DRAFT of 11/10/2005
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 or 15 (D) OF THE SECURITES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 2005
[_] TRANSISTION REPORT UNDER SECTION 13 OR 15 (D) OF THE EXCHANGE ACT
COMMISSION FILE NUMBER: 0-21419
NETFABRIC HOLDINGS, INC.
(Exact name of small business issuer as specified its charter)
Delaware 76-0307819
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
Three Stewart Court
Denville, New Jersey, 07834
(Address of principal executive offices)
(973)-887-2785
(Issuer's telephone number)
(Former address, if changed since last report)
Check whether the issuer (1) filed all reports required by Section 13 or 15 (d)
of the Exchange Act during the past 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by a check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of November 4, 2005, 62,448,357
shares of common stock, $.001 par value per share, of the issuer were
outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
NETFABRIC HOLDINGS, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets 1
Condensed Consolidated Statements of Operations 2
Condensed Consolidated Statement of Stockholders'
Equity (Deficit) 3
Condensed Consolidated Statements of Cash Flows 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
Item 3. Controls and Procedures 24
PART II. OTHER INFORMATION 24
Signatures 26
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2005
(UNAUDITED) DECEMBER 31, 2004
------------------ ------------------
ASSETS
CURRENT ASSETS:
Cash $ 1,235 $ 67,719
Trade accounts receivable, net 2,405,168 --
Inventory 55,000 72,025
Due from related party 23,593 --
Prepaid expenses and other current assets 168,773 88,910
------------------ ------------------
Total current assets 2,653,769 228,654
Property and equipment, net 309,255 171,931
Deferred offering costs -- 368,683
Goodwill and other intangibles 34,166,977 --
Other assets 16,948 43,053
------------------ ------------------
TOTAL $ 37,146,949 $ 812,321
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bridge loans, net of unamortized discount $ 454,262 $ 749,659
Convertible debentures payable to stockholder and 27,036
director, net of unamortized discounts
Loans and advances from stockholders and directors 452,639 32,639
Accounts payable and accrued liabilities 3,482,573 273,707
Accrued compensation 256,377 --
Convertible debenture-current portion, 135,184 --
net of unamortized discounts
Deferred revenues and customer advances 423,212 25,966
------------------ ------------------
Total current liabilities 5,231,283 1,081,971
Convertible debentures, net of unamortized discount 34,043 --
------------------ ------------------
Total liabilities 5,265,326 1,081,971
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.001 par value, 100,000,000 shares 62,885 34,652
authorized, 62,885,500 and 34,652,204 shares
issued and outstanding, respectively
Additional paid-in capital 36,848,443 1,216,523
Deferred employee compensation (40,732) --
Accumulated deficit (4,988,973) (1,520,825)
------------------ ------------------
Total stockholders' equity (deficit) 31,881,623 (269,650)
------------------ ------------------
TOTAL $ 37,146,949 $ 812,321
================== ==================
SEE NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED, NINE MONTHS ENDED,
--------------------------------- ---------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
-------------- ------------- ------------- -------------
Revenues $ 5,210,697 $ -- $ 7,484,026 $ --
------------- ------------- ------------- -------------
EXPENSES:
Direct employee compensation and
consultant expenses 3,786,571 -- 5,567,722 34,719
Selling, general and administrative expenses 2,138,451 164,122 4,036,628 425,974
Research and development 92,146 192,057 414,427 192,057
Amortization of debt discounts - and debt
issuance costs 454,131 36,420 808,357 36,420
Interest and bank charges 19,166 4,021 52,783 4,270
Depreciation and amortization 34,349 -- 72,257 --
------------- ------------- ------------- -------------
Total expenses 6,524,814 396,620 10,952,174 693,440
------------- ------------- ------------- -------------
Loss before provision for income taxes (1,314,117) (396,620) (3,468,148) (693,440)
------------- ------------- ------------- -------------
Provision for income taxes -- -- -- --
------------- ------------- ------------- -------------
NET LOSS $ (1,314,117) $ (396,620) $ (3,468,148) $ (693,440)
============= ============= ============= =============
Net loss per common share, basic and diluted $ (0.02) $ (0.01) $ (0.07) $ (0.02)
============= ============= ============= =============
Weighted average number of shares
outstanding, basic and diluted 62,767,581 32,137,032 49,420,164 31,039,934
============= ============= ============= =============
SEE NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
2
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock
------------------------------------------------------------
ADDITIONAL
SHARES PAR VALUE AMOUNT PAID-IN CAPITAL
---------------- ---------------- ----------------
Balances at December 31, 2004 34,652,204 $ 34,652 $ 1,216,523
Sale of common stock to investors,
net of offering costs of $368,683 2,000,000 2,000 629,317
Settlement of bridge loan with
common stock 1,000,000 1,000 499,000
Issuance of shares in connection
with acquisition 24,096,154 24,096 32,746,673
Allocation of value to warrants
in connection with bridge loan -- -- 392,196
Deferred employee stock option
compensation -- -- 67,500
Amortization of deferred employee
stock option compensation -- -- --
Issuance of shares in connecion
with prospective financing transaction 687,142 687 349,313
Issuance of shares in connection
with convertible debentures 450,000 450 155,608
Issuance of warrants in connection
with convertible debentures -- -- 375,804
Allocation of value to beneficial
conversion feature in connection
with convertible debentures -- -- 416,509
Net loss -- -- --
---------------- ---------------- ----------------
BALANCES AT SEPTEMBER 30, 2005 (UNAUDITED) 62,885,500 $ 62,885 $ 36,848,443
================ ================ ================
Total
STOCKHOLDERS
DEFERRED EMPLOYEE ACCUMULATED EQUITY
COMPENSATION DEFICIT (DEFICIT)
---------------- ---------------- ----------------
Balances at December 31, 2004 $ -- $ (1,520,825) $ (269,650)
Sale of common stock to investors,
net of offering costs of $368,683 -- -- 631,317
Settlement of bridge loan with
common stock -- -- 500,000
Issuance of shares in connection
with acquisition -- -- 32,770,769
Allocation of value to warrants
in connection with bridge loan -- -- 392,196
Deferred employee stock option
compensation (67,500) -- --
Amortization of deferred employee
stock option compensation 26,768 -- 26,768
Issuance of shares in connecion
with prospective financing transaction -- -- 350,000
Issuance of shares in connection
with convertible debentures -- -- 156,058
Issuance of warrants in connection
with convertible debentures -- -- 375,804
Allocation of value to beneficial
conversion feature in connection
with convertible debentures -- -- 416,509
Net loss -- (3,468,148) (3,468,148)
---------------- ---------------- ----------------
BALANCES AT SEPTEMBER 30, 2005 (UNAUDITED) $ (40,732) $ (4,988,973) $ 31,881,623
================ ================ ================
See Notes to Unaudited Condensed Consolidated Financial Statements
3
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED,
-----------------------------------------------
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
(UNAUDITED) (UNAUDITED)
------------------ ------------------
OPERATING ACTIVITIES
Net loss $ (3,468,148) $ (693,440)
Adjustments to reconcile net loss to net cash used
in operating activities:
Non-cash charge for common stock issued for rent 37,500 37,500
Non-cash charge for options issued
to non-employees 15,469 45,039
Non-cash charge for shares issued in connection
prospective financing transaction 350,000 --
Non-cash charge for amortization
of employee deferred compensation 26,768 --
Allowance for bad debts 18,284 --
Allowance for inventory obsolescence 192,888 --
Amortization of debt discount 792,436 36,420
Amortization of debt issuance costs 15,921
Depreciation and amortization 72,257 --
Changes in operating assets and liabilities:
Inventory (175,863) (33,010)
Trade accounts receivable (251,200) (10,602)
Due from related party (23,593) --
Prepaid expenses and other current assets (48,015) (2,000)
Other assets 27,584 --
Accounts payable and accrued liabilities 1,048,151 11,315
Accrued compensation 36,012 --
Deferred revenues and advances (675,455) 18,283
------------------ ------------------
Net cash used in operating activities (2,009,004) (590,495)
------------------ ------------------
INVESTING ACTIVITIES
Direct acquisition costs of UCA Services (187,000) --
Purchases of property and equipment (113,935) (8,937)
------------------ ------------------
Net cash used in investing activities (300,935) (8,937)
------------------ ------------------
FINANCING ACTIVITIES
Proceeds from issuance of common stock 1,000,000 250,000
Convertible debentures issued to stockholder and director 100,000 --
Loans from stockholders and directors 320,000 --
Proceeds from bridge loans -- 500,000
Proceeds from convertible debentures, net 849,000 --
Debt issuance costs (25,545) --
------------------ ------------------
Net cash provided by financing activities 2,243,455 750,000
------------------ ------------------
NET (DECREASE) INCREASE IN CASH (66,484) 150,568
CASH AT BEGINNING OF PERIOD 67,719 18,053
------------------ ------------------
CASH AT END OF PERIOD $ 1,235 $ 168,621
================== ==================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest expense $ 31,250 $ --
================== ==================
Cash paid for income taxes $ -- $ --
================== ==================
SEE NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS
NetFabric Holdings, Inc. ("Holdings" or the "Company") (formerly known as
Houston Operating Company, Inc.) was incorporated under the laws of the State of
Delaware on August 31, 1989. On December 9, 2004, Holdings entered into an
Exchange Agreement (the "Acquisition Agreement" or "Share Exchange") with all of
the stockholders of NetFabric Corporation ("NetFabric") whereby Holdings
acquired all of the issued and outstanding capital stock of NetFabric and
NetFabric became a wholly-owned subsidiary of Holdings. Upon completion of the
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 Holdings was a shell corporation without
any operations. As a result of these factors, this transaction was treated as a
reverse merger, and a capital transaction, equivalent to the issuance of stock
by NetFabric for Holdings' net assets, and accordingly, the historical financial
statements prior to December 9, 2004 are those of NetFabric. (Holdings and its
subsidiaries are collectively referred to as "Holdings").
