational at a
reasonable cost and without service interruptions;
o recruitment or departure of key personnel;
o geopolitical events such as war, threat of war or terrorist actions;
and
o sales of substantial amounts of our common stock, including shares
issued upon the exercise of outstanding options or warrants.
Because our business is changing and evolving, our historical operating
results may not be useful to you in predicting our future operating results. In
addition, the stock market has experienced significant price and volume
fluctuations that particularly have affected the trading prices of equity
securities of many telecommunications companies. Frequently, these price and
volume fluctuations have been unrelated to the operating performance of the
affected companies. In the past, following periods of volatility in the market
price of a company's securities, securities class action litigation has often
been instituted against such a company. This type of litigation, regardless of
the outcome, could result in substantial costs and a diversion of management's
attention and resources, which could materially adversely affect our business,
prospects, financial condition and results of operations.
OUR CERTIFICATE OF INCORPORATION AUTHORIZES US TO ISSUE ADDITIONAL SHARES OF
STOCK, WHICH COULD IMPEDE A CHANGE OF CONTROL THAT IS BENEFICIAL TO OUR
STOCKHOLDERS
We are authorized to issue up to 50 million shares of common stock that may
be issued by our board of directors for such consideration as they may consider
sufficient without seeking stockholder approval, subject to stock exchange rules
and regulations. Our certificate of incorporation also authorizes us to issue up
to 5 million shares of preferred stock and 5 million shares of preference stock,
the rights and preferences of which may be designated by our board of directors.
These designations may be made without stockholder approval. The designation and
issuance of preferred stock in the future could create additional securities
that have dividend and liquidation preferences prior in right to the outstanding
shares of common stock. These provisions could be used by our board to impede a
non-negotiated change in control, even though such a transaction may be
beneficial to holders of our securities, and may deprive you of the opportunity
to sell your shares at a premium over prevailing market prices for our common
stock. The potential inability of our stockholders to obtain a control premium
could reduce the market price of our common stock.
WE DO NOT INTEND TO PAY FUTURE CASH DIVIDENDS
We have never paid cash dividends and currently do not intend to pay cash
dividends on our common stock at any time in the near future. We may never pay
cash dividends or distributions on our common stock. Whether we pay cash
dividends in the future will be at the discretion of our board of directors and
will be dependent on our financial condition, results of operations, capital
requirements and any other factors that the board of directors decides are
relevant.
ITEM 7. FINANCIAL STATEMENTS
Information in response to this item is set forth in the Financial
Statements, beginning on Page F-1 of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
19
ITEM 8A. CONTROLS AND PROCEDURES
Our disclosure controls and procedures are designed to ensure that material
information relating to the Company are made known to our Chief Executive
Officer ("CEO"), Chief Financial Officer ("CFO") and others in the Company
involved in the preparation of this annual report, by others within the Company.
Our CEO and CFO have reviewed our disclosure controls and procedures as of March
31, 2004 and have concluded that they are effective. There were no significant
changes in our internal controls or other factors that could significantly
affect our internal controls subsequent to the last date they were reviewed by
our CEO and CFO.
20
HOUSTON OPERATING COMPANY
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-2
of J.H. Cohn LLP
Consolidated financial statements:
Consolidated Balance Sheets, December 31, 2004 and 2003 F-3
Consolidated Statements of Operations, for the years ended F-4
December 31, 2004 and 2003 and for the period from
inception (January 1, 2003) to December 31, 2004
Consolidated Statements of Stockholders' Equity (Deficit), F-5
for the years ended December 31, 2004 and 2003
and for the period from inception (January 1, 2003)
to December 31, 2004
Consolidated Statements of Cash Flows, for the years ended F-6
December 31, 2004 and 2003 and for the period from
inception (January 1, 2003) to December 31, 2004
Notes to Consolidated financial statements F-7 - F-18
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Houston Operating Company
We have audited the accompanying consolidated balance sheets of Houston
Operating Company (a development stage company) as of December 31, 2004 and
2003, and the related consolidated 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 consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Houston
Operating Company as of December 31, 2004 and 2003, and its consolidated 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 consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company is in the development stage, has
had net losses from inception and has working capital and net capital
deficiencies. 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 consolidated financial statements do not include
any adjustments that might results from the outcome of this uncertainty.
