UNITED STATES 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 JUNE 30, 2006
COMMISSION FILE NUMBER: 0-21419
NETFABRIC HOLDINGS, INC.
(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 76-0307819
---------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S 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, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the 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 August 14, 2006, 74,293,883
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 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 22
Item 3. Controls and Procedures 29
PART II. OTHER INFORMATION 29
Item 1. Legal Proceedings 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits 29
Signatures 30
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2006 DECEMBER 31, 2005
(UNAUDITED) (NOTE 2)
------------- -----------------
ASSETS
CURRENT ASSETS:
Cash $ 191,363 $ 9,540
Trade accounts receivable, net 1,935,386 2,090,201
Due from related party 232,716 192,056
Prepaid expenses and other current assets 137,290 78,119
------------- ----------------
Total current assets 2,496,755 2,369,916
Property and equipment, net 179,513 164,984
Goodwill 13,982,451 13,982,451
Other intangibles, net 989,709 1,099,717
Other assets 12,392 9,994
------------- ----------------
TOTAL ASSETS $ 17,660,820 $ 17,627,062
============= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bridge loans, net of unamortized discount $ -- $ 441,125
Convertible debentures, net of unamortized discounts 521,852 366,666
Note payable to officer, net of unamortized discount -- 100,941
Loans and advances from officer and stockholders 52,639 202,639
Accounts payable and accrued liabilities 2,913,103 2,988,410
Accrued compensation 399,050 380,722
Deferred revenues and customer advances 1,272,100 66,019
Revolving note, net of unamortized discount 487,825 --
------------- ----------------
Total current liabilities 5,646,569 4,546,522
------------- ----------------
Derivative financial instruments -- 4,087,517
Convertible debentures, net of unamortized discount -- 612,059
Convertible note, net of unamortized discount 191,606 --
------------- ----------------
Total liabilities 5,838,175 9,246,098
------------- ----------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common Stock, $.001 par value, 100,000,000 shares
authorized, 66,043,883 and 62,44,357 and outstanding,
respectively 66,044 62,448
Additional paid-in capital 34,854,832 16,657,804
Deferred employee compensation -- (36,478)
Accumulated deficit (23,098,231) (8,302,810)
------------- ----------------
Total stockholders' equity 11,822,645 8,380,964
------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,660,820 $ 17,627,062
============= ================
See Notes to Unaudited condensed consolidated Financial Statements.
1
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30,
2006 2005 2006 2005
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
-------------- -------------- -------------- --------------
Revenues $ 4,299,958 $ 2,273,330 $ 8,398,404 $ 2,273,330
-------------- -------------- -------------- --------------
OPERATING EXPENSES:
Direct employee compensation and
consultant expenses 3,198,055 1,780,808 6,195,158 1,780,808
Selling, general and administrative
expense 1,472,958 775,666 2,894,017 775,666
Non-cash charge for dispute settlements -- -- 9,492,070 --
Non-cash charge for employee share-based
compensation 92,062 32,828 181,681 32,828
Depreciation and amortization 72,259 37,908 142,427 37,908
-------------- -------------- -------------- --------------
Total operating expenses 4,835,334 2,627,210 18,905,353 2,627,210
-------------- -------------- -------------- --------------
Loss from operations (535,376) (353,880) (10,506,949) (353,880)
OTHER INCOME / (EXPENSE):
Amortization of debt discounts and debt
issuance costs (783,781) (132,353) (2,236,428) (354,226)
Interest and bank charges (90,676) (22,666) (167,908) (33,617)
Gain on derivative financial instruments -- -- 336,352 --
Debt extinguishment costs (1,125,000) -- (1,746,077) --
-------------- -------------- -------------- --------------
Total other income / (expense) (1,999,457) (155,019) (3,814,061) (387,843)
-------------- -------------- -------------- --------------
Loss before provision for income taxes (2,534,833) (508,899) (14,321,010) (741,723)
Provision (benefit) for income taxes -- -- -- --
-------------- -------------- -------------- --------------
LOSS FROM CONTINUING OPERATIONS (2,534,833) (508,899) (14,321,010) (741,723)
-------------- -------------- -------------- --------------
DISCONTINUED OPERATIONS:
Loss from operations of discontinued
segment (234,269) (637,203) (474,411) (1,412,309)
-------------- -------------- -------------- --------------
NET LOSS $ (2,769,102) $ (1,146,102) $ (14,795,421) $ (2,154,032)
============== ============== ============== ==============
Net loss from continuing operations
per common share, basic and diluted $ (0.04) $ (0.01) $ (0.23) $ (0.02)
============== ============== ============== ==============
Net loss from discontinued operations
per common share, basic and diluted $ (0.00) $ (0.01) $ (0.00) $ (0.03)
============== ============== ============== ==============
Net loss per common share, basic and
diluted $ (0.04) $ (0.02) $ (0.23) $ (0.05)
============== ============== ============== ==============
Weighted average number of shares
outstanding, basic and diluted 64,066,520 48,773,506 63,283,310 42,635,842
============== ============== ============== ==============
See Notes to Unaudited condensed consolidated Financial Statements.