NetFabric, a Delaware corporation incorporated on December 17, 2002, began
operations in July 2003. NetFabric develops and markets a family of Voice Over
Internet Protocol ("VoIP") appliances that simplifies the integration of
standard telephone systems with an IP infrastructure.
On May 20, 2005, Holdings entered into and closed on a share exchange agreement
("Exchange Agreement"), whereby Holdings acquired all of the issued and
outstanding shares of UCA Services, Inc. ("UCA Services"), a New Jersey company,
from its shareholders in exchange for the issuance of 24,096,154 shares of
common stock of Holdings (See Note 3). Holdings emerged from the development
stage upon the acquisition of UCA Services.
NOTE 2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AND PRACTICES
BASIS OF PRESENTATION / INTERIM FINANCIAL STATEMENTS
The accompanying unaudited condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been omitted
pursuant to such rules and regulations. However the Company believes that the
disclosures are adequate to make the information presented not misleading. The
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) that are, in the opinion of management, necessary for a
fair presentation of the Company's financial position and results of operations.
The operating results for the three and nine months ended September 30, 2005 and
2004 are not necessarily indicative of the results to be expected for any other
interim period of any future year. The accompanying unaudited condensed
consolidated financial statements should be read in conjunction with the
Company's December 31, 2004 consolidated financial statements, including the
notes thereto, which are included in the Company's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2004 and the audited financial statements
of UCA Services for the year ended December 31, 2004 included in the Company
Form 8-K filed on August 3, 2005.
As shown in the accompanying condensed consolidated financial statements, the
Company has an accumulated deficit of $4,988,973 and has a working capital
deficit of $2,577,514 at September 30, 2005. 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 plans and satisfy its obligations on a timely basis. Management
believes that such cash flows will be funded by additional equity and/or debt
financings (See Note 4) through the time in which the Company consistently
generates sufficient positive cash flows from its operations, if ever. However
there can be no assurance that management's plans will be achieved.
CONSOLIDATION
The condensed consolidated financial statements include the accounts of Holdings
and its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated.
5
RECLASSIFICATIONS
Certain reclassifications have been made in the prior period consolidated
financial statements to conform to the current period presentation.
ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
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, accounting for goodwill and intangible assets,
the fair value of the Company's common stock, the fair value of options issued
for services, the allocation of proceeds from the bridge loans 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 derives revenue from the sale of its communication equipment
products and as a provider of information technology consulting and
infrastructure development services.
In accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition,"
revenue is recognized when persuasive evidence of an arrangement exists,
delivery of the product or services has occurred, the fee is fixed and
determinable, collectibility is reasonably assured, contractual obligations have
been satisfied, and title and risk of loss have been transferred to the
customer.
UCA Services derives revenue primarily from professional services, managed IT
services, application development services and from business process management
services. Arrangements with customers for services are generally on a time and
material basis or fixed-price, fixed-timeframe. Revenue on time-and-material
contracts is recognized as the related services are performed. Revenue from
fixed-price, fixed-timeframe service contracts are recognized ratably over the
term of the contract, as per the proportional performance method. When the
Company receives cash advances from customers in advance of the service period,
amounts are reported as advances from customers until the commencement of the
service period. Billings and collections in excess of revenue recognized are
classified as deferred revenue.
To date NetFabric's communication equipment products have been marketed only
through a network of distributors and value-added resellers ("VAR"). In the VAR
channel, NetFabric recognizes revenue at the time of shipment if all other
contractual obligations to the VAR have been satisfied. In the distributor
channel, NetFabric recognizes revenue when the distributor sells and ships
NetFabric products to its own VARs, resellers or end-user customers, provided
the Company has satisfied all other terms and conditions with the distributor.
Accordingly, NetFabric receives distribution sales and inventory information
regarding its products from its distributors for the purpose of determining the
appropriate timing of revenue recognition.
Both VARs and distributors have limited rights to return products to NetFabric
but must obtain prior approval from NetFabric before returning products,
consistent with industry practice. NetFabric has no obligation to accept the
return of any unsold products. If required, the Company accrues a provision for
estimated sales returns and other allowances and deferrals as a reduction of
revenue at the time of revenue recognition. To date no sales have been made and
as such, no provisions for estimated sales returns and other allowances have
been recognized. The Company has no obligation to provide service, repair,
counseling or other assistance to any customers of the VARs or distributors
unless NetFabric has a specific agreement directly with such customer.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. These
estimated losses are 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. The Company recorded allowances for bad debts of $18,284 and $0 during
the three and nine months ended September 30, 2005 and 2004, respectively.
6
INVENTORY
Inventory consists primarily of finished goods and purchased electronic
components which are stated at the lower of cost or market. Cost is determined
by using the first-in, first-out method.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value 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 consolidated balance sheets
at September 30, 2005 and December 31, 2004.
BUSINESS CONCENTRATIONS AND 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 cash 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.
The Company's services have been provided primarily to a limited number of
clients located worldwide in a variety of industries. The Company had revenues
from 2 clients representing 41% (30% and 11%, respectively) of revenues during
the three months ended September 30, 2005. The Company had revenues from 2
clients representing 43% (32% and 11%, respectively) of revenues for the nine
months ended September 30, 2005.
The Company generally does not require its clients to provide collateral.
Additionally, the Company is subject to a concentration of credit risk with
respect to its accounts receivable. The Company had 3 clients accounting for 53%
(21%, 19% and 13%) of total gross accounts receivable as of September 30, 2005.
GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles represent the Company's preliminary allocation of
the estimated cost to acquire UCA Services in excess of the fair value of net
assets acquired. The purchase price and its allocation is preliminary and
subject to change based on finalization of the Company's valuation. The actual
purchase price and its allocation, to reflect the fair values of assets acquired
and liabilities assumed, will be based upon management's ongoing evaluation.
Accordingly, the final purchase price and its allocation of the purchase price
may differ significantly from the preliminary allocation.
Under SFAS No. 142 Goodwill and Other Intangible Assets, goodwill is not
amortized but is reviewed for impairment annually, as well as when a triggering
event indicates impairment may have occurred.
The goodwill test for impairment consists of a two-step process that begins with
an estimation of the fair value of the reporting unit. The first step of the
process is a screen for potential impairment and the second step measures the
amount of impairment, if any. The Company will perform a goodwill impairment
test annually, as well as when a triggering event indicating impairment may have
occurred.
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.
