Securities and Exchange Commission on April 7, 2005
Registration No.
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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HOUSTON OPERATING COMPANY
(Name of Small Business Issuer in Its Charter)
DELAWARE 4813 76-0307819
(State or other (Primary Standard (I.R.S. Employer
jurisdiction Industrial Identification No.)
of incorporation or Classification Code Number)
organization)
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67 Federal Road, Building A, Suite 300
Brookfield, CT 06804
(203) 775-1178
(Address and Telephone Number of Principal Executive Offices
and Principal Place of Business)
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Jeff Robinson
Chief Executive Officer
Houston Operating Company
67 Federal Road, Building A, Suite 300
Brookfield, CT 06804
(203) 775-1178
(Name, Address and Telephone Number of Agent for Service)
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Copies to:
Robert S. Matlin, Esq.
Lillian C. Wilkinson, Esq.
Thelen Reid & Priest LLP
875 Third Avenue
New York, New York 10022
(212) 603-2000
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Approximate Date of Proposed Sale to the Public: From time to time after
the effective date of this Registration Statement as determined by market
conditions and other factors.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering.
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.
If delivery of this prospectus is expected to be made pursuant to Rule 434,
please check the following box.
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CALCULATION OF REGISTRATION FEE
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Proposed Proposed
Maximum Maximum Amount of
Title of Each Class of Amount to be Offering Price Aggregate Registration
Securities to be Registered Registered * Per Share * Price * Fee *
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Common stock, $0.001 par value 7,750,000 $1.50 $1.50 $1,368.26
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Total 7,750,000 $1.50 $1.50 $1,368.26
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* Estimated solely for the purpose of calculating the registration fee pursuant
to Rule 457(c), based on the average high and low prices of the Common Stock as
reported on OTC Bulletin Board on April 1, 2005.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED APRIL 7, 2005
PRELIMINARY PROSPECTUS
7,750,000 SHARES OF COMMON STOCK
HOUSTON OPERATING COMPANY
This prospectus relates to the resale from time to time of shares of common
stock, par value $0.001 per share, of the Houston Operating Company by certain
selling stockholders listed under and defined in the section entitled "Selling
Stockholders" for their resale of up to 7,750,000 shares of our common stock.
The common stock offered by this prospectus may be offered by the Selling
Stockholders from time to time in transactions reported on the OTC Bulletin
Board, in negotiated transactions, or otherwise, or by a combination of these
methods, at fixed prices which may be changed, at market prices at the time of
sale, at prices related to market prices or at negotiated prices. We will not
receive any proceeds from the sale of the shares by the Selling Stockholders,
except if they exercise their warrants.
On December 9, 2004, Houston Operating Company ("HOC" or the "Company")
entered into an exchange agreement ("Exchange Agreement") with all of the
stockholders of NetFabric Corporation ("NetFabric"). At the closing, HOC
acquired all of the issued and outstanding capital stock of NetFabric in
exchange for an aggregate of 32,137,032 newly-issued shares of common stock of
HOC.
Our shares are traded on the OTC Bulletin Board (the "OTCBB") under the
symbol "HOOC.OB." On April 1, 2005, the last reported sale of our common stock
on the OTCBB Board was $1.50 per share.
In this prospectus, "we," "us," "our company," "the Company," and "our"
refer to Houston Operating Company and its consolidated subsidiary NetFabric
unless the context requires otherwise.
INVESTING IN OUR COMMON STOCK INVOLVES A NUMBER OF RISKS. SEE "RISK
FACTORS" BEGINNING ON PAGE [3] TO READ ABOUT SIGNIFICANT RISK FACTORS YOU SHOULD
CONSIDER BEFORE INVESTING IN THE SECURITIES.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THIS PROSPECTUS INCORPORATES IMPORTANT BUSINESS AND FINANCIAL INFORMATION
ABOUT HOUSTON OPERATING COMPANY THAT IS NOT INCLUDED OR DELIVERED WITH THIS
DOCUMENT. THIS INFORMATION IS DESCRIBED IN GREATER DETAIL IN THE SECTION OF THIS
PROSPECTUS ENTITLED "WHERE YOU CAN FIND MORE INFORMATION." IN ADDITION, THE
INFORMATION IS AVAILABLE WITHOUT CHARGE UPON A WRITTEN OR ORAL REQUEST TO
HOUSTON OPERATING COMPANY, 67 FEDERAL ROAD, BUILDING A, SUITE 300, BROOKFIELD,
CT 06804, (203) 775-1178, ATTN: INVESTOR RELATIONS.
The date of this prospectus is April 7, 2005.
TABLE OF CONTENTS
PAGE
PROSPECTUS SUMMARY...........................................................1
RISK FACTORS.................................................................3
FORWARD-LOOKING STATEMENTS...................................................8
USE OF PROCEEDS..............................................................8
DIVIDEND POLICY..............................................................8
SELECTED FINANCIAL DATA......................................................9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................................10
BUSINESS....................................................................16
MANAGEMENT..................................................................23
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............29
SELLING STOCKHOLDERS........................................................30
PLAN OF DISTRIBUTION........................................................31
DESCRIPTION OF OUR CAPITAL STOCK............................................32
LEGAL MATTERS...............................................................34
EXPERTS.....................................................................34
SHARES ELIGIBLE FOR FUTURE SALE.............................................34
AVAILABLE INFORMATION.......................................................35
You should rely only on the information contained in this prospectus. We
have not, and the Selling Stockholders have not, authorized any other person to
provide you with information that is different from that contained in this
prospectus. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of common stock.
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PROSPECTUS SUMMARY
You should read this summary together with the entire prospectus, including
the more detailed information in our consolidated financial statements and
related notes appearing elsewhere in this prospectus.
The following summary highlights selected information from this prospectus
and may not contain all the information that is important to you. To understand
our business and this offering fully, you should read this entire prospectus
carefully, along with the more detailed information and financial statements and
the notes to the financial statements appearing elsewhere in this prospectus
before you decide whether to participate in this offering. This prospectus
contains forward-looking statements and information relating to our Company. See
"Forward Looking Statements" beginning on page [8]. We will pay all expenses of
the registration. Any brokers' or underwriters' fees or commissions, however,
will be paid by the Selling Stockholders. We will not receive any proceeds from
the sale of the shares of common stock by the Selling Stockholders, except if
they exercise their warrants.
The Selling Stockholders have not advised us of any specific plans for the
distribution of the shares covered by this prospectus. We anticipate, however,
that the shares will be sold from time to time primarily in transactions on the
OTC Bulletin Board at the then current market price, although sales may also be
made in negotiated transactions or otherwise. The Selling Stockholders and the
brokers and dealers through whom the sale of the shares may be made may be
deemed to be "underwriters" within the meaning of the Securities Act of 1933 and
their commissions or discounts and other compensation may be regarded as
underwriters' compensation. See "Plan of Distribution" on page [31].
Our principal executive offices are located at 67 Federal Road, Building A,
Suite 300, Brookfield, CT 06804. Our telephone number is (203) 775-1178.
OUR BUSINESS
On December 9, 2004, HOC entered into an Exchange Agreement (the
"Acquisition Agreement") with all of the stockholders (the "NetFabric
Stockholders") of NetFabric. At the closing, which occurred at the same time as
the execution of the Acquisition Agreement, the Company acquired all of the
issued and outstanding capital stock of NetFabric from the NetFabric
Stockholders in exchange for an aggregate of 32,137,032 newly-issued shares of
the Company's Common Stock (the "Acquisition"). In addition, the Company assumed
the obligation to issue a total of 5,162,526 shares of common stock, underlying
warrants and stock options issued by NetFabric. However, for accounting
purposes the acquisition was a reverse merger and the financial statements
herein reflect NetFabric as the acquiring company.
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.
NetFabric develops and sells a family of Internet Protocol ("IP")
appliances that simplify the incorporation of any telephone system into a
customer's IP infrastructure thus reducing the cost of telephone calls and
providing a software platform for additional products and services. NetFabric's
products deliver productivity gains to small and medium sized businesses with
cost reductions while maintaining Public Switched Telephone Network ("PSTN")
class reliability and ease of use. The market for NetFabric's products is a
multi-billion dollar marketplace and NetFabric, to its knowledge, is one of the
first companies to introduce Customer Premise Equipment ("CPE") that transforms
the consumer Voice over Internet Protocol ("VoIP") services from many providers
into one that is reliable enough to be used in a business environment.
NETFABRIC'S PRODUCTS
NetFabric'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. NetFabric'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 side of the company's network usually coming from the Private
Branch Exchange ("PBX") or Key System). The FUSION 12x8 product contains all of
the functionality of the FUSION 4x4 product plus additional capabilities; for
example, the FUSION 12x8 product features port expansion. 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.
PRODUCT STRATEGY
NetFabric's product strategy assumes that potential 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 ("SMB") market because of perceived issues with cost, reliability, ease
of use, quality of service and potential Emergency 911 problems. NetFabric's
products solve these and other problems and deliver customers a fast return on
their investment in NetFabric's products that can be measured in the short term.
NetFabric's product strategy has two phases. Phase 1 of NetFabric'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 NetFabric's products.