/s/ J.H. Cohn LLP
-----------------------------------
Jericho, New York
March 30, 2005
F-2
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
DECEMBER 31, 2004 DECEMBER 31, 2003
----------------- -----------------
ASSETS
CURRENT ASSETS:
Cash $ 67,719 $ 18,053
Trade accounts receivable 18,284 -
Inventory 72,025 -
Due from stockholders - 90
Prepaid expenses 70,626 2,354
------------------ --------------
Total current assets 228,654 20,497
Property and equipment, net 171,931 -
Other assets 43,053 5,665
Deferred offering costs 368,683 -
------------------ --------------
TOTALS $ 812,321 $ 26,162
================== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bridge loans, net of unamortized discount $ 749,659 $ -
Loans payable to stockholder 32,639 10,000
Accounts payable and accrued liabilities 281,389 248
Deferred revenue 18,284 -
------------------ --------------
Total current liabilities 1,081,971 10,248
------------------ --------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Common Stock, $.001 par value, 50,000,000 shares 34,652 29,830
authorized, 34,652,204 and 29,829,758 shares issued an
outstanding
Additional paid-in capital 1,216,523 4,649
Deficit accumulated during the development stage (1,520,825) (18,565)
------------------ --------------
Total stockholders' equity (deficit) (269,650) 15,914
------------------ --------------
TOTALS $ 812,321 $ 26,162
================== ==============
See Notes to Consolidated Financial Statements
F-3
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 2004 AND 2003
AND FOR THE PERIOD FROM INCEPTION (JANUARY 1, 2003) TO DECEMBER 31, 2004
- --------------------------------------------------------------------------------
For the period
from inception
(January 1, 2003)
to December 31,
2004 2003 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 189,150 3,500 192,650
General and administrative expenses 638,330 8,720 647,050
Legal and professional expenses 93,238 6,097 99,335
Interest and bank charges 175,365 248 175,613
Depreciation and amortization 8,211 - 8,211
------------- ------------- --------------
Net loss before provision for income taxes $ (1,502,260) $ (18,565) $ (1,520,825)
Provision (credit) for income taxes - - -
------------- ------------- --------------
NET LOSS $ (1,502,260) $ (18,565) $ (1,520,825)
============= ============= ==============
Net loss per share, basic and diluted $ (0.05) $ (0.00)
============= =============
Weighted average number of shares outstanding
basic and diluted 31,362,838 29,678,950
============= =============
See Notes to Consolidated Financial Statements
F-4
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED
DECEMBER 31, 2004 AND 2003
AND FOR THE PERIOD FROM INCEPTION (JANUARY 1, 2003) TO DECEMBER 31, 2004
- --------------------------------------------------------------------------------
DEFICIT
ACCUMULATED TOTAL
COMMON STOCK 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 at $0.000 per share 29,664,953 29,665 (29,575) - 90
Sale of common stock to investor at $0.152 per share 164,805 165 24,835 - 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 29,829,758 29,830 4,649 (18,565) 15,914
=========== =========== =========== ============ ============
Sale of common stock to investors at $0.152 per share 1,648,053 1,648 248,352 - 250,000
Issuance of common stock to landlord in lieu of
rent at $0.152 per share 659,221 659 99,341 - 100,000
Issuance of options to purchase common stock
to non-employees for services - - 115,719 - 115,719
Common stock issued in connection with share
exchange at $0.001 per share 1,765,172 1,765 (30,874) - (29,109)
Allocation of proceeds from bridge loans to
common stock at $0.823 per share 500,000 500 410,903 - 411,403
Value of shares and warrants issued in
connection with financing commitment
at $1.475 per share 250,000 250 368,433 - 368,683
Net loss - - - (1,502,260) (1,502,260)
----------- ----------- ----------- ------------ ------------
BALANCES AT DECEMBER 31, 2004 34,652,204 $ 34,652 $1,216,523 $(1,520,825) $ (269,650)
=========== =========== =========== ============ ============
See Notes to Consolidated Financial Statements
F-5
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2004 AND
2003 AND FOR THE PERIOD FROM INCEPTION (JANUARY 1, 2003) TO DECEMBER 31, 2004
- --------------------------------------------------------------------------------
FOR THE PERIOD FROM
INCEPTION (JANUARY 1,
2003) TO
2004 2003 DECEMBER 31, 2004
-------------- -------------- ---------------------
OPERATING ACTIVITIES
Net loss $ (1,502,260) $ (18,565) $ (1,520,825)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 100,000 - 100,000
Amortization of options issued to 60,059 1,370 61,429
non-employees for services
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 281,141 248 281,389
Deferred revenue 18,284 - 18,284
--------------- -------------- -----------------
Net cash used in operating activities (1,013,812) (16,947) (1,030,759)
--------------- --------------- -----------------
INVESTING ACTIVITIES
Purchases of property and equipment (180,142) - (180,142)
Decrease (Increase) in due from stockholder 90 (90) -
--------------- --------------- -----------------
Net cash used in investing activities (180,052) (90) (180,142)
--------------- --------------- -----------------
FINANCING ACTIVITIES
Proceeds from issuance of common stock 250,000 25,090 275,090
Repayment of loan payable to stockholder (6,470) 10,000 3,530
Proceeds from bridge loans 1,000,000 - 1,000,000
--------------- --------------- -----------------
Net cash provided by financing activities 1,243,530 35,090 1,278,620
--------------- --------------- -----------------
NET INCREASE IN CASH 49,666 18,053 67,719
CASH AT BEGINNING OF PERIOD 18,053 - -
--------------- --------------- ----------------
CASH AT END OF PERIOD $ 67,719 $ 18,053 $ 67,719
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest expense $ - $ - $ -
--------------- --------------- -----------------
Cash paid for income taxes $ - $ - $ -
--------------- --------------- -----------------
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Net liabilities of Houston Operating
Company assumed in share exchange $ (29,109) $ - $ (29,109)
--------------- --------------- -----------------
Fair value of options issued to non-employees
for services initially deferred $ 115,719 $ 9,389 $ 125,108
--------------- --------------- -----------------
Imputed discount on bridge loans relating to $ 411,403 $ - $ 411,403
warrants issued and beneficial conversion feature --------------- --------------- -----------------
Value of shares and warrants issued in $ 368,683 $ - $ 368,683
connection with financing commitment --------------- --------------- -----------------
See Notes to Consolidated Financial Statements
F-6
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Houston Operating Company ("HOC") was incorporated under the laws of the
State of Delaware on August 31, 1989. On December 9, 2004, HOC entered into
an Exchange Agreement (the "Acquisition Agreement" or "Share Exchange")
with all of the stockholders of NetFabric Corporation ("NetFabric") (see
Note 7) whereby HOC issued common stock and acquired all of the issued and
outstanding common stock of NetFabric and NetFabric became a wholly-owned
subsidiary of HOC (HOC and NetFabric are referred to collectively as the
"Company"). Upon the completion of merger the NetFabric stockholders
controlled approximately 95% of the then issued and outstanding common
stock, NetFabric's business activities were the activities of the merged
Company and HOC was a shell corporation without any operations. As a result
of these factors, this transaction has been treated as a reverse merger,
and a capital transaction, equivalent to the issuance of stock by NetFabric
for HOC's net assets and accordingly the historical financial statements
prior to December 9, 2004 are those of NetFabric. All shares and per share
data prior to the merger have been restated to reflect the stock issuances
and related recapitalization. HOC, as the Registrant, has applied to change
its name to NetFabric, Inc. (Note 11).
All the share and per share amounts have been retroactively adjusted to
reflect the 3.2961 to 1 exchange of shares occurring in connection with the
merger of HOC and NetFabric.