7
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:
NINE MONTHS ENDED, THREE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------- -------------------------------------
2005 2004 2005 2004
--------------- --------------- --------------- ---------------
Net loss, as reported $ (3,468,148) $ (693,440) $ (1,314,117) $ (396,620)
Stock-based employee compensation recorded 26,768 -- 4,253 --
--------------- --------------- --------------- ---------------
Sub-total (3,441,380) (693,440) (1,309,864) (396,620)
Stock-based employee compensation
expense determined under fair value
method 570,081 65,709 103,680 60,483
--------------- --------------- --------------- ---------------
--------------- --------------- --------------- ---------------
Pro forma net loss, as adjusted $ (4,011,461) $ (759,149) $ (1,413,544) $ (457,103)
=============== =============== =============== ===============
Loss per share:
Basic and diluted-as reported $ (0.07) $ (0.02) $ (0.02) $ (0.01)
Basic and diluted-pro forma (0.08) (0.02) (0.02) (0.01)
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 three and nine months ended September 30,
2005 dividend yield of 0%, risk-free interest rates ranging from 3.97% to 4.21%,
volatility of 100% and expected life of approximately five years. For the three
and nine months ended September 30, 2004 dividend yield of 0%, risk-free
interest rates ranging from 2.72% to 3.97%, volatility of 100% and expected life
of approximately five years. The estimated value of the options is amortized
over their service periods of one to four years for pro forma disclosure only.
EARNINGS PER SHARE
The Company calculates earnings 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 per share are
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 per share consider 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.
For the three and nine months ended September 30, 2005 and 2004, the effect of
the assumed issuance of potential common shares of 12,947,526 and 4,569,227,
primarily related to outstanding stock options, warrants and convertible debt,
is anti-dilutive and accordingly have been excluded from the Company's
computation of diluted net loss per share. Therefore, basic and diluted loss per
share were the same for the three and nine months ended September 30, 2005 and
2004.
8
RECENT ACCOUNTING PRONOUNCEMENTS
During December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
("SFAS 123R") requiring all share-based payments to employees, including grants
of employee stock options, to be recognized as compensation expense in the
consolidated financial statements based on their fair values. As amended by the
SEC on April 14, 2005, this standard is effective for annual periods beginning
after December 15, 2005, and includes two transition methods. Upon adoption, the
Company will be required to use either the modified prospective or the modified
retrospective transition method. Under the modified retrospective approach, the
previously reported amounts are restated for all periods presented to reflect
the FASB Statement No. 123 amounts in the income statement. Under the modified
prospective method, awards that are granted, modified, or settled after the date
of adoption should be measured and accounted for in accordance with SFAS 123R.
Unvested equity-classified awards that were granted prior to the effective date
should continue to be accounted for in accordance with SFAS 123 except that
amounts must be recognized in the income statement. The Company will adopt SFAS
123R on January 1, 2006 and is currently evaluating the impact of this standard
and its transitional alternatives.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4 ("SFAS No. 151"). SFAS No. 151 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 re-handling 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 No. 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" ("SFAS No. 153"). The guidance in
APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of assets exchanged. The guidance in that Opinion, however, included
certain exceptions to that principle. This Statement amends Opinion 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for
nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005.
The adoption of SFAS No. 153 is not expected to have a material impact on the
Company's financial position and results of operations.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS No. 154"). SFAS 154 changes the requirements for the accounting for, and
reporting of, a change in accounting principle. SFAS 154 requires that a
voluntary change in accounting principle be applied retrospectively with all
prior period financial statements presented using the new accounting principle.
SFAS No. 154 is effective for accounting changes and corrections of errors in
fiscal years beginning after December 15, 2005. The implementation of SFAS 154
is not expected to have a material impact on the Company's consolidated
financial statements.
NOTE 3. ACQUISITION
The Company acquired UCA Services on May 20, 2005. Pursuant to the terms of the
Exchange Agreement, Holdings acquired all of the issued and outstanding shares
of UCA Services from the UCA Services' shareholders in exchange for the issuance
of 24,096,154 shares of common stock of Holdings. The acquisition of UCA
Services allows the Company to enter the IT services industry and is strategic
to the NetFabric IP equipment development.
The acquisition was accounted for as a business combination with Holdings as the
acquirer. Under the purchase method of accounting, the assets and liabilities of
UCA Services acquired by Holdings are recorded as of the acquisition date at
their respective fair values, and added to those of Holdings, and the results of
UCA Services have been included with those of the Company since the date of
acquisition.
The preliminary purchase price of $34,166,977 consists of $32,770,769 of common
stock, $187,000 of acquisition costs and the assumption of $1,209,208 of net
liabilities. The fair value of Holdings' common stock issued in exchange for the
shares of UCA Services was based on the average closing market price of
NetFabric Holdings' common stock for a period of five days prior and five days
subsequent to the share exchange.
9
The determination of the purchase price and its allocation to the estimated fair
values of the assets acquired and liabilities assumed as reflected in the
unaudited condensed consolidated financial statements are preliminary and
subject to change based on finalization of the Company's valuation. The actual
purchase price and its allocation, to reflect the fair values of assets acquired
and liabilities assumed will be based upon management's ongoing evaluation.
Accordingly, the final purchase price and its allocation may differ
significantly from the preliminary amount and such allocation will impact the
Company's annual goodwill impairment testing and related future impairment
charge, if any.
The estimated fair value of the net liabilities assumed in the acquisition of
UCA Services are as follows:
Accounts receivable $ 2,153,968
Property, plant, other assets and equipment 190,602
Accounts payable and accrued expenses (2,481,077)
Deferred revenue and advances (1,072,701)
-----------
Net liabilities assumed $(1,209,208)
===========
Summarized below are the pro forma unaudited results of operations for the nine
months ended September 30, 2005 and 2004, and for the three months ended
September 30, 2004, respectively, as if the results of UCA Services were
included for the entire periods presented. The results for operations of UCA
Services for the three months ended September 30, 2005 are included in the
accompanying unaudited statements of operations for the three months ended
September 30, 2005. The pro forma results may not be indicative of the results
that would have occurred if the acquisition had been completed at the beginning
of the period presented or which may be obtained in the future:
Nine months Ended
-----------------------------------------------
September 30, 2005 September 30, 2004
(UNAUDITED) (UNAUDITED)
------------------ ------------------
Revenues $ 14,365,378 $ 9,849,685
Net loss (4,353,301) (694,502)
Basic and diluted loss per share $ (0.07) $ (0.01)
Weighted average common shares outstanding 61,688,902 55,136,088
Three Months Ended
------------------
September 30, 2004
(UNAUDITED)
------------------
Revenues $ 3,883,678
Net loss (552,425)
Basic and diluted loss per share $ (0.01)
Weighted average common shares outstanding 56,233,186
NOTE 4. DEBT FINANCINGS
BRIDGE LOANS
On July 22, 2004, NetFabric entered into a Financing Agreement which was amended
on December 2, 2004 (the "Financing Agreement") with Macrocom Investors, LLC,
("Macrocom") whereby Macrocom provided a loan to NetFabric in the amount of
$500,000 ("Loan 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 had the option to repay the principal in cash or in kind
by issuing 1,000,000 shares of common. In either event, the interest on Loan I
is payable in cash on the Due Date. In January 2005, in accordance with the
terms of the Financing Agreement, the Company elected to repay the principal of
Loan I in kind by issuing 1,000,000 shares of common stock. Additionally, in
connection with the Financing Agreement the Company issued to Macrocom 250,000
shares of common stock as additional consideration for Loan I in December 2004.
10
On October 14, 2004, NetFabric and Macrocom entered into a loan agreement which
was amended on December 2, 2004 (the "Loan Agreement"), whereby Macrocom agreed
to loan an additional $500,000 to NetFabric ("Loan II" or the "Second Loan"),
due 180 days from the original date of the Loan Agreement ("Second Due Date") at
an annual simple interest rate of 5%. On the Second Due Date, at the option of
Macrocom, Macrocom can convert the principal of the Second Loan into 1,000,000
shares of common stock or demand repayment of the principal in cash. In either
event, the interest on the Second Loan is payable in cash on the Second Due
Date. In addition, in December 2004 the Company issued to Macrocom 250,000
shares of common stock as additional consideration for the Second Loan. As noted
below, on the Second Due Date in April 2005 Macrocom did not request repayment
or conversion to common stock of Loan II.