Phase 2 of NetFabric's product strategy the "Advanced Product Family" provides a
tightly integrated solution coupled with a more sophisticated applications
platform.
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 ("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 generate significantly growing
revenue in the longer term. Service Providers are potentially the largest
long-term sales channel for NetFabric. OEMs represent another major long-term
revenue stream for NetFabric. Another type of OEM transaction would be to adapt
one or more of NetFabric's products to meet certain specific needs, for example,
redesigning the product to fit a particular board size and connector pin
configuration so that NetFabric's product can plug into the OEM's existing card
cage. The retail channel is becoming an avenue for penetrating the Small Office
Home Office ("SOHO") and SMB market. Companies such as Best Buy Co., Inc and
others are focused on the these markets and have invested in their own product
installation and configuration teams. Also, NetFabric presently employs several
direct sales representatives, and may add more in the future if this direct
sales channel proves effective.
DISTRIBUTORS
NetFabric has a written agreement with Williams Telecommunications Corp.
(www.williamsglobal.com) ("Williams"), whereby Williams purchases and resells
NetFabric products to end-users and VARS, and for use in conjunction with its
own customer product offerings. NetFabric currently has a non-binding verbal
distribution agreement with ABP Technology, Inc. (www.abptech.com) ("ABP"),
whereby ABP purchases and resells NetFabric products to VARS and small service
providers. NetFabric currently has a non-binding verbal distribution agreement
with CoMatrix, Inc. (www.comatrix.com) ("CoMatrix"), whereby CoMatrix purchases
and resells NetFabric products to Interconnects, integrators and VARS.
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MANUFACTURING AND COMPONENT SUPPLY
NetFabric uses Kimchuk, Inc. (www.kimchuk.com) ("Kimchuk") for its
manufacturing operations. NetFabric's relationship with Kimchuk is not
formalized in a written agreement, but is determined by the parties on a
manufacturing lot-by-lot basis.
THE OFFERING
On January 12, 2005, in accordance with previously disclosed financing and
compensation agreements between the Company and Macrocom Investors, LLC
("Macrocom"), and the Company and Michael Millon, the Managing Member of
Macrocom, the Company issued common shares of its stock as follows: 1,000,000
shares to Macrocom in conversion of the principal of the outstanding convertible
note dated July 12, 2004 in the amount of $500,000 at the agreed price per share
of $0.50; 1,000,000 shares to Macrocom following receipt from it of $500,000 in
equity financing at the agreed price per share of $0.50; 500,000 shares to
Macrocom as additional consideration for the July 22, 2004 and the October 13,
2004 loans of $500,000 each made by it to the Company; 250,000 shares to Michael
Millon as consideration for arranging the Macrocom financing for the Company. In
addition, Macrocom has the right to convert the principle of its October 13,
2004 loan of $500,000 into 1,000,000 of common stock. 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 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. On November 30, 2004, Littlehampton Investments, LLC had purchased
7,030,000 shares from shareholders of the Company. As part of the Acquisition
Agreement, Littlehampton Investments, LLC cancelled 6,030,000 shares of common
stock and was granted registration rights on 1,000,000 shares it still held.
Littlehampton Investments, LLC had the right to have 1,000,000 of its shares of
common stock registered.
Common stock offered................ 4,750,000 shares
Common stock underlying conversion
of note and exercise of warrants.... 3,000,000 shares
Common stock to be outstanding
after the offering.................. 38,652,204
Use of Proceeds..................... We will not receive any of the proceeds
from the sale of the shares of common
stock because they are being offered by
the Selling Stockholders, except we may
receive the proceeds from the exercise
of the warrants.
OTC Bulletin Board symbol........... HOOC.OB
This prospectus relates solely to the registration of 7,750,000 shares of our
common stock by the Selling Stockholders. The outstanding share information is
based on our shares outstanding as of March 22, 2005:
RISK FACTORS
Investing in our common stock involves a high degree of risk. You should
carefully consider the following risk factors and all other information
contained in this prospectus before purchasing our common stock. The risks and
uncertainties described below are not the only ones facing us. Additional risks
and uncertainties that we are unaware of, or that we currently deem immaterial,
also may become important factors that affect us.
If any of the following risks occur, our business, financial condition or
results of operations could be materially and adversely affected. In that case,
the trading price of our common stock could decline, and you may lose some or
all of your investment.
3
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 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.
OUR FINANCIAL CONDITION HAS RAISED SUBSTANTIAL DOUBT REGARDING OUR ABILITY TO
CONTINUE AS A GOING CONCERN
As discussed elsewhere in this prospectus, we have incurred substantial
operating and net losses, as well as negative operating cash flows, since our
inception. As a result, the independent auditor's report accompanying our
consolidated financial statements starting with our Annual Report on Form 10-KSB
for the year ended December 31, 2004, contains an explanation that our financial
statements have been prepared assuming that we will continue as a going concern.
Factors such as those described in these risk factors raise substantial doubt
about the Company's ability to continue as a going concern. Our ability to
continue to operate as a going concern will depend on our ability to raise
working capital and to increase sales. Our failure in these efforts may
materially and adversely affect our ability to continue as a going concern.
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
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'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
4
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.
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.
5
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.
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.
6
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;
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
7
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.
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. We have
based these forward-looking statements largely on our current expectations and
projections about future events and financial trends affecting the financial
condition of our business. These forward-looking statements are subject to a
number of risks, uncertainties and assumptions, including, among other things:
o general economic and business conditions, both nationally and in
our markets;
o our expectations and estimates concerning future financial
performance, financing plans, acquisitions or mergers, and the
impact of competition;
o our ability to implement our acquisition and growth strategy;
o anticipated trends in our business;
o advances in technologies; and,
o other risk factors set forth under "Risk Factors" beginning on
page 3 in this prospectus.
In addition, in this prospectus, we use words such as "anticipates",
"believes", "plans", "expects", "future", "intends", and similar expressions to
identify forward-looking statements.
We undertake no obligation to update publicly or revise any forward-looking
statements, whether as a result of new information, future events, or otherwise
after the date of this prospectus. In light of these risks and uncertainties,
the forward-looking events and circumstances discussed in this prospectus may
not occur and actual results could differ materially from those anticipated or
implied in the forward-looking statements.
USE OF PROCEEDS
The proceeds from the sale of the shares offered by this prospectus will be
received directly by the Selling Stockholders. We will not receive any proceeds
from the sale of the shares offered by this prospectus, except if the Macrocom
warrants are exercised.
DIVIDEND POLICY
The Company does not intend to pay any cash dividends on its common stock
in the foreseeable future. All cash resources are expected to be invested in
developing the Company's business plan.
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the OTCBB under the symbol "HOOC.OB". From
January 1, 2004 to December 31, 2004, it traded as high as $3.40 per common
share and as low as $0.20 per common share.
8
Rules 15g-1 through 15g-9 promulgated under the Exchange Act impose sales
practice and disclosure requirements on broker-dealers who engage in certain
transactions involving a "penny stock". Subject to certain exceptions, a penny
stock generally includes any non-Nasdaq equity security that has a market price
of less than $5.00 per share. The market price of our common stock on the OTCBB
during the twenty-one months ended February 28, 2005 has ranged between a high
of $3.40 and a low of $0.20 per share, and our common stock is thus deemed to be
penny stock for purposes of the Exchange Act. The additional sales practice and
disclosure requirements imposed upon broker-dealers may discourage them from
effecting transactions in our common stock, which could severely impair the
liquidity of our common stock in the secondary market.
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). The following table sets forth the quarterly high and low
sales prices based on bid quotations per share. Such over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
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 $0.51 $0.35
Fourth Quarter $0.35 $0.35
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.
SELECTED FINANCIAL DATA
FINANCIAL STATEMENTS
Information in response to this item is set forth in the Financial
Statements, beginning on Page F-1 of this report.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
On March 28, 2005, pursuant to approval by our board of directors, we
dismissed Michael Johnson & Co., LLC, as our independent registered public
accounting firm. The board of directors determined that, as a result of the
reverse acquisition in which NetFabric was the acquirer, the consolidated
financial statements of HOC going forward will be, effectively, the consolidated
financial statements of NetFabric and for reasons of continuity, J.H. Cohn LLP,
the accounting firm of NetFabric prior to the merger with HOC, should become our
independent registered public accounting firm.
During HOC's two most recently completed fiscal years and through the date
of the merger with NetFabric, there were no disagreements between HOC and
Michael Johnson & Co., LLC on any matter of accounting principles or practices,
9
financial statement disclosure or audit scope or procedure which, if not
resolved to Michael Johnson & Co., LLC's satisfaction, would have caused the
firm to make reference to the subject matter in connection with its reports on
HOC's financial statements for either such fiscal year or for any reporting
period since HOC's last fiscal year-end. During HOC's two most recently
completed fiscal years, and through the date of the merger, there were no
reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
On March 28, 2005, we retained J.H. Cohn LLP to be our principal
independent registered public accounting firm. During the two most recent fiscal
years and to March 28, 2005 we have not consulted with J.H. Cohn LLP regarding
either (1) the application of accounting principles to a specified transaction,
either completed or proposed; or the type of audit opinion that might be
rendered on our financial statement, and either a written report was provided to
us or oral advice was provided that J.H. Cohn LLP concluded was an important
factor considered by us in reaching a decision as to the accounting, auditing or
financial reporting issue; or (2) any matter that was the subject of a
disagreement and required to be reported under item 304(a)(1)(iv) of Regulation
S-B and the related instructions thereto.