2
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
COMMON STOCK
---------------------------
ADDITIONAL
SHARES PAR VALUE PAID-IN CAPITAL
------------ ------------ ---------------
Balances at December 31, 2005 62,448,357 $ 62,448 $ 16,657,804
Issuance of common shares in connection with settlement of
payable 60,526 61 57,439
Value of contributions from stockholder in connection with
settlement of disputes -- -- 9,492,070
Employee share-based compensation -- -- 181,681
Reclassification of deferred employee stock option
compensation -- -- (36,478)
Allocation of value to beneficial conversion feature in
connection with issuance of convertible note -- -- 511,577
Issuance of options and warrants in connection with debt
financing -- -- 1,432,743
Reissuance of warrants in connection with debt extinguishment -- -- 372,353
Reclassification of derivative financial instrument
relating to beneficial conversion feature -- -- 804,307
Reclassification of derivative financial instrument relating
to warrants -- -- 2,946,858
Settlement of bridge loans with common stock 2,500,000 2,500 1,622,500
Conversion of convertible debenture issued to officer with
common stock 100,000 100 49,900
Issuance of shares in connection with extension of
convertible debenture to officer 100,000 100 29,900
Allocation of value to beneficial conversion feature issued
in connection with issuance of convertible debenture -- -- 322,755
Allocation of value for warrants issued in connection with
convertible debentures -- -- 90,739
Allocation of value for common shares issued in connection
with convertible debentures 525,000 525 164,510
Allocation of value for warrants issued in connection with
extension of convertible debentures -- -- 99,107
Allocation of value of common shares issued in connection
with extension of convertible debentures 150,000 150 37,944
Issuance of common shares for services 160,000 160 4,507
Issuance of warrants for services -- -- 12,616
Net loss -- -- --
------------ ------------ ---------------
BALANCES AT JUNE 30, 2006 (UNAUDITED) 66,043,883 $ 66,044 $ 34,854,832
============ ============ ===============
DEFERRED ACCUMULATED TOTAL
COMPENSATION DEFICIT STOCKHOLDERS' EQUITY
------------ ------------ --------------------
Balances at December 31, 2005 $ (36,478) $ (8,302,810) $ 8,380,964
Issuance of common shares in connection with settlement of
payable -- -- 57,500
Value of contributions from shareholder in connection with
settlement of disputes -- -- 9,492,070
Employee share-based compensation -- -- 181,681
Reclassification of deferred employee stock option
compensation 36,478 -- --
Allocation of value to beneficial conversion feature in
connection with issuance of convertible note -- -- 511,577
Issuance of options and warrants in connection with debt
financing -- -- 1,432,743
Reissuance of warrants in connection with debt extinguishment -- -- 372,353
Reclassification of derivative financial instrument
relating to beneficial conversion feature -- -- 804,307
Reclassification of derivative financial instrument relating
to warrants -- -- 2,946,858
Settlement of bridge loans with common stock -- -- 1,625,000
Conversion of convertible debenture issued to officer with
common stock -- -- 50,000
Issuance of shares in connection with extension of
convertible debenture to officer -- -- 30,000
Allocation of value to beneficial conversion feature issued
in connection with issuance of convertible debenture -- -- 322,755
Allocation of value for warrants issued in connection with
convertible debentures -- -- 90,739
Allocation of value for common shares issued in connection
with convertible debentures -- -- 165,035
Allocation of value for warrants issued in connection with
extension of convertible debentures -- -- 99,107
Allocation of value of common shares issued in connection
with extension of convertible debentures -- -- 38,094
Issuance of common shares for services -- -- 4,667
Issuance of warrants for services -- -- 12,616
Net loss -- (14,795,421) (14,795,421)
------------ ------------ --------------------
BALANCES AT JUNE 30, 2006 (UNAUDITED) $ -- $(23,098,231) $ 11,822,645
============ ============ ====================
See Notes to Unaudited condensed consolidated Financial Statements.