As a result of these transactions, total debt discounts on Loan I and Loan II
(the "Bridge Loans"), including the value of the beneficial conversion feature,
of $411,403 were recorded in 2004. During the three months ended September 30,
2005 and 2004, $0 and $36,420, respectively, of the discounts were amortized on
the accompanying statements of operations. During the nine months ended
September 30, 2005 and 2004, $354,226 and $36,420, respectively of the discounts
were amortized on the accompanying statements of operations.
On May 24, 2005, NetFabric and Macrocom entered into an agreement to amend the
Loan Agreement between the parties. Under the terms of the amendment, the due
date for Loan II has been extended from April 10, 2005 until October 10, 2005.
At the same time and in connection with the extension of the due date for Loan
II, Macrocom and Holdings also amended the terms of the Financing Agreement with
respect to a warrant Macrocom originally received on December 9, 2004 (Note 5).
The warrant was set to expire on June 7, 2005; however, the parties agreed to
extend the term of the warrant until December 9, 2006. As a result of these
changes in terms, a debt discount of $392,196 was recorded on April 11, 2005.
During the three and nine months ended September 30, 2005, $242,576 and
$346,458, respectively, of the discount was amortized. On October 10, 2005
Macrocom did not require repayment or conversion of Loan II to common stock. The
Company and Macrocom agreed to extend the due date for Loan II until October 10,
2006.
CONVERTIBLE DEBENTURES
Macrocom Convertible Debentures
On July 19, 2005, the Company issued a convertible debenture in the amount of
$500,000 to Macrocom (the "Macrocom Debenture"). The Macrocom Debenture bears
interest at 5% per annum and is due on April 15, 2006. At the option of
Macrocom, the Macrocom Debenture may be converted into shares of the Company's
common stock at a conversion price of $.50 per share. The Company also issued
Macrocom warrants to acquire 1,000,000 shares of the Company's common stock at
an exercise price of $1.50 per share. The warrants expire in three years from
the date of issuance. Additionally, the Company issued 375,000 shares of the
Company's common stock to Macrocom as additional consideration. As collateral
for the Macrocom Debenture, the Company has placed with an escrow agent
5,000,000 shares of its common stock.
The Company allocated the proceeds of the Macrocom Debenture based on the
computed relative fair values of the debt and equity components. The relative
fair value allocated to the debt component of $115,497 was used to measure the
intrinsic value of the embedded conversion option of the Macrocom Debenture
which resulted in a beneficial conversion feature of $115,497 recorded to
additional paid-in capital. The value of the beneficial conversion feature was
limited to the amount of the proceeds allocated to the debt component of the
Macrocom Debenture.
The aggregate amounts allocated to the warrants, common stock and beneficial
conversion feature, of $500,000 were recorded as a debt discount at the date of
issuance of the Macrocom Debenture and are amortized to interest expense over
the stated term of the Macrocom Debenture.
11
Structuring fees of $45,000 paid to Macrocom in connection with the Macrocom
Debenture have been netted against the proceeds and considered in the
calculation of the beneficial conversion feature. Financing costs of $3,000 paid
to third parties associated with the Macrocom Debenture are included in other
assets and amortized over the term.
Stockholder Convertible Debentures
On July 19, 2005, the Company agreed with a stockholder and an entity affiliated
with an officer of the Company, that aggregate advances of $100,000 made in June
2005 from the stockholder and entity affiliated with the officer to the Company
be structured as convertible debentures in the face amount of $50,000 each
("Related Party Convertible Debenture"). The Related Party Convertible
Debentures were sold on substantially similar terms as the Macrocom Debenture
and, accordingly, bear interest at 5% per annum, are due on April 15, 2006 and
at the option of the holder may be converted into shares of the Company's common
stock at a conversion price of $.50 per share. Additionally, in connection with
the sale of the Related Party Convertible Debentures, the Company issued
warrants to each to acquire 200,000 shares (or 100,000 each debenture) of the
Company's common stock at an exercise price of $1.50 per share which expire in
three years from the date of issuance. The Company also issued 75,000 shares (or
37,500 each debenture) of the Company's common stock to the stockholder and the
entity affiliated with an officer as additional consideration. The Company did
not provide any collateral.
The Company allocated the proceeds of the Related Party Convertible Debentures
based on the computed relative fair values of the debt and equity components.
The relative fair value allocated to the debt component of $27,212 was used to
measure the intrinsic value of the embedded conversion option of the Related
Party Convertible Debentures which resulted in a beneficial conversion feature
of $27,212 recorded to additional paid-in capital. The value of the beneficial
conversion feature was limited to the amount of the proceeds allocated to the
debt component of the Related Party Convertible Debentures.
The aggregate amounts allocated to the warrants, common stock and beneficial
conversion feature of $100,000 were recorded as a debt discount at the date of
issuance of the Related Party Convertible Debentures and are amortized to
interest expense over the stated term.
Cornell Convertible Debentures
On July 5, 2005, the Company entered into an agreement pursuant to which the
Company was to sell Cornell Capital Partners, LP ("Cornell") secured convertible
debentures in the aggregate principal amount of $1,000,000, which are
convertible, at Cornell's discretion, into common stock. A $400,000 debenture
was funded in July 2005, and a $600,000 debenture was to be funded two (2)
business days prior to the filing date of the registration statement. On October
27, 2005, at the same time as the Termination Agreement for the SEDA (Note 5),
the Company entered into a Securities Purchase Agreement (the "Securities
Purchase Agreement") with Cornell whereby the Company and Cornell agreed to
amend and consolidate all of the convertible debentures issued to Cornell
through October 26, 2005 into one new secured convertible debenture in the
principal amount of $1,650,000 (the "Cornell Debentures"). Prior to entering
into the Securities Purchase Agreement on October 27, 2005, the Company had
issued secured convertible debentures to Cornell in a principal aggregate amount
equal to $1,000,000 of which $450,000 was funded through September 30, 2005.
The Cornell Debentures have a 36-month term from the date of issuance and accrue
interest at 5% per annum. The Cornell Debentures may be redeemed at the
Company's option at any time, in whole or in part prior to maturity at a
redemption premium of 15% of the principal amount redeemed in addition to
principal and accrued interest. The Cornell Debentures are convertible at the
Cornell's option at a conversion price equal to the lesser of (i) $1.00 or (ii)
an amount equal to 95% of the lowest closing bid price of the Company's common
stock for the 30 trading days immediately proceeding the conversion date. As
collateral for the Cornell Debentures, both the Company and certain officers and
shareholders have pledged certain assets and 1,428,572 common shares of the
Company to secure the Company's obligations under the Securities Purchase
Agreement.
In connection with the Cornell Debentures, the Company issued Cornell warrants
to acquire 560,000 shares of its common stock at an exercise price $0.50 per
share as additional consideration.
12
Through September 30, 2005, the Company allocated the $450,000 of proceeds
received of the Cornell Debentures based on the computed relative fair values of
the debt and warrants issued. The 560,000 warrants issued in connection with the
Cornell Debentures have been allocated to each draw down of the Cornell
Debenture based on the relative percentage of the draw down to the total
$1,650,000 of the Cornell Debentures. The relative fair value allocated to the
debt component of $274,432 was used to measure the intrinsic value of the
embedded conversion option of the $450,000 of the Cornell Debentures funded
through September 30, 2005, which resulted in a beneficial conversion feature of
$273,800 recorded to additional paid-in capital. The value of the beneficial
conversion feature was limited to the amount of the proceeds allocated to the
debt component of the Cornell Debentures.
The aggregate amounts allocated to the warrants and beneficial conversion
feature of approximately $449,000 were recorded as a debt discount at the date
of issuance of the Cornell Debentures and are amortized to interest expense
using the over the stated 36-month term from the date of issuance of the Cornell
Debenture.
Structuring fees of $56,000 paid to Cornell or its affiliates in connection with
the Cornell Debentures have been netted against the proceeds and considered in
the calculation of the beneficial conversion feature. Financing costs of $22,545
paid to third parties associated with the Cornell Debentures are included in
other assets and amortized over the term of the debt.
Pursuant to the Securities Purchase Agreement, Cornell funded the remaining
$650,000 balance of Cornell Debentures on October 27, 2005. The Company will
allocate the proceeds received in October 2005 based on the computed relative
fair values of the debt and warrant components and will measure the intrinsic
value of the embedded conversion feature. Debt discounts will be charged to
interest expense over the 36-month term commencing on the date of issuance. The
Company anticipates that the amount of aggregate debt discounts will approximate
the face amount of the Cornell Debentures received in October 2005.