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 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 stated in their report on our consolidated financial
statements that, as discussed in Note 1 to the Company's consolidated financial
statements, the Company is in the development stage, has had net losses from
inception and has working capital and net capital deficiencies and 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.
CORPORATE HISTORY
On December 9, 2004, HOC entered into an Acquisition Agreement with all of
the NetFabric Stockholders. 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 NetFabric Stockholders in
exchange for an aggregate of 32,137,032 newly-issued shares of HOC's Common
Stock. Therefore, in this prospectus, "we," "us," "our company," "the Company,"
and "our" refer to Houston Operating Company and its consolidated subsidiary
NetFabric Corporation unless the context requires otherwise.
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 $1,499,746 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
10
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
========== ==========
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.
11
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
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.
BUSINESS AND PLAN OF OPERATION
The Company, headquartered in Brookfield, CT, is a leading 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 4.5 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 FUS1ONTM 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 FUS1ON, 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 the 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 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
12
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
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.
[GRAPHIC OMITTED][GRAPHIC OMITTED]
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, FUS1ON, 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.
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 FUS1ON and fast ROI
scenarios could easily be demonstrated to the business customer.
CRITICAL ACCOUNTING POLICIES
Basis of Preparation of Consolidated Financial Statements
The consolidated financial statements include the accounts of HOC and
NetFabric, 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.
13
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.
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
14
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
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
15
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.
BUSINESS
BUSINESS HISTORY
Houston Operating Company was incorporated in Delaware in August of 1989,
and has not had operations since before 2002. NetFabric Corporation 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" or "Share Exchange"). 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
16
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; and,
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.
17
Number of Total Employees
Employees 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
TOTAL SMB
Totals 4,851,266 40,973,082 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
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.
18
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 analogous 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.
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.
19
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.
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
20
o Service Providers
o Original Equipment Manufacturers ("OEM")
o Retailers
Master Distributors sell primarily to 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
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.
21
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 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
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
22
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.
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 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.
LEGAL PROCEEDINGS
The Company might be involved as a party to a number of legal claims
arising in the ordinary course of business. The Company believes the ultimate
resolution of these claims will not have a material effect on its financial
position, results of operation or cash flow. In addition, the Company has
received notice alleging that the Company is in default in filing this
registration statement on behalf of certain of the Selling Shareholders. If the
registration statement relating to the Macrocom stock is not effective within
180 days of the Closing Date for reasons not beyond NetFabric's control,
NetFabric will pay Macrocom liquidated damages of 45,000 shares of the common
stock of the Company for each month or any portion thereof, until such
registration statement is effective. The Company believes it is not in default
based upon oral extensions granted to it by the Selling Shareholders and
believes the filing of the registration statement will cure any alleged default.
MANAGEMENT
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 CEO Mr. Robinson is a co-founder
of NetFabric and has been a
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
23
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 Direc-
tor 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.
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
Officer NetFabric 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
24
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
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
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
second 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 Chairman and Audit Committee Financial Expert.
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.
25
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.
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 Securities
Annual Restricted Underlying
Compen- Stock Options/ LTIP All Other
Name and Year Salary Bonus sation Awards SARs Payouts Compensation
Principal Position (1) ($) ($) ($) ($) (#) ($) ($)
- -------------------------- ----- --------- ------- --------- ---------- ----------- ------- -----------
Fred Nazem
Chief Executive Officer(2) 2004 175,000 0 0 0 0 0 0
Jeff Robinson
Chief Executive Officer(3) 2004 175,000 0 0 0 0 0 0
Walter Carozza, Chief
Financial Officer 2004 60,000 0 0 0 988,832 0 0
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.
(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 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 a Company 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
26
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
non-employee 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:
Weighted Average Weighted Average
Options 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
========================================================
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.
Number of
Securities % of Total Options
Underlying Options Granted to Employees Exercise Price
Name Granted in 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
27
Number of
Securities % of Total Options
Underlying Options Granted to Employees Exercise Price
Name Granted in Fiscal Period per Share Expiration Date
- -------------------- ------------------ -------------------- -------------- ------------------
William Meltzer 164,805 5.65% $0.152 January 1, 2014
Joseph Welfeld 148,325 5.08% $0.152 April 26, 2014
Dominick Zumbo 148,325 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.
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.
28
Number of
Securities % of Total Options
Underlying Options Granted to Employees Exercise Price
Name Granted in 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 148,325 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 $0.1517 per share with
each warrant expiring five years from the date of issuance.
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 with
each option expiring 10 years from the date of issuance.
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.
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 Chairman and CEO 14,832,476(1) 42.80%
Fred Nazem 14,832,477(1) 42.80%
Walter Carozza CFO 824,026(2) 2.38%
Philip Barak VP Finance 247,208(3) 0.71%
Victoria Desidero VP Marketing 98,883(4) 0.29%
Madelyn M. DeMatteo Director 15,625(5) 0.05%
Charlotte G. Denenberg Director 15,625(5) 0.05%
Richard F. Howard Director 15,625(5) 0.05%
Macrocom Investors, LLC 1,750,000(6) 5.05%
1365 York Avenue, 28B
New York, NY 10021
ALL DIRECTORS AND OFFICERS 16,049,468 (7) 46.32%
AS A GROUP
29
- ---------------
* Except as otherwise noted, the address for the shareholder is the Company's
address.
(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.
(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.
SELLING STOCKHOLDERS
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, among other terms and conditions, Macrocom provided a
loan to NetFabric in the amount of $500,000 ("Loan") for a period of 180 days
from the original date of the Financing Agreement ("Due Date") at an annual
simple interest rate of 5%. On the Due Date, the Company had the option to repay
the principal in cash or in kind by issuing 1,000,000 shares of Post Closing
Stock, as defined. In either event, the interest on the Loan was payable in cash
on the Due Date. The Company must issue to Macrocom 250,000 shares of Post
Closing Stock as additional consideration for the Loan. In January 2005, in
accordance with the terms of the Financing Agreement, the Company elected to
repay the principal by issuing 1,000,000 shares of Post Closing Stock, and
issued those shares and the 250,000 additional consideration shares to Macrocom.
On October 14, 2004, NetFabric and Macrocom entered into another loan
agreement which was amended on December 2, 2004 (the "Loan Agreement"), whereby
Macrocom agreed to loan an additional $500,000 to NetFabric ("Second Loan"), due
180 days from the original date of the Loan Agreement ("Second Due Date") at an
annual simple interest rate of 5%. On the Second Due Date, at the option of
Macrocom, Macrocom can convert the principal of the Second Loan into 1,000,000
shares of Post Closing Stock or demand repayment of the principal in cash. In
either event, the interest on the Second Loan is payable in cash on the Second
Due Date. In addition, NetFabric agreed to issue and has issued to Macrocom
250,000 shares of Post Closing Stock as additional consideration for the Second
Loan.
In addition to the bridge loan transactions described above, Macrocom has
provided $1,000,000 of equity financing to the Company and in return has
received 2,000,000 shares of common stock of the Company. In addition, under
this arrangement, Macrocom received 250,000 common shares of the Company 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. Under the terms of the Financing Agreement, the
Company agreed, at its cost, to file a registration statement for the
registration of the Macrocom stock with the Securities and Exchange Commission
as soon as practicable but no later than 90 days following the Closing Date. If
the registration statement relating to the Macrocom stock is not effective
within 180 days of the Closing Date for reasons not beyond NetFabric's control,
NetFabric will pay Macrocom liquidated damages of 45,000 shares of the common
stock of the Company for each month or any portion thereof, until such
registration statement is effective.
On November 30, 2004, Littlehampton Investments, LLC had purchased
7,030,000 shares from shareholders of the Company. As part of Acquisition
Agreement, Littlehampton Investments, LLC cancelled 6,030,000 shares of common
stock and was granted registration rights on the remaining 1,000,000 shares it
still held.
The shares of common stock are being registered to permit public secondary
trading of the shares, and the Selling Stockholders may offer the shares for
resale from time to time. .
Information regarding beneficial ownership of our common stock by the
Selling Stockholders as of March 7, 2005 follows. The shares beneficially owned
have been determined in accordance with rules promulgated by the SEC, and the
information is not necessarily indicative of beneficial ownership for any other
30
purpose. Unless otherwise indicated below, each Selling Stockholder has sole
voting and investment power with respect to its or his shares of common stock.
The inclusion of any shares in this table does not constitute an admission of
beneficial ownership for the Selling Stockholder. The Selling Stockholders may
from time to time offer and sell pursuant to this prospectus any or all of the
common stock being registered. No estimate can be given as to the amount of
shares that will be held by the Selling Stockholders after completion of this
offering because the Selling Stockholders may offer all or some of the shares
and because there currently are no agreements, arrangements or understandings
with respect to the sale of any of the shares.