3
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2006 (UNAUDITED) 2005 (UNAUDITED)
------------------------- -------------------------
OPERATING ACTIVITIES
Net loss $ (14,795,421) $ (2,154,032)
Loss from discontinued operations 474,411 1,412,309
Adjustments to reconcile net loss to net cash used in
operating activities:
Non-cash charge for options issued
to non-employees 43,054 10,313
Non-cash charges for shares and warrants issued for services 17,283 --
Non-cash charge for interest expense 22,500 --
Non-cash charge for settlement of disputes 9,492,070 --
Non-cash charge in connection with settlement of debt 1,125,000
Non-cash charge for reissuance of warrants in connection with
debt extinguishment 372,353 --
Non-cash charge for amortization
of employee deferred compensation -- 22,515
Non-cash charge for employee share based compensation 181,681
Non-cash gain on derivative financial instrument (336,352) --
Amortization of debt discounts 2,218,130 354,226
Amortization of debt issuance costs 18,298 --
Depreciation and amortization 142,427 37,908
Changes in operating assets and liabilities:
Inventory -- (137,236)
Trade accounts receivable 154,815 (306,622)
Due from related party (40,660) --
Prepaid expenses and other current assets (102,224) (42,719)
Other assets -- 32,740
Accounts payable and accrued liabilities (18,735) 1,058,426
Accrued compensation 18,328 239,314
Deferred revenues and advances 1,206,081 (312,407)
------------------------- -------------------------
Net cash provided by continuing operations 193,039 214,735
Net cash used in discontinued operations (454,344) (1,369,025)
------------------------- -------------------------
Net cash used in operating activities (261,305) (1,154,290)
------------------------- -------------------------
INVESTING ACTIVITIES
Direct acquisition costs of UCA Services -- (187,000)
Purchases of property and equipment (67,015) (78,342)
------------------------- -------------------------
Net cash used in investing activities (67,015) (265,342)
------------------------- -------------------------
FINANCING ACTIVITIES
Proceeds from issuance of common stock -- 1,000,000
Loans and advances from stockholders and officers 20,000 370,000
Repayment of note to officer (200,000) --
Convertible debentures issued 650,000 --
Repayments of bridge loans (500,000) --
Repayment of convertible debentures (1,658,160) --
Proceeds from issuance of revolving note, net 958,500 --
Proceeds from issuance of convertible note, net 1,430,500 --
Debt issuance costs (20,697) --
Repayment of loans from officer and director (170,000) --
------------------------- -------------------------
Net cash provided by financing activities 510,143 1,370,000
------------------------- -------------------------
NET INCREASE IN CASH 181,823 (49,632)
CASH AT BEGINNING OF PERIOD 9,540 67,719
------------------------- -------------------------
CASH AT END OF PERIOD $ 191,363 $ 18,087
========================= =========================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest expense $ 70,727 $ 12,500
========================= =========================
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 AND MANAGEMENT'S PLANS
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. 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 Voice Over Internet
Protocol ("VoIP") appliances that simplify the integration of standard telephone
systems with an IP infrastructure. On May 5, 2006, the Company announced its
decision to exit from the hardware-based VoIP communications product line
(including resale of transport services) that is targeted at small to mid-sized
businesses. In accordance with Statement of Financial Accounting Standards No.