NOTE 5. STOCKHOLDERS' EQUITY
Macrocom Financings
In addition to the Bridge Loan transactions (Note 4), during 2004 Macrocom
entered into a commitment with NetFabric to purchase common stock of Holdings
subsequent to the Closing Date, under certain terms. Pursuant to this financing
commitment, in two separate closings in January and March 2005 the Company sold
an aggregate of 2,000,000 shares of common stock to Macrocom resulting in
aggregate proceeds of $1,000,000 or $0.50 per share. Additionally, 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 (the "Macrocom Warrant"), 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 this additional
consideration paid to Macrocom as part of this financing commitment, totaling
$368,683, has been recorded as offering costs and offset against the proceeds of
the additional purchases of common stock in 2005. The term of the Macrocom
Warrant was extended in April 2005 (Note 4).
Cornell SEDA
On July 5, 2005, the Company entered into a Standby Equity Distribution
Agreement (the "SEDA") with Cornell. Pursuant to the SEDA, the Company was, at
its discretion, to periodically sell to Cornell shares of common stock, for a
total purchase price of up to Ten Million Dollars ($10,000,000). On July 5,
2005, in connection with the SEDA, Cornell received a commitment fee of 680,000
shares of common stock from the Company. In addition, the Company issued to
Newbridge Securities Corporation ("Newbridge") 7,142 shares of common stock
under a placement agent agreement in connection with the SEDA. In October 2005,
the Company and Cornell agreed to terminate the SEDA and for Cornell to provide
only financing to the Company through the issuance of secured convertible
debentures (Note 4). The Company and Cornell entered into a Termination
Agreement on October 27, 2005 (the "Termination Agreement") which terminated all
of the rights and obligations of both the Company and Cornell under the SEDA.
Pursuant to the Termination Agreement, the Company agreed to allow Cornell to
retain 242,857 shares of the Company's common stock that was previously issued
to Cornell as part of the commitment fee under the SEDA and Cornell agreed to
return the balance of the commitment fee consisting of certificates representing
437,143 shares of the common stock of the Company within ten (10) business days
of the Termination Agreement.
The $340,000 fair value of the 242,857 commitment shares issued and retained by
Cornell was accounted for as a terminated offering expense and charged to
selling, general and administrative expense during the three months ended
September 30, 2005. Similarly the $10,000 fair value of the common stock issued
to Newbridge was charged to operations during the three months ended September
30, 2005.
13
NOTE 6. STOCK-BASED COMPENSATION
During the three months ended September 30, 2005 and 2004, the Company
recognized nonemployee compensation expenses of $5,157 and $15,013,
respectively, as a result of the vesting of options, which is included in
general and administrative expenses on the accompanying consolidated statements
of operations. During the nine months ended September 30, 2005 and 2004, the
Company recognized nonemployee compensation expenses of $10,313 and $30,026,
respectively, as a result of the vesting of options, which is included in
general and administrative expenses on the accompanying consolidated statements
of operations.
NOTE 7. RELATED PARTY TRANSACTIONS
Loans and advances payable to stockholders and directors on the accompanying
consolidated balance sheet at September 30, 2005 represent amounts owed to
stockholders and directors of the Company for advances of cash provided to the
Company. Convertible debentures payable to stockholders and directors represent
amounts received by the Company pursuant to a financing arrangement (Note 4).
After the acquisition of UCA Services in May 2005, certain shareholders of the
Company are also the owners of UCA Computer Systems, Inc. ("Systems"), a
computer hardware company with which UCA Services has historically had
transactions with.
The Company subleases certain office space and incurs occupancy related costs
under an agreement with UCA Global, Inc. ("Global"), an entity affiliated with a
shareholder of the Company, whereby the Company pays rent and other occupancy
costs based on the proportion of square footage occupied by the Company in the
Systems office facility. Rent and occupancy expenses incurred by the Company
under this agreement, which commenced on May 20, 2005, was $33,063 and $39,078
and is included in selling, general and administrative expenses during the three
and nine months ended September 30, 2005, respectively.
During the three months ended September 30, 2005, UCA Services paid for certain
expenses of approximately $23,000 on behalf of Global which are included in due
from related party on the accompanying consolidated balance sheet at September
30, 2005.
In connection with delivering hardware and software to certain of its customers,
Systems has engaged the Company to assist with certain elements of its customer
contracts, including, but not limited to, hardware and software configuration
and implementation. Such services are provided to Systems pursuant to an
arrangement between the companies. From May 20, 2005, the date of acquisition of
UCA Services, through September 30, 2005 the Company has not provided any
services to Systems.
From time to time, prior to the acquisition of UCA Services by the Company, UCA
Services provided short-term borrowings to Systems and received short-term
borrowings from Systems to meet working capital needs. At the date of
acquisition of UCA Services the net amount due from Systems of $779,870,
consisting of $255,746 in trade accounts receivable related to services provided
by UCA Services and $524,124 of amounts due to Systems for advances of cash and
accounts payable. On May 17, 2005 UCA Services and Systems entered into an
unsecured Non-Negotiable Promissory Note (the "Systems Note") whereby the net
amount due to UCA Services from Systems of $779,870 was aggregated into the
Systems Note. The Systems Note provides for interest at a rate equal to the
minimum applicable federal rate of interest per annum and for equal monthly
payments from Systems to UCA Services over a period of thirty-nine months
commencing on June 1, 2005. Due to uncertainties related to the realizability of
the amounts due from Systems, the entire balance due from affiliate, which was
acquired by Holdings as part of the acquisition of UCA Services, had been fully
reserved for by UCA Services prior to the acquisition by the Company.
14
NOTE 8. SEGMENTS
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" established standards for reporting information about operating
segments in financial statements. Operating segments are defined as components
of an enterprise engaging in business activities about which separate financial
information is available that is evaluated by the chief operating decision maker
or group in deciding how to allocate resources and in assessing performance. The
Company operates in two business segments: Voice over Internet Protocol and
Information Technology Services. These reportable segments are strategic
business units that are in different phases of development that the Company
manages and finances separately based on the fundamental differences in their
operations. The Company defines segment earnings as earnings before interest,
taxes, depreciation and amortization and other charges determined to be
non-recurring in nature, such as restructuring and impairment charges.
Information about the Company operating segments, the presentation of which
reflects changes in information that is now being made available to the
Company's chief operating decision maker, is as follows:
IT Services VoIP Corporate Total
------------- ----------- ----------- -------------
Nine months Ended September 30, 2005
Revenues $ 7,484,026 $ -- $ -- $ 7,484,026
Earnings before interest, taxes, 135,363 (1,995,294) (703,477) (2,563,408)
depreciation and amortization
Net income (loss) 115,003 (2,656,926) (926,225) (3,468,148)
Total assets 36,553,806 583,519 9,624 37,146,949
Three Months Ended September 30, 2005
Revenues $ 5,210,697 $ -- $ -- $ 5,210,697
Earnings before interest, taxes, (84,497) (1,398,953) (244,831) (1,728,281)
depreciation and amortization
Net income (loss) 205,570 (838,291) (681,396) (1,314,117)
Total assets 36,553,806 583,519 9,624 37,146,949
Prior to the acquisition of UCA Services on May 20, 2005, the Company did not
have operating segments.
NOTE 9. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Nine months Ended
-----------------------------------------------
September 30, 2005 September 30, 2004
(UNAUDITED) (UNAUDITED)
------------------ ------------------
Settlement of bridge loan with common stock $ 500,000 $ --
Non-cash offering costs, netted against proceeds from sales of common stock $ 368,683 $ --
Common stock issued in the acquisition of UCA Services $ 32,770,769 $ --
Discount on bridge loans relating to warrants $ 392,196 $ --
Discount on loan relating to shares $ -- $ 100,000
Deferred employee stock option compensation $ 67,500 $ --
Discount on convertible debentures relating to warrants $ 375,804 $ --
Discount on convertible debentures relating to shares $ 156,058 $ --
Discount on convertible debentures relating to beneficial conversion feature $ 416,509 $ --
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
REVIEW OF OPERATIONS
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the condensed
consolidated financial statements and accompanying notes and the other financial
information appearing elsewhere in this report and reports included herein by
reference. The following discussion contains forward-looking statements that
reflect the Company's plans, estimates and beliefs. Our actual results could
differ materially from those discussed in the forward-looking statements.