- ----------------------------------------------------------------------------------------
PRIOR TO OFFERING AFTER THIS OFFERING
- ----------------------------------------------------------------------------------------
TOTAL TOTAL
AMOUNT OF AMOUNT OF
SHARES PERCENTAGE SHARES PERCENTAGE
NAME OF BENEFICIALLY OF COMMON BENEFICIALLY OF COMMON
BENEFICIAL OWNERS OWNED STOCK OWNED OWNED STOCK OWNED
- ----------------------------------------------------------------------------------------
Macrocom Investors, LLC 6,500,000 16.82 0 0
- ----------------------------------------------------------------------------------------
Littlehampton
Investments, LLC 1,000,000 2.59 0 0
- ----------------------------------------------------------------------------------------
Michael Millon 250,000 0.65 0 0
- ----------------------------------------------------------------------------------------
Total Shares 7,750,000 20.06 0 0
- ----------------------------------------------------------------------------------------
PLAN OF DISTRIBUTION
The Selling Stockholders and any of their donees, pledgees, assignees and
other successors-in-interest, may, from time to time, sell any or all of their
shares of common stock being offered under this prospectus on any stock
exchange, market or trading facility on which the shares are traded or in
private transactions. These sales, which may include block transactions, may be
at fixed or negotiated prices. The Selling Stockholders may use any one or more
of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent, but may position and resell a portion of the
block as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resales by the
broker-dealer for its own account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o short sales, which are contracts for the sale of shares of stock
that the seller does not own, or certificates for which are not
within his control, so as to be available for delivery at the
time when, under applicable rules, delivery must be made;
o transactions to cover short sales;
o broker-dealers may agree with the Selling Stockholder to sell a
specified number of shares at a stipulated price per share;
o a combination of any of these methods of sale; or
o any other method permitted by applicable law.
The sale price to the public may be:
31
o the market price prevailing at the time of sale;
o a price related to the prevailing market price;
o at negotiated prices; or
o a price the Selling Stockholder determines from time to time.
Subject to the applicable securities laws, the shares may also be sold
under Rule 144 under the Securities Act, if available, rather than under this
prospectus. The Selling Stockholders have the sole and absolute discretion not
to accept any purchase offer or make any sale of shares if it deems the purchase
price to be unsatisfactory at any particular time.
The Selling Stockholders may also engage in short sales against the box,
which are sales where the seller owns enough shares to cover the borrowed
shares, if necessary, puts and calls and other transactions in securities or
derivative securities of our Company and may sell or deliver shares in
connection with these trades. The Selling Stockholders may pledge their shares
to a broker under the margin provisions of customer agreements. If the Selling
Stockholders defaults on a margin loan, the broker may, from time to time, offer
and sell the pledged shares.
Broker-dealers engaged by the Selling Stockholders may arrange for other
broker-dealers to participate in sales. Broker-dealers may receive commissions
or discounts from the selling security holder (or, if any broker-dealer acts as
agent for the purchaser of shares, from the purchaser) in amounts to be
negotiated. The Selling Stockholders do not expect these commissions and
discounts to exceed what is customary in the types of transactions involved.
The Selling Stockholders and any broker-dealers or agents that are involved
in selling the shares may be deemed to be "underwriters" within the meaning of
the Securities Act in connection with these sales. In that event, any
commissions received by these broker-dealers or agents and any profit on the
resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act.
The Selling Stockholders, alternatively, may sell all or any part of the
shares offered under this prospectus through an underwriter. To our knowledge,
the Selling Stockholders have not entered into any agreement with a prospective
underwriter, and we cannot assure you as to whether any such agreement will be
entered into. If a Selling Stockholder informs us that it has entered into such
an agreement or agreements, any material details will be set forth in a
supplement to this prospectus or, if required, in a replacement prospectus
included in a post-effective amendment to the registration statement of which
this prospectus is a part.
The Selling Stockholders and any other persons participating in the sale or
distribution of the shares offered under this prospectus will be subject to
applicable provisions of the Exchange Act and the rules and regulations under
that act, including Regulation M. These provisions may restrict activities of,
and limit the timing of purchases and sales of any of the shares by, the Selling
Stockholder or any other person. Furthermore, under Regulation M, persons
engaged in a distribution of securities are prohibited from simultaneously
engaging in market making and other activities with respect to those securities
for a specified period of time prior to the commencement of such distributions,
subject to specified exceptions or exemptions. All of these limitations may
affect the marketability of the shares.
DESCRIPTION OF OUR CAPITAL STOCK
The following general summary of our capital stock is qualified in its
entirety by reference to our Certificate of Incorporation. See "Where You Can
Find More Information" for a description of the documents incorporated by
reference.
GENERAL
The Company's authorized capital stock consists of 50,000,000 shares of
common stock, par value $0.001 per share, of which there are 38,652,204 issued
and outstanding, and 10,000,000 shares of preferred stock, par value $0.001 per
32
share, of which none have been designated or issued. All of the issued and
outstanding shares of NetFabric's common stock are held by the Company as a
result of the acquisition. The following statements relating to the capital
stock set forth the material terms of these securities; however, reference is
made to the more detailed provisions of, and these statements are qualified in
their entirety by reference to, the Company's Certificate of Incorporation and
Bylaws, copies of which are filed as exhibits to the Company's SEC reports.
COMMON STOCK
Holders of shares of the Company's common stock are entitled to one vote
for each share on all matters to be voted on by the stockholders. Holders of
common stock do not have cumulative voting rights. Holders of common stock are
entitled to share ratably in dividends, if any, as may be declared from time to
time by the Board of Directors in its discretion from funds legally available
therefore. In the event of any liquidation, dissolution or winding up, the
holders of common stock are entitled to a pro-rata share of all assets remaining
after payment in full of all liabilities and preferential payments, if any, to
holders of preferred stock. All of the outstanding shares of common stock are
fully paid and non-assessable. Holders of common stock have no preemptive rights
to purchase our common stock. There are no conversion or redemption rights or
sinking fund provisions with respect to our common stock.
PREFERRED STOCK
The Board of Directors of the Company is authorized to provide for the
issuance of shares of preferred stock in series and, by filing a certificate
pursuant to the applicable law of Delaware, to establish from time to time the
number of shares to be included in each of these series, and to fix the
designation, powers, preferences and rights of the shares of each of these
series and the qualifications, limitations or restrictions applicable to each
series without any further vote or action by the stockholders. Any shares of
preferred stock so issued would have priority over the common stock with respect
to dividend or liquidation rights. Any future issuance of preferred stock may
have the effect of delaying, deferring or preventing a change in control of the
Company without further action by the stockholders and may adversely affect the
voting and other rights of the holders of common stock. At present, we have no
plans to issue any preferred stock or adopt any series, preferences or other
classification of preferred stock.
The issuance of shares of preferred stock, or the issuance of rights to
purchase shares of preferred stock, could be used to discourage an unsolicited
acquisition proposal. For instance, the issuance of a series of preferred stock
might impede a business combination by including class voting rights that would
enable the holder to block a business combination transaction, or facilitate a
business combination by including voting rights that would provide a required
percentage vote of the stockholders. In addition, the issuance of preferred
stock could adversely affect the voting power of the holders of the common
stock. Although the Board of Directors is required to make any determination to
issue such stock based on its judgment as to the best interests of our
stockholders, the Board of Directors could act in a manner that would discourage
an acquisition attempt or other transaction that some, or a majority, of the
stockholders might believe to be in their best interests or in which
stockholders might receive a premium for their stock over the then market price
of such stock. At present, the Board of Directors does not intend to seek
stockholder approval prior to any issuance of currently authorized stock, unless
otherwise required by law or applicable stock exchange rules. We have no present
plans to issue any preferred stock.
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 $0.1517 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 $0.1517 per share.
TRANSFER AGENT
Securities Transfer Corporation of Dallas, Texas currently acts as our
transfer agent and registrar.
33
LEGAL MATTERS
The validity of the shares offered hereby has been passed upon for us by
Thelen Reid & Priest LLP, 875 Third Avenue, New York, New York 10022, (212)
603-2215.
You should rely only on the information contained or incorporated by
reference in this prospectus. We have not authorized any other person to provide
you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. You should assume that the
information appearing in this prospectus as well as information that we have
previously filed with the Securities and Exchange Commission and incorporated by
reference is accurate only as of the date of the applicable document.
EXPERTS
The consolidated financial statements as of Houston Operating Company (a
development state 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 are included in this Registration
Statement in reliance on the report of J.H. Cohn LLP, independent registered
public accounting firm, which report contains an explanatory paragraph related
to the ability of Houston Operating Company and subsidiaries to continue as a
going concern, and have been so included in reliance on the authority of that
firm as experts in auditing and accounting.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of our common stock in the public market, or
the perception that such sales may occur, could adversely affect the prevailing
market price and impair our ability to raise capital in the future.
As of March 31,, 2005, 38,652,204 shares of our common stock were issued
and outstanding. Approximately 765,172 of our outstanding shares are freely
tradable without restriction or further registration under the Securities Act
before giving effect to this prospectus. After giving effect to this prospectus,
7,750,000 additional common shares will be freely tradable.