NetFabric, 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 consolidated financial statements commences on January 1,
2003. NetFabric develops and markets a family of Internet Protocol ("IP")
appliances that simplifies the integration of standard telephone systems
with an IP infrastructure. NetFabric's products deliver productivity gains
and significant cost reductions, while maintaining Public Switched
Telephone Network ("PSTN") class reliability and ease of use. NetFabric 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. NetFabric
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, NetFabric's principal product
line, uses an external VoIP gateway to facilitate its use with any service
provider utilizing any protocol.
NetFabric has not generated significant revenue and is considered to be a
development stage company and as such the consolidated financial statements
presented herein are presented in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 7.
The accompanying consolidated financial statements have been prepared on a
going concern basis. As shown in the accompanying consolidated financial
statements, the Company has incurred losses in the development stage
totaling $1,520,825 and has a working capital deficit of $853,317 at
December 31, 2004. These factors, among others, indicate that the Company
may be unable to continue as a going concern. The consolidated 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
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.
F-7
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
BASIS OF PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements include the accounts of HOC and its
wholly-owned subsidiary. All significant intercompany transactions and
balances have been eliminated. The preparation of the consolidated
financial statements in conformity with generally accepted accounting
principles in the United States of America ("GAAP") 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 consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. The accounting estimates
that require management's most difficult and subjective judgments include
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, the Company 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 consists primarily of finished goods and purchased electronic
components, and is stated at the lower of cost or market. Cost is
determined by using the first-in, first-out method.
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.
F-8
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
with finite lives, 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.
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, 2004 and 2003.
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 2004 and 2003 were
$395,452 and $0, 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
F-9
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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,
2004 2003
------------ ---------
Pro forma net loss, as reported $(1,502,260) $(18,565)
Stock-based employee compensation expense
determined under fair value method 128,486 -
------------ ---------
Pro forma net loss, as adjusted $(1,630,746) $(18,565)
------------ ---------
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, 2004, dividend
yield of 0%, risk-free interest rate of 3.50%, volatility of 100% and
expected life of approximately five years. 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. 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 temporary 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.
EARNINGS (LOSS) PER SHARE
The Company calculates earnings (loss) per share in accordance with SFAS
No. 128, "Earnings per Share." SFAS No. 128 computes basic earnings (loss)
per share by dividing the net income (loss) by the weighted average number
F-10
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of shares of common stock outstanding during the period. Diluted earnings
(loss) per share is computed by dividing the net income (loss) by the
weighted average number of shares of common stock outstanding during the
period plus the effects of any dilutive securities. Diluted earnings (loss)
per share considers the impact of potentially dilutive
securities except in periods in which there is a loss because the
inclusion of the potential common shares would have an anti-dilutive
effect. The Company's potentially dilutive securities include common
shares which may be issued upon exercise of its stock options, exercise
of warrants or conversion of convertible debt.
Diluted earnings (loss) per share for the years ended December 31, 2004 and
2003 exclude potentially issuable common shares of approximately 6,162,526
and 247,208, respectively, primarily related to the Company's outstanding
stock options, warrants and convertible debt, because the assumed issuance
of such potential common shares is antidilutive.
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 consolidated 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 2004 and 2003.
SEGMENT REPORTING
The Company determines and discloses its segments in accordance with SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related
Information," which uses a "management" approach for determining segments.
The management approach designates the internal organization that is used
by management for making operating decisions and assessing performance as
the source of a company's reportable segments. SFAS No. 131 also requires
disclosures about products or services, geographic areas and major
customers. The Company's management reporting structure provides for only
one reportable segment and accordingly, no separate segment information is
presented.
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
F-11
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 that are small business issuers for interim
or annual periods beginning after December 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.
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 APB 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 8,211
and amortization -------------
$171,931
=============
F-12
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31, 2004 and 2003:
2004 2003
------------------- -------------------
Trade accounts payable $185,638 $248
Accrued professional fees 74,273 -
Accrued interest payable 13,796 -
Advances from customers 7,682 -
------------------- -------------------
$281,389 $248
=================== ===================
5. BRIDGE LOANS
Bridge loans consist of the following as of December 31, 2004:
2004
---------------------
Loan I, due January 18, 2005 $ 500,000
Loan II, due April 12, 2005 500,000
---------------------
1,000,000
Less: Unamortized debt discount (250,341)
---------------------
$ 749,659
=====================
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 I") 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 common (Note 11). In either event, the interest on
Loan I is payable in cash on the Due Date. In connection with the
Financing Agreement the Company issued to Macrocom 250,000 shares of
common stock as additional consideration for Loan I in December 2004.
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
("Loan II" or the "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
common 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, in December 2005 the Company issued to Macrocom
250,000 shares of common stock as additional consideration for the
Second Loan.
Since the actual issuance and availability of HOC common stock at the
time of the NetFabric Financing and Loan Agreements was contingent upon
the consummation of a share exchange transaction with a then
unidentified entity, the Post Closing Stock, as defined, 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 is
amortized to interest expense using the effective interest method over
the stated terms of the respective notes. Upon consummation of the
Share Exchange, the contingency regarding the issuance of the Post
Closing Stock relating to the Financing Agreement and Loan Agreement
F-13
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
was resolved and 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 share exchange transaction. 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 HOC
subsequent to the Closing Date, under certain terms. Under this
arrangement, Macrocom received 250,000 shares of common stock and a
six-month warrant to purchase 2,000,000 shares of common 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 record as deferred offering costs as of
December 31, 2004 on the accompanying consolidated 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, the Company 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 the Company's control, HOC 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.
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, 2004 DECEMBER 31, 2003
----------------------- -------------------------
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 future tax assets at December 31,
2004 and 2003 are as follows:
DECEMBER 31, 2004 DECEMBER 31, 2003
----------------------- -------------------------
Tax effect of operating loss carryforwards $ 672,000 $ 8,400
Effect of valuation allowance (672,000) (8,400)
----------------------- -------------------------
Net deferred tax assets $ - $ -
----------------------- -------------------------
F-14
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 December 2003, the Company sold 164,805 shares of the Company's
common stock along with a warrant to purchase 164,805 shares of common
stock, at an exercise purchase price of approximately $0.1517 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.