The Company's independent registered public accounting firm has indicated in
their report dated March 30, 2005 on the Company's December 31, 2004 financial
statements that the Company is in the development stage, has had net losses from
inception and has working capital and net capital deficiencies. The report
indicates that these matters raise substantial doubt about the Company's ability
to continue as a going concern. The Company's plan with regard to this matter is
discussed elsewhere in this document. The condensed consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
CORPORATE HISTORY
NetFabric Holdings, Inc., formerly Houston Operating Company, ("NetFabric
Holdings" or the "Company") was incorporated in Delaware in August of 1989, and
did not have operations since 2002. NetFabric Corporation ("NetFabric") was
incorporated in the State of Delaware on December 17, 2002, as a new
corporation. On December 9, 2004, the Company entered into an acquisition
agreement ("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 acquirer ("Acquisition"). 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
stockholders in exchange for an aggregate of 32,137,032 newly-issued shares of
the Company's common stock. On April 19, 2005, the Company's name was changed
from Houston Operating Company to NetFabric Holdings, Inc. and its stock symbol
was changed from OTC.BB: HOOC to OTC.BB: NFBH.
UCA SERVICES, INC. ACQUISITION
On May 20, 2005, the Company entered into and closed on a share exchange
agreement, whereby the Company purchased all of the issued and outstanding
shares of UCA Services, Inc. ("UCA") from its shareholders in exchange for the
issuance of 24,096,154 shares of the common stock of the Company, valued at
$32.7 million, based on the average quoted market price of the Company's common
stock at the time of the acquisition. Including the net assumed liabilities of
$1.2 million, the preliminary purchase price was approximately $34.1 million.
UCA is an information technology ("IT") solutions company that serves the
information and communications needs of a wide range of Fortune 500 and small to
mid-size business clients in the financial markets industry as well as the
pharmaceutical, health care and hospitality sectors. UCA delivers a broad range
of IT consulting and infrastructure development services, including multi-year
managed services contracts, via an integrated network of branch offices and
alliance partners in the United States, Canada, Europe and India. UCA's services
include solutions in the practice areas of infrastructure builds and
maintenance, application development and maintenance, business process managed
services and professional IT services.
The acquisition was accounted using the purchase method of accounting with the
results of operations of UCA included in the consolidated financial statements
from the date of acquisition.
-17-
Goodwill and other intangibles represent the Company's preliminary allocation of
the estimated cost to acquire UCA Services, Inc. in excess of the fair value of
net assets acquired. The allocation is preliminary and subject to change based
on finalization of the Company's valuation. The actual purchase price and its
allocation, to reflect the fair value of assets acquired and liabilities
assumed, will be based upon management's ongoing evaluation. Accordingly, the
final purchase price and its allocation may differ significantly from the
preliminary allocation.
The actual purchase price of assets acquired and liabilities assumed will be
based upon management's estimate of the value of stock exchanged in the
transaction. Management's estimate will be supported by an independent appraisal
of the net assets acquired and the shares exchanged so that a final purchase
price and its allocation may be made in connection with the preparation of our
financial statements for the year ended 2005.
UCA derives revenues primarily from professional services, managed IT services,
application development services and from business process management services.
Arrangements with customers for services are generally on a time and material
basis or fixed-price, fixed-timeframe revenue.
OVERVIEW
Prior to acquiring UCA, the Company was a provider of hardware and services to
the burgeoning sector of the telecom industry that utilizes the Internet for
telephone and data communications. Specifically, the Company offers distributed
Voice over Internet Protocol ("VoIP") platforms, as well as Services over IP
("SoIP") solutions, that provide small to mid-sized Businesses ("SMB"s) and
Enterprise Branch Offices ("EBO"s) with a flexible migration path to an all-IP
infrastructure. The large and very lucrative market of more than 4.9 million
SMBs and EBOs that the Company targets is sometimes referred to collectively in
this document as "Small Offices." The Company develops and markets Small Office
Customer Premises Equipment ("CPE") in the form of integrated telephony services
platforms that provide businesses with a flexible VoIP migration path from a
legacy PBX to IP soft switch. 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 markets and sells its products to SMBs through Value Added Resellers
("VAR"s), Service Providers and OEM relationships, and will sell to Fortune 500
EBO customers, through a direct consultative sales organization. To date, the
Company's VoIP operations have generated very minimal revenues. Further, there
can be no assurance that the Company will generate meaningful revenues from its
VoIP operations in the future.
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 market 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
undertaking a large equipment upgrade is extremely attractive to the Company's
partners. 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.
As previously noted, the December 9, 2004 acquisition was accounted for as a
reverse merger whereby NetFabric was treated as the acquirer. Accordingly, the
historical financial statements of NetFabric have been presented for all periods
required. NetFabric began operations in January 2003 and was a development stage
company until the UCA acquisition in May 2005. The Company's operating
activities until the UCA acquisition consisted primarily of developing its VoIP
telephony products for the marketplace, including 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, marketing programs and filing of product patents.
-18-
RESULTS OF OPERATIONS
Comparison of three and nine months ended September 30, 2005 and 2004:
As previously noted, the December 9, 2004 acquisition has been accounted for as
a reverse merger whereby NetFabric was treated as the accounting acquirer.
Accordingly, the historical financial statements of NetFabric have been
presented for all periods required. NetFabric began operations in January 2003
and was a development stage company until the UCA acquisition. The UCA
acquisition of UCA was accounted using the purchase method of accounting with
the results of the operations included in the Company's consolidated financial
statements from the date of acquisition.
Revenues. Revenues for the three and nine months ended September 30, 2005,
increased by $5,210,697 and by $7,484,026, respectively, compared to the same
periods of the prior year. The increase was due to the UCA acquisition. Prior to
the UCA acquisition, the Company did not have any revenues during the periods
reported. The Company anticipates that its revenues will increase for the
remainder of 2005 due to the UCA acquisition. On a pro forma basis, UCA had
revenues of $14,365,378 for the nine months ended September 30, 2005 compared to
$9,849,685 in comparable period in 2004 due to increased levels of activity.
Direct employee compensation and consultant expenses. For the three months ended
September 30, 2005, direct employee compensation and consultant expenses
increased by $3,786,571 to $3,786,571. For the nine months ended September 30,
2005, direct employee compensation and consultant expenses increased by
$5,533,003 to $5,567,722 compared to the same period of the prior year. The
increases were due to increased revenues resulting from the UCA acquisition. The
Company anticipates direct employee compensation and consultant expenses to
increase for the remainder of 2005 in line with the anticipated increase in its
revenues.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased for the three and nine months ended September
30, 2005 by $1,974,329 and $3,610,654, respectively, compared to the same
periods of the prior year. Increases were, in part, due to the UCA acquisition
and, in part, due to an increased level of marketing activities in 2005. In
addition, in 2005 the Company incurred additional expenses for professional fees
and others costs due to being a public company.
Research and development. Research and development expenses for the three and
nine months ended September 30, 2005, were $92,146 and $414,427, respectively.
These expenses mainly represented the product development costs for the
Company's VoIP products including associated engineering wages.
Amortization of debt discounts. Amortization of debt discounts for the three
months ended September was $454,131 compared to $36,420 during the comparable
period in 2004. Amortization of debt discount for the nine months ended
September 30, 2005 was $808,357 compared to $36,420 during the comparable period
in 2004. Increases were due to the amortization of debt discount resulting from
the allocation of value to certain equity instruments issued in connection with
debt incurred in 2004 and 2005. At September 30, 2005 the aggregate unamortized
debt discount was approximately $900,000, which will amortized and charged to
operations over the term of the respective debt.
Depreciation and amortization. For the three months and nine ended September 30,
2005, depreciation and amortization was $34,349 and $72,257, respectively, due
to additional assets arising from the UCA acquisition and due to depreciation on
equipment and purchased software acquired by the Company in late 2004 and 2005.