In general, under Rule 144 of the Securities Act as currently in effect, a
person who has beneficially owned restricted securities for at least one year
would be entitled to sell within any three-month period a number of shares that
does not exceed the greater of the following:
o one percent of the number of shares of common stock then
outstanding,
o the average weekly trading volume of the common stock during the
four calendar weeks preceding the sale. However, pursuant to the
rules and regulations promulgated under the Securities Act, the
OTC Bulletin Board, where our common stock is quoted, is not an
"automated quotation system" referred to in Rule 144(e). As a
consequence, this market-based volume limitation allowed for
securities listed on an exchange or quoted on Nasdaq is
unavailable for our common stock.
Sales under Rule 144 are also subject to requirements with respect to
manner-of-sale requirements, notice requirements and the availability of current
public information about us. Under Rule 144(k), a person who is not deemed to
have been our affiliate at any time during the three months preceding a sale,
and who has beneficially owned the shares proposed to be sold for at least two
years, is entitled to sell his or her shares without complying with the
manner-of-sale, public information, volume limitation or notice provisions of
Rule 144.
Rule 701, as currently in effect, permits our employees, officers,
directors, and consultants who purchased shares pursuant to a written
compensatory plan or contract to resell these shares in reliance upon Rule 144,
but without compliance with the specific restrictions of Rule 144. Rule 701
provides that affiliates may sell their Rule 701 shares under Rule 144 without
complying with the holding period requirement and that non-affiliates may sell
their shares in reliance on Rule 144 without complying with the holding period,
public information, volume limitation or notice provisions of Rule 144.
34
AVAILABLE INFORMATION
This prospectus incorporates documents by reference which are not presented
in or delivered with this prospectus. You should rely only on the information
contained in this document or to documents that we have referred you to. We have
not authorized anyone to provide you with any additional information.
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
these reports, proxy statements and other information at:
Public Reference Room
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
You may obtain information on the operation of the Public Reference Room by
calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities
and Exchange Commission maintains a website that contains reports, proxy and
information statements, and other information regarding issuers that file
electronically with the Securities and Exchange Commission, located at
http://www.sec.gov.
The Securities and Exchange Commission permits us to "incorporate by
reference" the information we file with it, which means that we can disclose
important information to you by referring to those documents. The information
incorporated by reference is an important part of this prospectus, and
information that we file later with the Securities and Exchange Commission will
automatically update and supersede this information. We incorporate by reference
the following documents we filed with the Securities and Exchange Commission
pursuant to the Exchange Act:
o our current report on Form 8-K dated and filed with the
Securities and Exchange Commission on December 9, 2004;
o our current report on Form 8-KA dated and filed with the
Securities and Exchange Commission on February 24, 2005; and
o our current report on Form 14c, dated and filed with the
Securities and Exchange Commission on March 22, 2005.
o Our current report on Form 10KSB, dated and filed with the
Securities and Exchange Commission on March 31, 2005.
We will provide to you at no cost a copy of any or all of the information
incorporated by reference into this prospectus. You may make a request for a
copy of this information in writing or by telephone. Requests should be directed
to:
Houston Operating Company
67 Federal Road, Building A, Suite 300
Brookfield, CT 06804
Attn: Victoria Desidero
(203) 775-1178
FINANCIAL STATEMENTS
Information in response to this item is set forth in the Financial
Statements, beginning on Page F-1 of this report.
35
HOUSTON OPERATING COMPANY
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
of J.H. Cohn LLP F-2
Consolidated financial statements:
Consolidated Balance Sheets, December 31, 2004 and 2003 F-3
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 F-4
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 F-5
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 F-6
Notes to Consolidated financial statements F-7-F-16
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
(except for Note 12, as to
which the date is April 7, 2005)
See Notes to Consolidated Financial Statements
F-1
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
authorized, 34,652,204 and 29,829,758 shares issued
an outstanding 34,652 29,830
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
ADDITIONAL ACCUMULATED TOTAL
COMMON STOCK PAID-IN DURING THE STOCKHOLDERS'
SHARES PAR VALUE CAPITAL DEVELOPMENT STAGE EQUITY (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
non-employees for services 60,059 1,370 61,429
Amortization of debt discount 161,062 - 161,062
Depreciation and amortization 8,211 - 8,211
Changes in operating assets and liabilities:
Inventory (72,025) - (72,025)
Trade accounts receivable (18,284) - (18,284)
Prepaid expenses (50,000) - (50,000)
Accounts payable and accrued liabilities 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
warrants issued and beneficial conversion
feature $ 411,403 $ - $ 411,403
--------------- ---------------- ----------------------
Value of shares and warrants issued in
connection with financing commitment $ 368,683 $ - $ 368,683
--------------- ---------------- ----------------------
See Notes to 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.
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
F-7
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.
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
F-8
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 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:
F-9
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 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
F-10
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 and 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 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
F-11
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 and
amortization 8,211
----------
$171,931
==========
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
============
F-12
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 January 2005.
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 January 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 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.
F-13
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 $ - $ -
------------------------------------------------
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.
F-14
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:
Options Weighted Average Weighted Average Fair
Exercise Price 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).
F-15
9. COMMITMENTS
The Company leases office space under an operating lease, which covers the
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.
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.
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 equity investment provided by Macrocom.
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.
12. SUBSEQUENT DISPUTE UNDER FINANCING AGREEMENT
The Company has received a notice on March 31, 2005 from certain of the
Macrocom Investors alleging that the Company is in default in filing
registration statement. If the registration statement relating to the Macrocom
stock is not effective within 180 days of the Closing Date for reasons not
beyond NetFabric's control, NetFabric will pay Macrocom liquidated damages of
45,000 shares of the common stock of the Company for each month or any portion
thereof, until such registration statement is effective. The Company believes it
is not in default based upon oral extensions granted to it by Macrocom and
believes the filing of the registration statement will cure any alleged default.
Management believes that it will not have any material effects in subsequent
periods on the Company's consolidated financial position, results of operation
or cash flow based on or as a result of the outcome from this matter.
F-16
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the expenses (other than the underwriting
discounts and commissions and the Underwriter's Non-Accountable Expense
Allowance) expected to be incurred in connection with the issuance and
distribution of the securities being registered. All amounts are estimates
except the Securities and Exchange Commission registration fee.
SEC Registration Fee $1,368.26
Legal Fees and Expenses $25,000
Accounting Fees $5,000
Miscellaneous $3,000
Total $34,368.26
INDEMNIFICATION OF DIRECTORS AND OFFICERS
(a) Article IX of the Registrant's By-Laws (the "By-Laws") provides that
the Registrant shall, to the fullest extent permitted by applicable law as then
in effect, indemnify any person who is or was involved or threatened to be made
so involved in any action by reason of the fact that he is or was a director or
officer of the Registrant, or is or was serving at the request of the Registrant
as a director or officer of another entity; provided that the Registrant shall
indemnify a person seeking indemnification in connection with an action
initiated by such person only if: (i) required by law; (ii) authorized by its
board of directors; (iii) pursuant to the powers vested in the Registrant by the
Delaware General Corporation Law (the "DGCL"); or, (iv) to establish a right of
indemnification under an indemnity agreement or any other law or as required by
section 145 of the DGCL. The right to indemnification includes the right to
receive payment of expenses in advance of the final disposition of the
proceeding; provided that the Registrant shall only make a payment of expenses
in advance upon receipt of an undertaking by the indemnified person to repay all
advanced amounts should it ultimately be determined that the person was not
entitled to indemnification. All indemnification rights in Article IX are
contract rights. The Registrant also may provide indemnification for employees
and agents of the Registrant by action of its board of directors. Article IX
expressly states that no amendment to the By-Laws or the Certificate of
Incorporation shall adversely affect any right to indemnification for acts
occurring prior to such amendment. The right of indemnification is not exclusive
of any other rights of indemnification that may be available.
In determining the right to indemnification, the Registrant has the burden
of proving that the indemnitee has not met the applicable standard of conduct.
If successful in whole or in part in such a proceeding, the indemnitee is
entitled to be indemnified for expenses incurred in connection with such
proceeding. All reasonable expenses incurred by an indemnitee in connection with
any proceeding shall be advanced by the Registrant after receipt of a statement
from the indemnitee requesting such advance. If a claim for indemnification is
not paid by the Registrant within ninety (90) days after a written claim has
been received by the Registrant, the indemnitee may at any time thereafter bring
suit against the Registrant to recover the unpaid amount of the claim.
Article IX provides that the Registrant may purchase and maintain insurance
in connection with any expenses, liability or loss relating to any proceeding,
whether or not the Registrant would have the power to indemnify the officer,
director, employee, agent, attorney, trustee or representative. The Registrant
also may enter into indemnification contracts with any of the foregoing persons,
which contracts are deemed specifically approved and authorized by the
Stockholders.