The Company sold an additional 1,648,053 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 988,832
warrants on the same terms and conditions as described in the preceding
paragraph. In 2004, the Company also issued 659,221 shares of common
stock (valued at $100,000) as payment for certain expenses.
On December 9, 2004, (the "Closing Date") HOC completed the Share
Exchange 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, HOC acquired all of the issued
and outstanding common stock of NetFabric from the Stockholders in
exchange for an aggregate of 32,137,032 newly-issued shares of the
HOC's common stock. Since the Stockholders of NetFabric received
approximately 95% of the shares in the Company and HOC had no
significant assets and liabilities or operations prior to the merger
and the NetFabric management team continued in their existing roles at
HOC, for accounting purposes the acquisition has been treated as a
recapitalization of NetFabric with NetFabric as the acquirer, a reverse
acquisition. Since HOC prior to the merger was a public shell
corporation with no significant operations, pro-forma information
giving effect to the merger is not presented.
8. STOCK-BASED COMPENSATION
From time to time, the Company issued 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, 2004 and 2003 the Company recognized
nonemployee compensation expense of $60,059 and $1,370 as a result of
issuing options, respectively, which is included in general and
administrative expenses on the accompanying consolidated statements of
operations. The unamortized value of such stock issuances are included in
prepaid expenses (for the current portion) and other assets (for the
noncurrent portion) on the accompanying consolidated balance sheets. Such
amounts will be amortized into expense over the respective vesting periods
of the options.
The following is a summary of the Company's stock option activity for the
years ended December 31, 2004 and 2003:
F-15
HOUSTON OPERATING COMPANY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Weighted Weighted
Average Average
Options Exercise Price Fair Value
------------------- ------------------ -----------------
Options outstanding January 1, 2003 - $ - $ -
Options granted 82,403 0.15 0.15
Options exercised - - -
Options cancelled - - -
------------------- ------------------ -----------------
Outstanding, December 31, 2003 82,403 $0.15 $0.15
Options granted 3,926,486 0.15 0.15
Options exercised - - -
Options cancelled - - -
------------------- ------------------ -----------------
Outstanding, December 31, 2004 4,008,889 $0.15 $0.15
=================== ================== =================
Exercisable, December 31, 2004 1,320,502 $0.15 $0.15
=================== ================== =================
Exercisable, December 31, 2003 - $0.15 $0.15
=================== ================== =================
The options outstanding at December 31, 2004 have an exercise price of
approximately $0.1517 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 of the Share Exchange all NetFabric outstanding
stock options were exchanged for options in HOC. Prior to the Share
Exchange, HOC did not maintain a stock option plan. As a result of the
Share Exchange, the board of directors has approved the creation of an
HOC stock option plan as an incentive for, and to encourage share
ownership by, its officers, directors and other key employees and/ or
consultants and potential management of possible future acquired
companies (Note 11).
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 659,221 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 consolidated 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.
10. RELATED PARTY TRANSACTIONS
Loans payable to stockholders on the accompanying consolidated balance
sheets at December 31, 2004 and 2003 represent amounts owed to
stockholders of the Company for expenses paid on behalf of the Company.
F-16
11. SUBSEQUENT EVENTS
In January 2005, in accordance with the terms of the Financing Agreement,
the Company elected to repay the principal of Loan I by issuing 1,000,000
shares of common stock. In addition, the Company issued 2,000,000 shares of
its common stock in connection with the warrant provided to Macrocom more
fully disclosed in note 5.
In March 2005, the Company's board of directors approved several
actions, including i) a change of the Company's name to NetFabric,
Inc., ii) new bylaws for the Company, which among other things
increased the Company's authorized common stock to 100 million shares,
and iii) approved the adoption of an HOC stock option plan. Such
actions will become effective upon required notification and approval
of stockholders.
F-17
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
Set forth below are the names of the Company's directors and officers,
their ages, all positions and offices that they hold with the Company, the
period during which they have served as such, and their business experience
during at least the last five years. These officers and directors will hold
identical positions with the Company following the acquisition.
NAME AGE POSITION HELD EXPERIENCE
- ---- --- ------------- ----------
Jeff Robinson 52 Chairman and Mr. Robinson is a co-founder of NetFabric and has been a
CEO Director and President since December 2002 and its Chairman
and CEO since November 2004. He has served on the Board of
Directors of NetFabric since 2002. Mr. Robinson
is an experienced entrepreneur and technologist.
He was the CEO of IQ NetSolutions from June 1994 to July 2002,
a company that created one of the first
voice-over-packet systems with an emphasis on ease of
installation. During the period from October 1987 to July 1994,
he was the Chairman and CTO of Star Semiconductor, the company
that created the world's first commercially available
multi-processor DSP. During the period from December 1982 to
September 1987, Mr. Robinson was the Director of VLSI at General
DataComm, and an IC Design Manager at Texas Instruments. Mr.
Robinson is the owner or co-owner of over 30 patents.
Richard Howard 55 Director Mr. Howard has been a Director of the Company since November
2004. He received a BS in Economics and Corporate Finance
from the Wharton School at the University of Pennsylvania.
Since 2004, he has been the President of Flagship Healthcare
Management, Inc. From 2003 to 2004, was the Managing
Director of BLH Strategies, a consulting firm that provides
management services to companies and nonprofit
organizations. From 1985 to 2003, he worked for Genesis
Health Ventures, Inc. At various times during his seventeen
years with Genesis he served as Vice Chairman, President and
Chief Operating Officer. He also served as a member of the
Board of Directors for all seventeen years. While with
Genesis, the company grew from a private company operating
twelve skilled nursing centers to a $2.5 billion publicly
traded company employing over 45,000 people.