Net loss. As a result of the foregoing, for the three months ended September 30,
2005, net loss increased by $917,497 to a loss of $1,314,117 compared to a net
loss of $396,620 for the corresponding period in 2004. For the nine months ended
September 30, 2005, net loss increased by $2,774,708 to a loss of $3,468,148
compared to a net loss of $693,440 for the corresponding period in 2004.
-19-
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2005 our working capital deficiency was $2,577,514 compared to
a working capital deficiency of $853,317 at December 31, 2004. The increase in
the working capital deficiency was due to a negative working capital deficiency
the Company assumed in the UCA acquisition and due to operating losses. During
the nine months ended September 30, 2005, the Company utilized cash from its
operating activities of approximately $2,000,000.
On July 22, 2004, the Company 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 the Company 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%. In
January 2005, in accordance with the terms of the Financing Agreement, the
Company elected to repay the principal of Loan I in kind by issuing 1,000,000
shares of common stock.
During the first quarter of 2005, Macrocom completed its financing commitment to
the Company, as required under the terms of the Financing Agreement, generating
$1,000,000 of gross proceeds to the Company in exchange for the shares of the
Company's common stock.
On May 24, 2005, the Company and Macrocom entered into an agreement to amend the
Financing Agreement between the parties. Under the terms of the amendment, the
due date for Loan II has been extended from April 10, 2005 until October 10,
2005. At the same time and in connection with the extension of the due date for
Loan II, Macrocom and the Company also amended the terms of the Financing
Agreement with respect to warrant Macrocom originally received on December 9,
2004. The warrant was set to expire on June 7, 2005; however, the parties have
agreed to extend the term of the warrant so that it expires on December 9, 2006.
In October 2005, the Company and Macrocom agreed to extend the due date of the
loan to October 2006.
During the nine months ended September 30, 2005, stockholders of the Company
loaned the Company an aggregate of $320,000 to enable the Company to meet its
working capital requirements.
The Company sold on July 19, 2005, a Convertible Debenture (the "Macrocom
Debenture") in the face amount of $500,000 to Macrocom. The Macrocom Debenture
bears interest at 5% and is due on April 15, 2006. At the option of Macrocom,
the Macrocom Debenture can be converted into shares of the Company's common
stock at a conversion price of $.50 per share. In connection with the sale, the
Company issued Macrocom warrants to acquire 1,000,000 shares of its common at an
exercise price of $1.50 per share. The warrants expire in three years from the
date of issuance. The Company also issued to Macrocom 375,000 shares of its
common stock as additional consideration. As collateral for the Debenture, the
Company has placed with an escrow agent 5,000,000 shares of its common stock. On
July 19, 2005, the Company sold to a stockholder and an entity affiliated with
an officer of the Company convertible debentures in the face amount of $50,000
each. These debentures were sold on substantially similar terms as the Debenture
sold to Macrocom. However, the Company did not provide any collateral to the
debenture holders.
-20-
In July 2005, the Company entered into a Standby Equity Distribution Agreement
(the "SEDA") with Cornell Capital Partners, LP ("Cornell"). Pursuant to the
SEDA, the Company may, at its discretion, periodically sell to Cornell shares of
common stock, for a total purchase price of up to Ten Million Dollars
($10,000,000). Cornell's obligation to purchase shares of the Company's common
stock under the SEDA is subject to certain conditions, including the Company
obtaining an effective registration statement for shares of common stock sold
under the SEDA and is limited to Seven Hundred Fifty Thousand Dollars ($750,000)
per weekly advance.
In October 2005 the Company and Cornell agreed that it was in the best interest
of both parties to terminate the SEDA and for Cornell to provide financing to
the Company through the issuance of secured convertible debentures. As a result
of their decision the Company and Cornell entered into a Termination Agreement
on October 27, 2005 which terminated all of the rights and obligations of both
the Company and Cornell under the SEDA. Pursuant to the Termination Agreement
the Company agreed to allow Cornell to retain 242,857 shares of the Company's
common stock that was previously issued to Cornell as part of the commitment fee
under the SEDA. Cornell agreed to return the balance of the commitment fee to
the Company which was equal to 437,143 shares of the Company's common stock. The
fair value 242,857 shares issued to Cornell approximated $340,000 and this
amount was charged to operations during the three months ended September 30,
2005.
On July 5, 2005, the Company entered into an agreement (the "Securities Purchase
Agreement") pursuant to which the Company shall sell to Cornell, and Cornell
shall purchase from the Company, secured convertible debentures (the "Cornell
Debentures") in the aggregate principal amount of One Million Dollars
($1,000,000), which are convertible, at Cornell's discretion, into common stock.
On October 27, 2005, the Company entered into a Securities Purchase Agreement
with Cornell Capital Partners whereby both parties agreed to amend and
consolidate all of the convertible debentures issued to Cornell Capital Partners
into one new secured convertible debenture in the principal amount of
$1,658,160. Prior to entering into the Securities Purchase Agreement the Company
issued secured convertible debentures to Cornell Capital Partners in a principal
aggregate amount equal to $1,000,000. Of those secured convertible debentures
previously issued to Cornell Capital Partners, $400,000 was funded on July 5,
2005; $50,000 was funded on September 1, 2005; $150,000 was funded on October 6,
2005, and $400,000 was funded on October 13, 2005. Pursuant to the Securities
Purchase Agreement, Cornell Capital Partners funded an additional $650,000 on
October 27, 2005. The $1,000,000 in secured convertible debentures and the
additional $650,000 in secured convertible debentures were consolidated into one
new secured convertible debenture along with the accrued and unpaid interest on
those debentures. The secured convertible debenture has a 36-month term and
accrues annual interest of 5%. The secured convertible debenture may be redeemed
by the Company at any time, in whole or in part by paying redemption premium of
15% of the amount redeemed in addition to such redemption. The secured
convertible debenture is convertible at the holder's option at a conversion
price equal to the lesser of (i) an amount equal to $1.00 or (ii) an amount
equal to 95% of the lowest closing bid price of our common stock for the 30
trading days immediately proceeding the conversion date. The debenture is
secured by substantially all our assets.
The Company's business strategy calls for growth internally as well as through
acquisitions. To this end, the Company intends 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. If adequate funds are not available on acceptable terms, then
the Company may not be able to meet our business objectives for expansion.
The Company's ability to continue as a going concern and future success are
dependent upon its ability to raise capital in the near term to: (1) satisfy its
current obligations, (2) continue its research and development efforts, and (3)
the successful wide scale development, approval, deployment and marketing of its
products and services.
Management's plans in this regard include, but are not limited to current
discussions and negotiations with a number of additional financing alternatives,
one or more of which it believes will be able to successfully close to provide
necessary working capital, while maintaining sensitivity to shareholder dilution
issues. However, there can be no assurance that the Company will generate
sufficient revenues to provide positive cash flows from operations or that
sufficient capital will be available, when required or at terms favorable to us,
to permit the Company to realize its plans. The accompanying unaudited condensed
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
-21-
To fund the Company's operations for the remainder of fiscal 2005, the Company
needs to raise additional financing and generate cash flows from its operations.
Should additional cash flows not be available, the Company believes that it
would have the ability to restructure its operations and if necessary initiate
significant reductions in expenses. In addition, the Company will have to
negotiate with its lenders to extend the repayment dates of its indebtedness.
There can be no assurance, however, that the Company will be able to
successfully restructure its operations or debt obligations in the event it
fails to obtain additional financing.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial conditions and results of
operations is based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to revenue recognition, accounts receivable
and long-lived assets. The Company bases its estimates on historical experience
and on various other assumptions that it believes to be reasonable under the
current circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.
The Company believes the following critical accounting policies affect its
judgment and estimates used in preparation of our consolidated financial
statements.
Revenue Recognition
The Company derives revenue from the sale of its communication equipment
products and as a provider of information technology consulting and
infrastructure development services.
In accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition,"
revenue is recognized when persuasive evidence of an arrangement exists,
delivery of the product or services has occurred, the fee is fixed and
determinable, collectibility is reasonably assured, contractual obligations have
been satisfied, and title and risk of loss have been transferred to the
customer.
UCA derives revenue primarily from professional services, managed IT services,
application development services and from business process management services.