(b) Under Section 145 of the DGCL, indemnification of any person who is or
was a party or threatened to be made so in any action by reason of the fact that
he is or was a director, officer, employee or agent of the corporation or was
serving in such capacity for another corporation or other enterprise at the
request of the corporation is permitted against expenses, fines and amounts paid
in settlement actually and reasonably incurred by him in such proceeding where
II-1
the indemnified person acted in good faith and in a manner he reasonably
believed to be in or not opposed to the best interests of the corporation, and
in criminal actions, where he had no reasonable cause to believe his conduct was
unlawful. Indemnification is also permitted in lawsuits brought by or on behalf
of the corporation if the standards of conduct described above are met, except
that no indemnification is permitted in respect to any matter in which the
person is adjudged to be liable to the corporation unless a court shall
determine that indemnification is fair and reasonable in view of all the
circumstances of the case. Indemnification against expenses (including
attorneys' fees) actually and reasonably incurred by directors, officers,
employees and agents is required under Section 145 of the DGCL in those cases
where the person to be indemnified has been successful on the merits or
otherwise in defense of a proceeding of the type described above. In cases where
indemnification is permissive, a determination as to whether the person met the
applicable standard of conduct must be made (unless ordered by a court) by
majority vote of the disinterested directors, by independent legal counsel, or
by the Stockholders. Such indemnification rights are specifically not deemed to
be exclusive of other rights of indemnification by agreement or otherwise and
the corporation is authorized to advance expenses incurred prior to the final
disposition of a matter upon receipt of an undertaking to repay such amounts on
a determination that indemnification was not permitted in the circumstances of
the case.
(c) Under Section 145 of the DGCL and Article IX of the By-Laws, the
Registrant may purchase and maintain insurance on behalf of any person who is or
was a director, officer, employee, or agent of the Registrant, or who serves as
a director, officer, employee or agent of another corporation or other
enterprise, against liability asserted against or incurred by such person in any
such capacity whether or not the Registrant would have the power to provide
indemnity under Section 145 or the By-Laws. The Registrant has obtained
insurance which, subject to certain exceptions, insures the directors and
officers of the Registrant and its subsidiaries.
(d) As permitted by Section 102(b)(7) of the DGCL, Article SEVENTH of the
Registrant's Amended and Restated Certificate of Incorporation provides that a
director of the Registrant shall not be personally liable to the Registrant or
its Stockholders for monetary damages for breach of fiduciary duty as a
director, except for liability (i) for any breach of the director's duty of
loyalty to the Registrant or its Stockholders; (ii) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law; (iii) for any unlawful payment of a dividend or unlawful stock purchase or
redemption; or (iv) for any transaction from which the director derived any
improper personal benefit.
(e) Certain registration rights agreements provide for the indemnification
of the Registrant, which may be deemed to include its directors and officers, by
the Selling Stockholders. The indemnification provided for by the Selling
Stockholders is limited to matters arising in connection with this Registration
Statement.
The above discussion of the Registrant's By-Laws, Amended and Restated
Certificate of Incorporation, indemnification agreements, and of Section 145 of
the DGCL is not intended to be exhaustive and is respectively qualified in its
entirety by such By-Laws, Amended and Restated Certificate of Incorporation and
statutes.
RECENT SALES OF UNREGISTERED SECURITIES
Set forth below is information regarding securities sold by us since
December 31, 2003 which were not registered under the Securities Act. This
information excludes the securities being registered under this Registration
Statement. We believe that each transaction was exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) of the Securities
Act and/or Regulation D promulgated thereunder as transactions not involving a
public offering, based on the private nature of the transactions and the
financial sophistication of the purchasers, all of whom had access to complete
information concerning us and acquired the securities for investment and not
with a view to the distribution thereof.
Security Type Security Type Date Issued No of Shares
Common Stock Jeff Robinson December 9,2004 14,832,476(1)
Common Stock Fred Nazem December 9,2004 8,240,265(1)
Common Stock Fred F. Nazem Children's Trust December 9,2004 6,592,212(1)
Common Stock Walter Carozza December 9,2004 164,805(1)
Common Stock Fridolyn Facklemayer December 9,2004 329,611(1)
II-2
Common Stock Craig A. Drill December 9,2004 1,318,442(1)
Common Stock Roy Young December 9,2004 659,221(1)
Common Stock Macrocom Investors, LLC January 12, 2005 6,500,000(2)
Common Stock Michael Millon January 12, 2005 250,000(2)
Warrants Walter Carozza December 8, 2003 164,805(3)
Warrants Fridolyn Facklemayer January 29, 2004 329,611(3)
Warrant Roy Young January 1, 2004 659,221(3)
(1) On December 9, 2004, Houston Operating Company entered into an Exchange
Agreement with all of the stockholders of NetFabric Corporation whereby 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.
(2) See "Offering" beginning on page 3.
(3) These warrants were issued in connection with an equity financing
transaction with NetFabric whereby the warrant holder was granted 100% of their
original equity investment in NetFabric.
II-3
Exhibits and Financial Statement Schedules
EXHIBIT NO. DESCRIPTION
2.1* Amended and Restated Share Exchange Agreement between Houston
Operating Company and NetFabric Corporation, dated December 9, 2004.
2.2* Financing Agreement between Macrocom Investors, LLC and NetFabric
Corporation dated July 22, 2004
3.1.1** Certificate of Amendment to the Amended and Restated Certificate of
Incorporation of Houston Operating Company
3.1.2** Certificate of Amendment to the Amended and Restated Certificate of
Bylaws of Houston Operating Company
4.1 Certificate for Shares
5.1 Consent of Thelen Reid & Priest LLP
10.1** Houston Operating Company's 2005 Stock Option Plan
14.1 Code of Business Conduct and Ethics Policy
23.1 Consent of Independent Registered Public Accounting Firm.
23.2 Consent of Thelen Reid & Priest LLP (contained in Exhibit 5).
24.1 Power of Attorney (Included on signature page)
* Incorporated by reference to the exhibit previously filed on December 9, 2004
with the registrant's Form 8-K.
** Incorporated by reference to the exhibit previously filed on December 9,
2004, with the registrant's Form 8-K, and our current report on Form 14c, dated
and filed with the Securities and Exchange Commission on March 25, 2005.
UNDERTAKINGS
The undersigned hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the
most recent post-effective amendment thereof) which, individually
or in the aggregate, represent a fundamental change in the
information set forth in the registration statement.
Notwithstanding the foregoing, any increase or decrease in volume
of securities offered (if the total dollar value of securities
offered would not exceed that which was registered) and any
deviation from the low or high and of the estimated maximum
offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate,
the changes in volume and price represent no more than a 20
percent change in the maximum aggregate offering price set forth
in the "Calculation of Registration Fee" table in the effective
registration statement; and
II-4
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the Registration
Statement or any material change to such information in the
Registration Statement.
Provided, however, that paragraphs (1)(i) and (1)(ii) above do not
apply if the information required to be included in a post-effective
amendment by those paragraphs is contained in periodic reports filed
by the registrant pursuant to Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") that
are incorporated by reference in the registration statement;
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each
filing of the registrant's annual report pursuant to Section 13(a) or
15(d) of the Exchange Act (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Exchange Act) that is incorporated by reference in the registration
statement shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof;
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to the directors, officers,
and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification
is against public policy as expressed in the Securities Act and is,
therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer, or
controlling person in connection with the securities being registered,
the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and
will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be
deemed to be part of this registration statement as of the time it was
declared effective.
(2) For the purposes of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering
thereof.
II-5
SIGNATURES
In accordance with the requirement of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filings on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in New York City, State
of New York on April 7, 2005.
HOUSTON OPERATING COMPANY
By: /s/ JEFF ROBINSON
-----------------------------
Jeff Robinson
Chief Executive Officer
By: /s/ WALTER CAROZZA
-----------------------------
Walter Carozza
Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints each of Jeff Robinson and Walter Carozza,
individually, as their true and lawful attorney-in-fact and agent, with full
power of substitution for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments and post-effective amendments to this
registration statement, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto each said attorney-in-fact and agent full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, thereby ratifying and confirming all that each said
attorney-in-fact and agent, or his substitutes, may lawfully do or cause to be
done by virtue thereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Date: April 7, 2005 /s/ JEFF ROBINSON
------------------------------
Jeff Robinson Chairman, President and
Chief Executive Officer
(principal executive officer)
Date: April 7, 2005 /s/ WALTER CAROZZA
------------------------------
Walter Carozza, Chief Financial Officer
(principal accounting officer)
Date: April 7, 2005 /s/ MADELYN DEMATTEO
------------------------------
Madelyn DeMatteo, Director
Date: April 7, 2005 /s/ CHARLOTTE G. DENENBERG
------------------------------
Charlotte G. Denenberg, Director
Date: April 7, 2005 /s/ RICHARD HOWARD
------------------------------
Richard Howard, Director
Exhibit 5.1
April 7, 2005
Houston Operating Company
67 Federal Road, Building A, Suite 300
Brookfield, CT 06804
Re: REGISTRATION STATEMENT ON FORM SB-2
Ladies and Gentlemen:
We have acted as counsel to Houston Operating Company, a Delaware
corporation (the "Registrant"), in connection with the preparation of a
Registration Statement on Form SB-2 (the " Registration Statement") filed on
April 7, 2005 with the Securities and Exchange Commission (the "Commission")
under the Securities Act of 1933, as amended (the "Securities Act"), relating to
the registration of (i) 7,750,000 shares of the Company's common stock, par
value $0.001 per share (the "Common Stock").
Capitalized terms used and not otherwise defined herein shall have the
respective meanings ascribed to them in the Registration Statement.