Charlotte G. Denenberg 58 Director Ms. Denenberg has been a Director of the Company since November
2004. She received a BA in Psychology and Mathematics with
Highest Distinction, Phi Beta Kappa, from Northwestern
University, and an MS and a PhD in Mathematics from the Illinois
Institute of Technology. For the past two years she has consulted
to a variety of companies in the telecommunications industry.
From 1998 to 2002, she worked for Metromedia Fiber Network
Services, Inc. (MFN) as Vice President, Optical Infrastructure
and as Vice President and Chief Technology Officer.
21
Madelyn DeMatteo 57 Director Ms. Madelyn DeMatteo has been a Director of the Company since
January 2005. Prior to joining the Company, from 1978
through 1999, Ms. DeMatteo was employed by Southern England
Telecommunications Corporation. During her employment, she
held the positions of Senior Vice President, General Counsel
and Corporate Secretary and Vice President, General Counsel &
Corporate Secretary from 1992-2000. Ms. DeMatteo received
her BA from Connecticut College in 1970 and her JD from
University of Connecticut in 1973.
Walter Carozza/(1)/ 50 Chief Financial Mr. Carozza has been the Chief Financial Officer of NetFabric
Officer since August 2004. Mr. Carozza received his BA and JD
degrees from The University of Wisconsin. He is admitted to
practice before the Court of International Trade, the U.S.
Supreme Court, and the District of Columbia Court of Appeals. He
is a member of the DC and Wisconsin Bars. For the past five years
he has been employed as a Manager of the General Partner of East
River Ventures, a venture capital firm based in New York City.
Philip Barak/(1)/ 52 VP Finance Mr. Barak has been the VP of Finance of NetFabric since
January 2003. He holds a BS in Accounting from Rider
University and is a Certified Public Accountant and a member
of the AICPA and NYSSCPA. For the past five years he has
been employed as a General Partner and Chief Financial
Officer of Nazem & Company, a venture capital firm founded
in 1976.
Victoria Desidero 44 VP Marketing Ms. Desidero has been the VP Marketing of NetFabric since June
2004. For the past five years she had been employed as the VP
Marketing for Merlot Communications.
- --------------------
(1) These individuals are part-time employees of the Company. The Company
intends to hire a full time CFO and/or other individuals by the end of the first
quarter of 2005 to replace these individuals.
BOARD OF DIRECTORS
Our directors are elected annually to serve until the next annual meeting
of shareholders or until successors are duly elected and qualified. Our board of
directors has created a Compensation Committee and an Audit Committee.
AUDIT COMMITTEE AND AUDIT COMMITTEE FINANCIAL EXPERT
The Audit Committee is responsible for making recommendations to the board
of directors as to the selection and independence of our external auditor,
maintaining communication between the board of directors and the independent
auditor, reviewing the annual audit report submitted by the independent auditor
and determining the nature and extent of problems, if any, presented by such
audit warranting consideration by our board of directors. The current members of
the Audit Committee are Ms. DeMatteo and Mr. Howard. Membership on the Audit
Committee is intended to be restricted to directors who are independent of
management and free from any relationship that, in the opinion of the board of
directors, could interfere with the exercise of independent judgment as a
committee member. In this regard, the Company has established a fully
independent Audit Committee as required under Nasdaq rules. In addition, Ms
DeMatteo has been designated the Audit Committee Financial Expert.
22
CODE OF ETHICS
The Company has adopted a Code of Ethics for all its employees. The Company
shall, without charge, provide to any person, upon request, a copy of its Code
of Ethics. All such requests should be mailed to: 67 Federal Road, Building A,
Suite 300, Brookfield, CT 06804.
COMPENSATION OF DIRECTORS
The independent Directors of the Company will receive an initial grant of
Stock Options to purchase 125,000 shares of Stock with an exercise price equal
to the Fair Market Value. The Option shall vest 15,625 shares on the date of
grant and thereafter 15,625 shares every three months for as long as the Board
member is a member of the Board as of such date. The Option shall have a term of
ten years from the date of grant. They all also received a similar bi-annual
grant. Independent Director's are also reimbursed for out-of-pocket expenses in
connection with attendance at Board of Directors' and/or committee meetings.
COMPENSATION COMMITTEE
The Compensation Committee is authorized to review and make recommendations
to the board of directors on all matters regarding the remuneration of our
executive officers, including the administration of our compensation plans. The
Compensation Committee is intended to be comprised of at least three members.
Currently, the Compensation Committee is comprised of: Ms. Charlotte G.
Denenberg (Chairman) and Mr. Richard Howard.
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth information concerning all cash and non-cash
compensation awarded to, earned by or paid to all executive officers and other
key employees of the Company who were serving as of December 31, 2004, for
services in all capacities.
SUMMARY COMPENSATION TABLE
- -----------------------------------------------------------------------------------------------------------------------
Annual Compensation Long-Term Compensation
- -----------------------------------------------------------------------------------------------------------------------
Other Restricted Securities
Annual Stock Underlying LTIP All Other
Name and Year Salary Bonus Compensa- Awards Options/SARs Payouts Compensation
Principal Position /(1)/ ($) ($) tion ($) ($) (#) ($) ($)
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Fred Nazem
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Chief Executive Officer 2004 175,000 0 0 0 0 0 0
/(2)/
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Jeff Robinson
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Chief Executive Officer 2004 175,000 0 0 0 0 0 0
/(3)/
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Walter Carozza, Chief 2004 60,000 0 0 0 998,832 0 0
Financial Officer
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Philip Barak, VP Finance 2004 0 0 0 0 494,416 0 0
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Victoria Desidero,
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
VP Marketing 2004 110,000 0 0 0 395,533 0 0
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
William Meltzer
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
Director, Software 2004 120,000 0 0 0 164,805 0 0
- --------------------------- ---------- ------------- ------- --------- ---------- -------------- -------- -------------
- --------------------
(1) No compensation was paid in 2003 by NetFabric.