Arrangements with customers for services are generally on a time and material
basis or fixed-price, fixed-time frame. Revenue on time-and-material contracts
is recognized as the related services are performed. Revenue for fixed-price,
fixed-timeframe services is recognized as the service is performed. Revenue from
fixed-price, fixed time-timeframe service contracts are recognized ratably over
the term of the contract, as per the proportional performance method. When the
Company receives cash advances from customers in advance of the service period,
amounts are reported as advances from customers until the commencement of the
service period. Billings and collections in excess of revenue recognized are
classified as deferred revenue.
To date NetFabric's communication equipment products have been marketed only
through a network of distributors and value-added resellers ("VAR"). In the VAR
channel, NetFabric recognizes revenue at the time of shipment if all other
contractual obligations to the VAR have been satisfied.
In the distributor channel, NetFabric recognizes revenue when the distributor
sells and ships NetFabric products to its own VARs, resellers or end-user
customers, provided the Company has satisfied all other the terms and conditions
with the distributor. Accordingly, NetFabric receives distribution sales and
inventory information regarding its products from its distributors for the
purpose of determining the appropriate timing of revenue recognition.
Both VARs and distributors have limited rights to return products to NetFabric
but must obtain prior approval from NetFabric before returning products,
consistently with common industry practice. NetFabric has no obligation to
accept the return of any unsold products. If required, the Company accrues a
provision for estimated sales returns and other allowances and deferrals as a
reduction of revenue at the time of revenue recognition. To date no sales have
been made and as such, no provisions for estimated sales returns and other
allowances have been recognized. The Company has no obligation to provide
service, repair, counseling or other assistance to any customers of the VARs or
distributors unless NetFabric has a specific agreement directly with such
customer.
-22-
Allowance for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. These
estimated losses are 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.
Inventory
Inventory consists primarily of finished goods and purchased electronic
components, and are stated at the lower of cost or market. Cost is determined by
using the first-in, first-out method.
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 consolidated balance
sheets at September 30, 2005 and December 31, 2004.
Goodwill and Other Intangibles
Goodwill and other intangibles represent the Company's preliminary allocation of
the estimated cost to acquire UCA Services in excess of the fair value of net
assets acquired. Under SFAS No. 142 Goodwill and Other Intangible Assets,
goodwill is not amortized but is reviewed for impairment annually, as well as
when a triggering event indicates impairment may have occurred. The goodwill
test for impairment consists of a two-step process that begins with an
estimation of the fair value of the reporting unit. The first step of the
process is a screen for potential impairment and the second step measures the
amount of impairment, if any. The Company will perform a goodwill impairment
test annually, as well as when a triggering event indicates impairment may have
occurred.
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.
-23-
ITEM 3. CONTROLS AND PROCEDURES
A. Evaluation of Disclosure Controls and Procedures:
Our disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports filed or submitted under the Exchange
Act is recorded, processed, summarized and reported, within the time period
specified in the SEC's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in the reports filed under the Exchange Act
is accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. As of the end of the period covered by this
report, we carried out an evaluation, under the supervision and with
participation of our management, including our Chief Executive officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based upon and as of the date of that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports we file and submit under the
Exchange Act are recorded, processed, summarized and reported as and when
required.
B. Changes in Internal Control over Financial Reporting:
There were no changes in our internal controls over financial reporting
identified in connection with our evaluation of these controls as of the end of
the period covered by this report that could have significantly affected those
controls subsequent to the date of the evaluation referred to in the previous
paragraph, including any correction action with regard to significant
deficiencies and material weakness.
PART II. OTHER INFORMATION
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
During the three months ended September 30, 2005,
On July 5, 2005, we entered into a Placement Agent Agreement with Newbridge
Securities Corporation, a registered broker-dealer. Pursuant to the Placement
Agent Agreement, we paid Newbridge Securities Corporation a one-time placement
agent fee of 7,142 restricted shares of common stock.
On July 19, 2005, the Company sold a convertible debenture in the face amount of
$500,000 to Macrocom. The debenture bears interest at 5% and is due on April 15,
2006. At the option of Macrocom, the debenture can be converted into shares of
the Company's common stock at a conversion price of $.50 per share. In
connection with the sale, the Company issued Macrocom warrants to acquire
1,000,000 shares of its common stock at an exercise price $1.50 per share. The
warrants expire in three years from the date of issuance. The Company also
issued to Macrocom 375,000 shares of its common stock as additional
consideration.
On July 19, 2005, the Company we sold to a stockholder and an entity affiliated
with an officer of NetFabric convertible debentures in the face amount of
$50,000 each. These debentures were sold on substantially similar terms as the
debenture sold to Macrocom.
In July 2005, the Company entered into a Standby Equity Distribution Agreement
(the "SEDA") with Cornell Capital Partners, LP ("Cornell"). Pursuant to the
SEDA, the Company issued to Cornell 680,000 shares of its common stock as
commitment fee under the SEDA. The Company and Cornell entered into a
Termination Agreement on October 27, 2005 which terminated all of the rights and
obligations of both the Company and Cornell under the SEDA. Pursuant to the
Termination Agreement the Company agreed to allow Cornell to retain 242,857
shares of the Company's common stock that was previously issued to Cornell as
part of the commitment fee under the SEDA. Cornell agreed to return the balance
of the commitment fee to the Company which was equal to 437,143 shares of the
Company's common stock.
The foregoing shares were issued pursuant to exemptions from registration under
Sections 3(a)(9) and 4(2) of the Securities Act of 1933.
-24-
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
31.1 Rule 13a-14(a)/15d-14(a) Certification (CEO)
31.2 Rule 13a-14(a)/15d-14(a) Certification (CFO)
32.1 Section 1350 Certification (CEO)
32.2 Section 1350 Certification (CFO)
(b) Reports on Form 8-K:
During the three months ended September 30, 2005, the Company filed;
(i) an 8-K/A for the event dated May 20, 2005 under Item 9.01 to provide
financial statements and pro forma information for the acquisition of UCA
Services, Inc.
(ii) an 8-K for the event dated July 5, 2005 under Items 1.01 and 3.02 to report
a financing transaction with Cornell Capital Partners, LP.
(iii) an 8-K for the event dated July 19,2005 under Items 1.01, 2.02 and 3.02 to
report a financing transaction with Macrocom Investors, LLC.
-25-
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities
Exchange Act , the registrant has caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: November 14, 2005 By: /s/ Jeff Robinson
----------------------------
Jeff Robinson
Chairman and Chief
Executive Officer
By: /s/ Vasan Thatham
----------------------------
Vasan Thatham
Principal Financial Officer and
Vice President
-26-
EXHIBIT 31.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES OXLEY ACT OF 2002
I, Jeff Robinson, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Netfabric Holdings,
Inc (the" Company").
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report;
4. The Company's other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d 15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) Evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter ( the Company's fourth fiscal quarter in case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting; and
5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the Company's ability to record, process, summarize
and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal control over
financial reporting.
November 14, 2005
/s/ Jeff Robinson
-------------------------------------------
Name: Jeff Robinson
Title: Chairman and Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES OXLEY ACT OF 2002
I, Vasan Thatham, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Netfabric Holdings,
Inc(the" Company").
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report;
4. The Company's other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d 15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) Evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter (the Company's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting; and
5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the Company's ability to record, process, summarize
and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal control over
financial reporting.
November 14, 2005
/s/ Vasan Thatham
- -------------------------------
Name: Vasan Thatham
Title: Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Netfabric Holdings, Inc. (the
"Company") on Form 10-QSB for the period ended September 30, 2005 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Jeff Robinson, Chairman Chief Executive Officer, certify, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
November 14, 2005
/s/ Jeff Robinson
- ---------------------------------
Name: Jeff Robinson
Title: Chairman and Chief Executive Officer
A signed original of this written statement required by Section 906 has been
provided to Netfabric Holdings, Inc. and will be retained by Netfabric Holdings,
Inc. and furnished to the Securities and Exchange Commission or its staff upon
request.
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Netfabric Holdings, Inc. (the
"Company") on Form 10-QSB for the period ended September 30, 2005 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Vasan Thatham, Chief Financial Officer, certify, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
November 14, 2005
/s/ Vasan Thatham
---------------------------------
Name: Vasan Thatham
Title: Chief Financial Officer
A signed original of this written statement required by Section 906 has been
provided to Netfabric Holdings, Inc. and will be retained by Netfabric Holdings,
Inc. and furnished to the Securities and Exchange Commission or its staff upon
request.