We have examined originals, copies, certified or otherwise identified to
our satisfaction: (i) the Registration Statement, (ii) the Certificate of
Incorporation and the By-Laws of the Registrant, each as amended to date, (iii)
resolutions of the Registrant's Board of Directors, and (iv) such documents,
records, agreements, proceedings and legal matters as we have deemed necessary
or advisable for the purpose of this opinion. With respect to any documents or
other corporate records which we have examined, we have assumed the genuineness
of all signatures on, and the authenticity of, all documents submitted to us as
originals, and the conformity to the original documents submitted to us as
certified or photostatic copies.
Based upon the foregoing, and subject to the assumptions, exceptions,
qualifications and limitations set forth hereinafter, we are of the opinion
that:
1. The Registrant is a corporation duly organized, validly existing and in
good standing under the laws of the State of Delaware.
2. The Common Stock has been duly authorized and validly issued, and is
fully paid and non-assessable.
The opinion expressed in the above paragraph 1 is given solely on the basis
of a certificate of the Secretary of State of the State of Delaware. The opinion
is limited to the meaning ascribed to such certificate by the Secretary of the
State of Delaware and applicable law.
The opinions and other matters in this letter are qualified in their
entirety and subject to the following:
We are members of the Bar of the State of New York and this opinion is
limited to the laws of the State of New York, the federal laws of the United
States of America and the General Corporation Law of the State of Delaware,
including the statutory provisions and all applicable provisions of the Delaware
Constitution and reported judicial decisions interpreting these laws. We express
no opinion concerning the law of any other jurisdiction.
We hereby consent to the filing of this opinion with the Commission as
Exhibit 5.1 to the Registration Statement. We also consent to the reference to
us in the prospectus included in the Registration Statement under the caption
"Legal Matters." In giving the foregoing consent, we do not thereby admit that
we are in the category of persons whose consent is required under Section 7 of
the Securities Act or the rules and regulations of the Commission there under.
This opinion is rendered solely for your benefit in connection with the
matters addressed herein. Except as stated in the immediately preceding
paragraph, without prior consent, this opinion may not be relied upon by you for
any purpose or furnished or quoted to, or relied upon by any person or entity
for any purpose.
Very truly yours,
/s/ THELEN REID & PRIEST LLP
----------------------------
THELEN REID & PRIEST LLP
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the inclusion in this registration statement on Form SB-2 of
our report dated March 30, 2005 (except for Note 12, as to which the date is
April 7, 2005), on our audits of the consolidated financial statements of
Houston Operating Company (a development stage company) as of December 31, 2004
and 2003 and for each of the years then ended and for the period from inception
(January 1, 2003) to December 31, 2004, which report contains an explanatory
paragraph related to the Company's ability to continue as a going concern. We
also consent to the reference to our firm under the caption "Experts."
/s/ J. H. Cohn LLP
Jericho, New York
April 7, 2005
EXHIBIT 99
THIS WARRANT AND THE SHARES ISSUABLE UPON EXERCISE OF THIS WARRANT HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933 (THE "ACT") OR ANY APPLICABLE STATE
SECURITIES LAW, AND MAY NOT BE TRANSFERRED EXCEPT (I) PURSUANT TO AN EFFECTIVE
REGISTRATION STATEMENT UNDER THE ACT OR (II) UPON FIRST FURNISHING TO THE
COMPANY AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT SUCH TRANSFER IS
NOT IN VIOLATION OF THE REGISTRATION REQUIREMENTS OF THE ACT OR ANY APPLICABLE
STATE SECURITIES LAW.
WARRANT NO. [ 1 ]
DATED AS OF DECEMBER 8, 2003
COMMON STOCK WARRANT
FOR THE PURCHASE OF 50,000 SHARES OF COMMON STOCK
OF
NETFABRIC CORPORATION
-------------------------------------
This Warrant is issued to Walter Carozza or his registered assigns (the
"Holder"), by NetFabric Corporation, a Delaware corporation (the "Company").
This Warrant is issued pursuant to the terms of a Securities Purchase Agreement
dated even date herewith (the "Purchase Agreement") in connection with the
issuance of shares of Common Stock (as defined in the Purchase Agreement) by the
Company to the Holder. Any capitalized terms not otherwise defined herein shall
have the meaning described to them in the Purchase Agreement.
1. Purchase Shares. Subject to the terms and conditions hereinafter set
forth, the Holder is entitled, upon surrender of this Warrant at the principal
office of the Company (or at such other place as the Company shall notify the
Holder in writing), to purchase 50,000 (after giving effect to a 100,000 for 1
stock split the Company intends to effectuate) shares of Common Stock (the
"Shares") at a per share exercise price equal to $0.50 (the "Exercise Price").
The number of Shares issuable pursuant to this Section 1 and the Exercise Price
shall be subject to adjustment pursuant to Section 7 hereof.
2. Exercise Period. Except as otherwise provided for herein, this Warrant
shall be exercisable, in whole or in part, at any time and from time to time,
after the date hereof and ending on the earliest to occur of (a) the
consummation of a Qualified Public Offering (as defined herein), (b) the closing
of an Extraordinary Transaction (as defined herein), or (c) at 5:00 p.m. eastern
time on the fifth (5th) anniversary of the date of this Warrant (the "Expiration
Date").
3. Definition. As used herein, the following terms shall have the
meanings ascribed to them below:
(a) "Qualified Public Offering" shall mean the closing of an
underwritten initial public offering of the common stock of the Company which
results in gross proceeds (before deduction of discounts, commissions or
applicable expenses) to the Company of at least $25,000,000; and
(b) "Extraordinary Transaction" shall mean the sale of all or
substantially all of the assets of the Company or the merger of the Company into
any other entity.
4. Exercise of Warrant.
(a) While this Warrant remains outstanding and exercisable in
accordance with Section 2 hereof, the rights represented by this Warrant may be
exercised by the Holder, in whole or in part (but not as to a fractional Share),
by the surrender of this Warrant (with the notice of exercise form attached
hereto as Exhibit 1 (the "Notice of Exercise") duly executed) at the office of
any duly appointed transfer agent for the Company or at the principal office of
the Company and upon payment to the Company, or for the account of the Company,
by cash or certified check or wire transfer, of the purchase price for such
shares in the amount equal to the product of (i) the Exercise Price, multiplied
by (ii) the number of Shares being purchased.
(b) Net Issue Election. The Holder may elect to receive, without the
payment by such Holder of any consideration (other than the surrender referred
to in this Section 4(b)), Shares equal to the value of this Warrant or any
portion hereof (as determined below) by the surrender of this Warrant or such
portion to the Company, with the Notice of Exercise duly executed by such
Holder, at the office of any duly appointed transfer agent for the Company or at
the principal office of the Company. Thereupon, the Company shall issue to such
Holder such number of fully paid and nonassessable Shares as is computed using
the following formula:
X = Y * (A-B)
A
where
X = the number of Shares to be issued to such Holder pursuant to this
Section 4(b)
Y = the number of Shares elected to be surrendered under this Warrant
(not to exceed the maximum number of Shares issuable under this
Warrant) at the time the net issue election is made pursuant to
this Section 4(b)
A = the Fair Market Value of one Share
B = the Exercise Price.
As used herein, "Fair Market Value" per Share as of any date shall mean the
fair market value of a Share determined in good faith by the Company's Board of
Directors.
5. Delivery of Stock Certificates on Exercise. As soon as practicable after
the exercise of this Warrant in accordance with Section 4 hereof and in any
event within 10 days thereafter, the Company at its expense will cause to be
issued in the name of and delivered to the Holder, or as such Holder (upon
payment by such holder of any applicable transfer taxes) may direct, a
certificate or certificates for the number of Shares to which such Holder shall
be entitled on such exercise, and, unless this Warrant has expired or has been
exercised in full, a new Warrant representing the number of Shares with respect
to which this Warrant shall not then have been exercised shall also be issued to
the Holder at such time. The Holder acknowledges that the certificate or
certificates representing the shares of stock issuable upon the exercise of this
Warrant shall be stamped or otherwise imprinted with a legend substantially in
the following form:
"THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF
1933, AS AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR
HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO
THE SECURITIES UNDER SAID ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE
COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED OR AN AVAILABLE EXEMPTION
FROM REGISTRATION UNDER SAID ACT."
Upon the request of a holder of a certificate representing Shares purchased
upon exercise of this Warrant, the Company shall remove the foregoing legend
from the certificate or issue to such holder a new certificate therefor free of
any transfer legend, if, with such request, the Company shall have received an
opinion of counsel reasonably satisfactory to the Company to the effect that
such legend may be removed from such certificate.
6. Shares to be Issued; Reservation of Shares; Holders of Record.
(a) Shares to be Issued. The Company covenants and agrees that all
Shares which may be issued upon the exercise of the rights represented by this
Warrant and payment in full of the exercise price therefore will, upon issuance,
be duly authorized and validly issued and outstanding, fully paid and
non-assessable, and free from all taxes, liens and charges with respect to the
issue thereof.
(b) Reservation of Stock. The Company covenants and agrees that,
during the period within which the rights represented by this Warrant may be
exercised, the Company will at all times have authorized and reserved a
sufficient number of shares of its Common Stock to provide for the exercise of
the rights represented by this Warrant.