23
(2) Effective November 30, 2004 Fred Nazem resigned as Chairman of the Board of
Directors and CEO of NetFabric, therefore he is no longer an officer or Director
of the Company.
(3) Effective November 30, 2004 Jeff Robinson was appointed CEO
and elected Chairman of NetFabric by its Board of Directors.
STOCK-BASED COMPENSATION
On the Closing Date of the Share Exchange all NetFabric outstanding stock
options were exchanged for options in the HOC. Prior to the Share Exchange, HOC
did not maintain a stock option plan. As a result of the Share Exchange, the
board of directors and the shareholders have approved the creation of an HOC
stock option plan as an incentive for, and to encourage share ownership by, its
officers, directors and other key employees and/ or consultants and potential
management of possible future acquired companies. On March 22, 2005, the Company
filed Form 14c with the SEC to, among other things, adopt the Company's 2005
Stock Option Plan. This adoption will be effective April 15, 2005.
From time to time, NetFabric issued 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. NetFabric 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
NetFabric'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, 2004 and 2003 NetFabric recognized
nonemployee compensation expense of $60,059 and $1,370 as a result of issuing
options, respectively, which is included in general and administrative expenses
on the accompanying consolidated statements of operations. The unamortized value
of such stock issuances are included in prepaid expenses (for the current
portion) and other assets (for the noncurrent portion) on the accompanying
consolidated balance sheets. Such amounts will be amortized into expense over
the respective vesting periods of the options.
The following is a summary of the NetFabric's stock option activity for the
years ended December 31, 2004 and 2003:
Options Weighted Average Weighted Average
Exercise Price Fair Value
--------------------- ----------------------- ----------------------
Options outstanding January 1, 2003 - $ - $ -
Options granted 82,403 0.152 0.152
Options exercised - - -
Options cancelled - - -
--------------------- ----------------------- ----------------------
Outstanding, December 31, 2003 82,403 $0.152 $0.152
Options granted 3,926,486 0.152 0.152
Options exercised - - -
Options cancelled - - -
--------------------- ----------------------- ----------------------
Outstanding, December 31, 2004 4,008,889 $0.152 $0.152
===================== ======================= ======================
Exercisable, December 31, 2004 1,320,502 $0.152 $0.152
===================== ======================= ======================
Exercisable, December 31, 2003 - $0.152 $0.152
===================== ======================= ======================
24
The options outstanding at December 31, 2004 have an exercise price of
approximately $0.1517 per share and have a weighted average remaining
contractual life of approximately 9.25 years. No options have been exercised to
date.
LONG-TERM INCENTIVE PLANS - AWARDS IN LAST FISCAL YEAR
The following table sets forth information with respect to awards made to
persons named in the Summary Compensation Table pursuant to a long-term
incentive plan in the fiscal year ending December 31, 2004.
% of Total Options
Number of Securities Granted to
Underlying Options Employees in Exercise Price
Name Granted Fiscal Period per Share Expiration Date
- ----------------------- -------------------- ------------------ --------------- -----------------
Walter Carozza 988,832 33.90% $0.152 January 1, 2014
Philip Barak 494,416 16.95% $0.152 January 1, 2014
Victoria Desidero 395,533 13.56% $0.152 June 14, 2014
William Meltzer 164,805 5.65% $0.152 January 1, 2014
Joseph Welfeld 148,325 5.08% $0.152 April 26, 2014
Dominick Zumbo 158,325 5.08% $0.152 August 16, 2014
EMPLOYMENT AGREEMENTS
- ----------------------------------------------------------------------------------------------------------------------------------
Jeff Robinson has no employment agreement of any kind with the Company. The
Company does not have formal employment agreements with its other employees.
Certain employees have limited employment letter agreements with NetFabric that
stipulate the amount of annual compensation, other employment benefits, and
participation in Company's stock option plan. There are currently no agreements
with regard to severance or non-competition.
BENEFIT PLANS
On March 3, 2005, the Board of Directors adopted the 2005 Stock Option and
Grant Plan (the "Plan"). The purpose of the Plan is to encourage and enable the
employees, directors and consultants of the Company upon whose judgment,
initiative and efforts the Company largely depends for the successful conduct of
its business to acquire a proprietary interest in the Company. It is anticipated
that providing such persons with a direct stake in the Company's welfare will
assure a closer identification of their interests with those of the Company,
thereby stimulating their efforts on the Company's behalf and strengthening
their desire to remain with and further the interests of the Company.
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND OTHER
STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the NASD over-the-counter
electronic bulletin board under the symbol HOOC.OB. The following table sets
forth on a per share basis for the periods shown, the high and low closing bid
prices of our common stock. The quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not represent actual
transactions.
When the trading price of the Company's common stock is below $5.00 per
share, the common stock is considered to be a "penny stock" that is subject to
rules promulgated by the Securities and Exchange Commission (Rule 15-1 through
15g-9) under the Securities Exchange Act of 1934. These rules impose significant
requirements on brokers under these circumstances, including: (a) delivering to
customers the SEC's standardized risk disclosure document; (b) providing
customers with current bid and ask prices; (c) disclosing to customers the
brokers-dealer's and sales representatives compensation; and (d) providing to
customers monthly account statements.
25
DIVIDENDS
Dividends, if any, will be contingent upon our revenues and earnings, if
any, capital requirements and financial conditions. The payment of dividends, if
any, will be within the discretion of the Company's Board of Directors. The
Company presently intends to retain all earnings, if any, for use in its
business operations and accordingly, the Board of Directors does not anticipate
declaring any dividends for the foreseeable future.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table discloses information as of December 31, 2004 with
respect to compensation plans (including individual compensation arrangements)
under which the Company's equity securities are authorized for issuance.