144 "Accounting for the Impairment or Disposal of Long-Lived Assets", ("SFAS No.
144"), the Company has presented the results of operations from its VoIP
business segment as discontinued operations in the accompanying condensed
consolidated balance sheets, statements of operations and statements of cash
flows (Note 3).
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") from its shareholders
in exchange for the issuance of 24,096,154 shares of common stock of Holdings
(See Note 4). Holdings emerged from the development stage upon the acquisition
of UCA Services.
UCA Services, a New Jersey company, is an information technology ("IT") services
company that serves the information needs of a wide range of Fortune 500 and
small to mid-size business ("SMB") clients in the financial markets industry as
well as the pharmaceutical, health care and hospitality sectors. UCA Services
delivers a broad range of IT services in the practice areas of infrastructure
builds and maintenance, application development and maintenance, managed
services and professional services.
MANAGEMENT'S PLANS
The accompanying condensed consolidated financial statements have been prepared
on a going concern basis. As shown in the accompanying condensed consolidated
financial statements, the Company has incurred accumulated losses totaling
$23,098,231 and a working capital deficit of $3,149,814 at June 30, 2006. These
factors, among others, indicate that the Company may be unable to continue as a
going concern. The condensed consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
Management recognizes that the Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to allow the Company
to continue the development of its business plans and satisfy its current and
long-term obligations on a timely basis. The Company believes that it will be
able to complete the necessary steps in order to meet its cash requirements
for the next 12 months and continue its business development efforts.
Management's plans in this regard include, but are not limited to, the
following:
o Settlement of liabilities with the Company's common stock.
o Current discussions and negotiations with a number of additional
financing alternatives, one or more of which management believes it
will be able to successfully close to provide necessary working
capital. There is no assurance that the Company will be successful
in completing a financing (Note 11).
In order to execute its business plan and achieve its objectives for the near
future, management believes it will require approximately $2,000,000 over the
remainder of fiscal year 2006 for working capital. A significant component of
this is for satisfying the Company's obligations as they become due, both
borrowing and vendor payables. Accordingly, the Company needs to raise
additional financing and generate cash flows from its operations. Should
additional cash flows not be available, management believes that the Company
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.
5
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 six months ended June 30, 2006 and 2005
are not necessarily indicative of the results to be expected for any other
interim period or any future year. The accompanying unaudited condensed
consolidated financial statements should be read in conjunction with the
Company's December 31, 2005 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, 2005 filed on April 17, 2006.
RECLASSIFICATIONS
Certain reclassifications have been made in the prior period consolidated
financial statements to conform to the current period presentation.
As a result of the Company's decision to exit the VoIP hardware business,
previously reported financial statements have been reclassified as discontinued
operations to conform to 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 other intangible
assets, the fair value of the Company's common stock, the fair value of options
and warrants issued for services, the allocation of proceeds from certain
financings to equity instruments and the computation of other reserves. Because
of the uncertainty inherent in such estimates, actual results may differ from
these estimates.
REVENUE RECOGNITION
The Company derives revenue principally from professional services. In
accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition,"
revenue is recognized when persuasive evidence of an arrangement exists,
delivery 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. 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.
6
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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, and has not experienced any material bad debt losses to date. The Company
did not record any provisions for doubtful accounts during the three and six
months ended June 30, 2006 and 2005.