(c) Holders of Record. Each person or entity in whose name any
certificate for Shares is issued upon the exercise of this Warrant in accordance
with its terms shall for all purposes be deemed to have become the holder of
record of the Shares represented thereby on, and such certificate shall be dated
the date upon which the Notice of Exercise was duly executed and payment of the
aggregate Exercise Price was made pursuant to Section 4 hereof. Prior to the
exercise of this Warrant, the Holder shall not be entitled to any rights of a
stockholder of the Company with respect to the Shares for which this Warrant
shall be exercisable, including, without limitation, the right to vote, to
receive dividends or other distributions or to exercise any preemptive rights
and shall not be entitled to receive any notice of any proceedings of the
Company, except as provided herein.
7. Adjustments.
(a) Adjustment for Stock Dividends, Subdivisions and Combinations.
Upon the issuance of additional shares of Common Stock after the initial
issuance thereof as a dividend or other distribution on outstanding shares of
Common Stock, the subdivision of outstanding shares of Common Stock into a
greater number of shares of Common Stock, or the combination of outstanding
shares of Common Stock into a smaller number of shares of Common Stock, the
number of Shares to be purchased hereunder shall be proportionately adjusted to
the nearest whole share. An adjustment made pursuant to this Section 7(a) shall
be given effect, upon payment of such a dividend or distribution, as of the
record date for the determination of stockholders entitled to receive such
dividend or distribution (on a retroactive basis) and in the case of a
subdivision or combination shall become effective immediately as of the
effective date thereof.
(b) Adjustments for Capital Reorganizations. Except as provided in
Section 2, if any capital reorganization or reclassification of the capital
stock of the Company shall be effected, whether by merger, consolidation, sale
of assets or otherwise (other than a subdivision or combination of shares or
stock dividend as provided for above) (in each case, a "Reorganization"), then,
as a condition of such Reorganization, lawful and adequate provision shall be
made whereby the holder hereof shall thereafter have the right to purchase and
receive upon the basis and upon the terms and conditions specified in this
Warrant, in lieu of Shares immediately theretofore to be purchased and to be
received upon the exercise of the rights represented hereby, those shares of
stock, securities or assets which would have been issued or payable with respect
to or in exchange for the Shares issuable upon exercise of this Warrant had this
Warrant been exercised immediately prior to the record date (or the effective
date, as the case may be) for such Reorganization. Except as provided in Section
2, upon any Reorganization this Warrant shall continue in full force and effect
and the terms hereof shall be applicable to the shares and other securities and
property receivable on the exercise of this Warrant after the consummation of
such Reorganization and shall be binding upon the issuer of any such stock or
other securities, including the person acquiring all or substantially all of the
properties or assets of the Company, whether or not such person shall have
expressly assumed the terms of this Warrant.
(c) Other Adjustments. In the event the Company shall make or issue,
or fix a record date for the determination of holders of Common Stock entitled
to receive, a dividend or other distribution payable in securities of the
Company other than shares of Common Stock, then and in each such event lawful
and adequate provision shall be made so that the Holders shall receive upon
exercise thereof in addition to the number of Shares receivable thereupon, the
number of securities of the Company which the Holder would have received had
such Warrants been exercised on the date of such event and had the Holder
thereafter, during the period from the date of such event to and including the
date of exercise, retained such securities receivable by the Holder as aforesaid
during such period, giving application to all adjustments called for during such
period under this Section 7 as applied to such distributed securities.
(d) Notice of Adjustment. When any adjustment is required to be made
in the number or kind of Shares to be purchased upon exercise of the Warrant,
the Company shall promptly notify the Holder of such event and of the adjusted
number of Shares or other securities or property thereafter to be purchased upon
exercise of this Warrant.
8. No Shareholder Rights. Prior to exercise of this Warrant, the Holder
shall not be entitled to any rights of a shareholder with respect to the shares
issuable hereunder, including, without limitation, the right to vote such
shares, receive dividends or other distributions thereon, exercise preemptive
rights or be notified of shareholder meetings, and such Holder shall not be
entitled to any notice or other communication concerning the business or affairs
of the Company. However, nothing in this Section 8 shall limit the right of the
Holder to be provided the notices required under this Warrant or the Purchase
Agreement.
9. Transfer. Subject to compliance with applicable securities laws, this
Warrant and all rights hereunder are transferable, in whole or in part, at the
offices referred to in Section 4 hereof by the Holder in person or by a duly
authorized attorney, upon surrender of this Warrant properly endorsed. Each
taker and holder of this Warrant, by taking or holding the same, consents and
agrees that this Warrant, when endorsed in blank, shall be deemed negotiable and
that when this Warrant is so endorsed, the holder hereof may be treated by the
Company and all other persons dealing with this Warrant as the absolute owner
hereof for any purposes and as the person entitled to exercise the rights
represented by this Warrant or to the transfer hereof on the books of the
Company, any notice to the contrary notwithstanding; but until each transfer on
such books, the Company may treat the registered holder hereof as the owner
hereof for all purposes.
10. Exchange. Subject to compliance with applicable securities laws, this
Warrant is exchangeable, upon the surrender hereof by the Holder at such offices
for new Warrants of like tenor representing in the aggregate the right to
subscribe for and purchase the number of Shares which may be subscribed for and
purchased hereunder, each of such new Warrants to represent the right to
subscribe for and purchase such number of Shares as shall be designated by the
Holder at the time of such surrender. Upon receipt of evidence satisfactory to
the Company of the loss, theft, destruction or mutilation of this Warrant and,
in the case of any such loss, theft or destruction, upon delivery of a bond of
indemnity satisfactory to the Company, or, in the case of any such mutilation,
upon surrender or cancellation of this Warrant, the Company will issue to the
holder hereof a new warrant of like tenor, in lieu of this Warrant, representing
the right to subscribe for and purchase the number of Shares which may be
subscribed for and purchased hereunder.
11. Notices. Notices or demands relating to this Warrant shall be
sufficiently given or made if sent by first-class mail, postage prepaid, by
facsimile or delivered by a nationally-recognized overnight or other courier, if
to the Company, at the address of its principal office or if to the holder of
this Warrant, at its address registered on the books of the Company. In case (i)
the Company shall take a record of the holders of its Common Stock (or other
stock or securities at the time receivable upon the exercise of this Warrant)
for the purpose of entitling them to receive any dividend or other distribution,
or any right to subscribe for or purchase any shares of stock of any class or
any other securities, or to receive any other right, (ii) of an Extraordinary
Transaction, (iii) of a Qualified Public Offering, or (iv) of any voluntary
dissolution, liquidation or winding-up of the Company, then, and in each such
case, the Company will mail or cause to be delivered or mailed to the Holder or
Holders of this Warrant a notice specifying, as the case may be, (A) the date on
which a record is to be taken for the purpose of such dividend, distribution or
right, and stating the amount and character of such dividend, distribution or
right, or (B) the date on which such Extraordinary Transaction, a Qualified
Public Offering or dissolution, liquidation or winding-up is to take place, and
the time, if any is to be fixed, as of which the holders of record of Common
Stock (or such stock or securities at the time receivable upon the exercise of
this Warrant) shall be entitled to exchange their shares of Common Stock (or
such other stock or securities) for securities or other property deliverable
upon such Extraordinary Transaction or dissolution, liquidation or winding-up.
Such notice shall be mailed at least 10 days prior to the date therein
specified.
12. Miscellaneous. The terms and provision of this Warrant shall inure to
the benefit of, and be binding upon, the Company and the Holder hereof and their
respective successors and assigns. This Warrant is one of a series of Warrants
(the "Warrants") issued to the "Investors" named in the Purchase Agreement. Any
amendment hereto or waiver of any provision hereof may be made only with the
written consent of the Company and the Holder (or the Investors holding a
majority-in-interest of the Warrants), which consent shall not be unreasonably
withheld. This Warrant shall inure to the benefit of and bind the successors,
permitted assigns, heirs, executors, and administrators of the parties hereto.
This Warrant shall be construed and enforced in accordance with and governed by
the laws of the State of Delaware, without regard to choice or conflict of law
principles thereof. The headings in this Warrant are for purposes of reference
only, and shall not limit or otherwise affect any of the terms hereof. The
invalidity or unenforceability of any provision hereof shall in no way affect
the validity or enforceability of any other provision.
IN WITNESS WHEREOF, the Company has caused this Warrant to be signed by a
duly authorized officer as of December 8, 2003.
NETFABRIC CORPORATION
By:
----------------------------
Name: Philip E. Barak
Title: Secretary
EXHIBIT 1
NOTICE OF EXERCISE
(To be Executed by the Registered Holder in Order to Exercise the Warrant)
1. The undersigned hereby irrevocably elects to purchase 50,000 shares of
Common Stock of NetFabric Corporation covered by Warrant No. 1 according to the
terms thereof and herewith makes payment of the Exercise Price in full.
2. Specify method of exercise by check mark:
____ a. Such payment is hereby made in the amount of by wire transfer
or by certified or bank check.
____ b. The holder elects to receive shares for the value (as
determined pursuant to Section 4(b) of the Warrant) of the
Warrant.
3. Please issue a certificate or certificates representing said shares
of Common Stock in the name of the undersigned or in such other name as is
specified below:
Walter Carozza
------------------------------
(Name)
------------------------------
(Address)
------------------------------
Signature
Dated:
---------------------------