% of Total Options
Number of Securities Granted to
Underlying Options Employees in Exercise Price
Name Granted Fiscal Period per Share Expiration Date
- ----------------------- -------------------- ------------------ --------------- -----------------
Walter Carozza 988,832 33.90% $0.152 January 1, 2014
Philip Barak 494,416 16.95% $0.152 January 1, 2014
Victoria Desidero 395,533 13.56% $0.152 June 14, 2014
William Meltzer 164,805 5.65% $0.152 January 1, 2014
Joseph Welfeld 148,325 5.08% $0.152 April 26, 2014
Dominick Zumbo 158,325 5.08% $0.152 August 16, 2014
OPTIONS AND WARRANTS
As of December 31, 2004, the Company had outstanding warrants to purchase
1,153,637 shares of common stock at an exercise price of $0.152 per share.
As of December 31, 2004, the Company had outstanding options to purchase
4,008,889 shares of common stock at an exercise price of $0.152 per share.
HOLDERS
As of December 31, 2004, the Company has issued an aggregate of 34,652,204
shares of its common stock to approximately 434 entities.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table set forth information regarding beneficial ownership of
our common stock as of December 31, 2004 (i) by each person who is known by us
to beneficially own more than 5% of our common stock; (ii) by each of our
officers and directors; and (iii) by all of our officers and directors as a
group:
Name & Address of Amount & Nature of
Beneficial Owner Office, If Any Beneficial Ownership Percent of Class
- ----------------- -------------- -------------------- ----------------
Jeff Robinson
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 Chairman and CEO 14,832,476/(1)/ 42.80%
26
Fred Nazem
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 14,832,477/(1)/ 42.80%
Walter Carozza
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 CFO 824,026/(2)/ 2.38%
Philip Barak
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 VP Finance 247,208/(3)/ 0.71%
Victoria Desidero
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 VP Marketing 98,883/(4)/ 0.29%
Madelyn M. DeMatteo
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 Director 15,625/(5)/ 0.05%
Charlotte G. Denenberg
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 Director 15,625/(5)/ 0.05%
Richard F. Howard
c/o NetFabric Corporation
67 Federal Road
Building A, Suite 300
Brookfield, CT 06804 Director 15,625/(5)/ 0.05%
Macrocom Investors, LLC
1365 York Avenue, 28B
New York, NY 10021 1,750,000/(6)/ 5.05%
ALL DIRECTORS AND 16,049,468/(7)/ 46.32%
OFFICERS AS A GROUP
- --------------------
(1) Includes 6,592,212 shares held by the Fred F. Nazem Childrens' Trust, whose
trustees are Alexander Nazem, Farhad Nazem and Sohelya Gharib. Fred Nazem
disclaims beneficial ownership of these securities. (2) Includes 494,416 options
at $0.152/share and 164,805 warrants at $0.152/share.
(3) Includes 247,208 options at $0.152/share.
27
(4) Includes 98,883 options at $0.152/share.
(5) Includes 15,625 options at $1.80 per share
(6) Includes 1,000,000 shares held by Littlehampton Investments LLC, and 250,000
shares held by Michael Millon. (7) Does not include shares held by the Fred F.
Nazem Children's Trust, or by Fred Nazem who resigned as the Chairman of the
Board and the CEO of NetFabric effective November 30, 2004.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 13. EXHIBITS AND REPORTS
A. EXHIBITS
Exhibit 2 Acquisition Agreement between the Company, NetFabric,
NetFabric's shareholders and Littlehampton LLC,
dated December 9, 2004
Exhibit 10.1(a) Letter Agreement between Houston Operating Company and
NetFabric Corporation and Macrocom Investors, LLC
and Littlehampton Investments, LLC, dated March 25, 2005**
Exhibit 10.1(b) Financing Agreement between NetFabric and Macrocom, dated
July 22, 2004
Exhibit 10.1(c) Loan Agreement between NetFabric and Macrocom, dated
October 14, 2004
Exhibit 10.1(d) Amendment to Financing and Loan Agreement between NetFabric
and Macrocom, dated December 2, 2004
Exhibit 10.2(a) Distribution Agreement between NetFabric and Williams,
dated November 29, 2004
Exhibit 10.2(b) Sales Agreement between NetFabric and CommuniTech, dated
February 25, 2004
Exhibit 10.2(c) Sample Purchase Order of NetFabric with Kimchuk
Exhibit 10.2(d) Lease Agreement between NetFabric and Silvermine,
dated January 1, 2004
Exhibit 10.3(a) Employment Letter with William Meltzer dated
January 28, 2004
Exhibit 10.3(b) Employment Letter with Joseph Welfeld dated April 2, 2004
Exhibit 10.3(c) Employment Letter with Victoria Desidero dated May 21, 2004
Exhibit 10.3(d) Employment Letter with Dominick Zumbo dated August 5, 2004
Exhibit 10.3(d) Employment Letter with Walter Carozza dated November 9, 2004
Exhibit 10.3(f) Employment Letter with Philip Barak dated November 9, 2004
Exhibit 10.4 2005 Stock Option Plan
Exhibit 10.5 Charter for the Compensation Committee
Exhibit 10.6 Charter for the Audit Committee
Exhibit 14.1 Corporate Governance Statement
Exhibit 14.2 Code of Business Conduct and Ethics
Exhibit 14.3 Written Disclosure Policy
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification (CEO)**
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification (CFO)**
Exhibit 32.1 Section 1350 Certification (CEO)**
Exhibit 32.2 Section 1350 Certification (CFO)**
**Filed herewith.
B. REPORTS:
Form 8K was filed by the Company with the SEC on December 15, 2004 to announce
the acquisition between it and NetFabric Corporation.
Form 8KA was filed by the Company with the SEC on February 24, 2005 to provide
the financial statements of NetFabric Corporation as they related to the
Acquisition.
Form 14c was filed by the Company with the SEC on March 22, 2005 to adopt the
2005 Stock Option Plan/
28
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the fees billed by our independent auditor,
J.H. Cohn LLP, for the fiscal years ended December 31, 2004 and 2003:
FY 2004 FY 2003
--------- ---------
Audit fees and quarterly reviews $ 61,000 $ -
All other fees:
Tax return preparation - -
Audit related services - -
Non-audit related services - -
--------- ---------
Total Fees $ 61,000 $ -
========= =========
The Audit Committee considered and determined that the services performed
for "financial information systems design and implementation fees" and "all
other fees" are compatible with maintaining the independence of the independent
auditors.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSABLE NON-AUDIT
SERVICES OF INDEPENDENT AUDITOR
The Audit Committee is responsible for pre-approving all audit and
permitted non-audit services to be performed for us by our independent auditor
as outlined in its Audit Committee charter. Prior to engagement of the
independent auditor for each year's audit, management or the independent auditor
submits to the Audit Committee for approval an aggregate request of services
expected to be rendered during the year, which the Audit Committee pre-approves.
During the year, circumstances may arise when it may become necessary to engage
the independent auditor for additional services not contemplated in the original
pre-approval. In those circumstances, the Audit Committee requires specific
pre-approval before engaging the independent auditor. The Audit Committee does
not delegate to management its responsibility to pre-approve services performed
by the independent auditor.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 31, 2005 /s/ JEFF ROBINSON
-----------------
Jeff Robinson Chairman
and Chief Executive Officer
(principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 31, 2005 /s/ JEFF ROBINSON
-----------------
Jeff Robinson Chairman
and Chief Executive Officer
(principal executive officer)
Date: March 31, 2005 /s/ WALTER CAROZZA
------------------
Walter Carozza, Chief Financial
Officer
(principal accounting officer)
Date: March 31, 2005 /s/ MADELYN DEMATTEO
--------------------
Madelyn DeMatteo, Director
Date: March 31, 2005 /s/ CHARLOTTE G. DENENBERG
--------------------------
Charlotte G. Denenberg, Director
Date: March 31, 2005 /s/ RICHARD HOWARD
------------------
Richard Howard, Director
30
EXHIBIT 10.1(a)
[GRAPHIC OMITTED]
67 Federal Road
Building A, Suite 300
Brookfield
CT 06804
March 25, 2005
Via Email
- ---------
Mr. Michael Millon
Macrocom Investors, LLC
Dear Michael:
This letter will confirm our understanding with respect to the Finance Agreement
between Macrocom Investors, LLC and NetFabric Corporation ("NetFabric") of July
22, 2004 ("Agreement") with respect to the shell company that you brought to us.
Specifically, under the terms of that agreement, it was agreed and understood
that Macrocom Investors, LLC or a company formed by you would either bring to
NetFabric a shell for purchase or purchase a shell and propose it to NetFabric
as a vehicle for merger or acquisition. In either event, the shell was subject
to acceptance by NetFabric after it conducted its own due diligence, and you
were to be compensated in post-closing stock of the shell company used for such
merger or acquisition.
As it happened, Littlehampton Investments, LLC, ("Littlehampton") a company
formed by you, purchased a controlling interest in Houston Operating Company
("HOC") and proposed HOC as the company for merger with NetFabric. We conducted
our due diligence, agreed to merge with HOC and proceeded to closing on December
9, 2004. At the time of the merger, Littlehampton had and retained 1,000,000
shares of post-closing stock of HOC as a result of its previous purchase of the
shell, which purchase NetFabric was not a party to, and you received no other
compensation for the providing the shell to NetFabric.
As a result, you have received all compensation due to you under the terms of
the Agreement for bringing the company, HOC, to NetFabric for purposes of the
merger transaction.
Please confirm your above understanding of the above by signing a copy of this
letter and returning an original to me for our files.
Sincerely,
Walter Carozza
CFO, Houston Operating Company and NetFabric Corporation
Understood and agreed to:
- -------------------------------------------
Michael Millon, for Macrocom Investors, LLC
and Littlehampton Investments, LLC
EXHIBIT 31.1
CERTIFICATION
I, Jeff Robinson, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-KSB of Netfabric, Inc.
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report.
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report.
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d 15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
Company and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the Company, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the Company's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the Company's internal
control over financial reporting that occurred during the period covered
by the annual report that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over
financial reporting.
5. The Company's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
control over financial reporting.
March 31, 2005
/s/ Jeff Robinson
-----------------------------------
Name: Jeff Robinson
Title: Chairman and
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION
I, Walter Carozza, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-KSB of Netfabric, Inc.
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report.
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report.
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d 15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
Company and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the Company, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the Company's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the Company's internal
control over financial reporting that occurred during the period covered
by the annual report that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over
financial reporting.
5. The Company's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
control over financial reporting.
March 31, 2005
/s/ Walter Carozza
-----------------------------------
Name: Walter Carozza
Title: Chief Financial Officer
EXHIBIT 32.1
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 Netfabric, Inc. (the "Company") on
Form 10-KSB for the period ended December 31, 2004 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), I, Jeff Robinson,
Chairman and Chief Executive Officer, certify, pursuant to 18 U.S.C. ss.1350,
as adopted pursuant to ss.906 of the Sarbanes-Oxley Act, 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.
March 31, 2005
/s/ Jeff Robinson
-----------------------------------
Name: Jeff Robinson
Title: Chairman and
Chief Executive Officer
A signed original of this written statement required by Section 906 has
been provided to Netfabric, Inc. and will be retained by Netfabric, Inc. and
furnished to the Securities and Exchange Commission or its staff upon request.
EXHIBIT 32.2
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 Netfabric, Inc. (the "Company") on
Form 10-KSB for the period ended December 31, 2003 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), I, Walter Carozza,
Chief Financial Officer, certify, pursuant to 18 U.S.C. ss.1350, as adopted
pursuant to ss.906 of the Sarbanes-Oxley Act, 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.
March 31, 2005
/s/ Walter Carozza
-----------------------------------
Name: Walter Carozza
Title: Chief Financial Officer
A signed original of this written statement required by Section 906 has
been provided to Netfabric, Inc. and will be retained by Netfabric, Inc. and
furnished to the Securities and Exchange Commission or its staff upon request