LONG-LIVED ASSETS
Long-lived assets, including property and equipment and intangible assets with
finite lives, are monitored and reviewed for impairment in value whenever events
or changes in circumstances indicate that the carrying amount of any such asset
may not be recoverable. The determination of recoverability is based on an
estimate of undiscounted cash flows expected to result from the use of an asset
and its eventual disposition. The estimated cash flows are based upon, among
other things, certain assumptions about expected future operating performance,
growth rates and other factors. Estimates of undiscounted cash flows may differ
from actual cash flows due to factors such as technological changes, economic
conditions, and changes in the Company's business model or operating
performance. If the sum of the undiscounted cash flows (excluding interest) is
below the carrying value, an impairment loss is recognized, measured as the
amount by which the carrying value exceeds the fair value of the asset.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash and accounts receivable. The Company
reduces credit risk by placing its 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 3 clients representing 55% (32%, 12%, and 11%, respectively) of revenues
during the three months ended June 30, 2006. The Company had revenues from 3
clients representing 54% (31%, 12% and 11%, respectively) of revenues during the
six months ended June 30, 2006.
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 46%
(25%, 11% and 10%, respectively) of total gross accounts receivable as of June
30, 2006.
GOODWILL
Goodwill represents the Company's allocation of the cost to acquire UCA Services
in excess of the fair value of net assets acquired. The purchase price and its
allocation, to reflect the fair values of identifiable assets acquired and
liabilities assumed, have been based upon management's evaluation, including
independent valuation.
Under SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"),
goodwill is not amortized but is reviewed for impairment annually. The Company
performs its annual goodwill impairment testing, by reportable segment, in the
second quarter of each year, or more frequently if events or changes in
circumstances indicate that goodwill may be impaired. Application of the
goodwill impairment test requires significant judgments including estimation of
future cash flows, which are dependent on internal forecasts, estimation of the
long-term rate of growth for UCA Services, the useful life over which cash flows
will occur, and determination of UCA Services cost of capital. Changes in these
estimates and assumptions could materially affect the determination of fair
value and/or conclusions on goodwill impairment for UCA Services.
OTHER INTANGIBLES
Other intangible assets with finite lives are accounted for under the provisions
of SFAS No. 142. These intangible assets arise from business combinations and
consist of customer relationships and restricted covenants related to employment
agreements that are amortized, on a straight-line basis, over periods of up to
six years. The Company follows the impairment provisions and disclosure
requirements of SFAS No. 142. Accordingly these intangible assets are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable.
7
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 "Disclosure about Fair Value of Financial Instruments", approximate
their carrying amounts presented in the balance sheets at June 30, 2006 and
December 31, 2005.
The Company accounts for derivative instruments in accordance with SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," as amended,
("SFAS No. 133") which establishes accounting and reporting standards for
derivative instruments and hedging activities, including certain derivative
instruments imbedded in other financial instruments or contracts and requires
recognition of all derivatives on the balance sheet at fair value. Accounting
for the changes in the fair value of the derivative instruments depends on
whether the derivatives qualify as hedge relationships and the types of the
relationships designated are based on the exposures hedged. Changes in the fair
value of derivative instruments which are not designated as hedges are
recognized in earnings as other income (loss).
The Company has issued financial instruments which have required a determination
of the fair value of certain related derivatives, where quoted market prices
were not published or readily available at the date of issuance. The Company
bases its fair value determinations on an evaluation of the facts and
circumstances and valuation techniques that require judgments and estimates.
STOCK-BASED COMPENSATION EXPENSE
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on estimated
fair values. SFAS 123(R) supersedes the Company's previous accounting under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") for periods beginning in fiscal 2006. In March 2005, the
SEC issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS
123(R). The Company has applied the provisions of SAB 107 in its adoption of
SFAS 123(R).
SFAS 123(R) requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Company's condensed
consolidated statements of operations. Prior to the adoption of SFAS 123(R), the
Company accounted for stock-based awards to employees and directors using the
intrinsic value method in accordance with APB 25 as allowed under Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). Under the intrinsic value method, stock-based
compensation expense was recognized in the Company's condensed consolidated
statement of operations based on the difference between the exercise price of
the Company's stock options granted to employees and directors, and the fair
market value of the underlying stock at the date of grant.
8
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company adopted SFAS 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of the Company's fiscal year. The Company's condensed
consolidated financial statements as of and for the three and six months ended
June 30, 2006 reflect the impact of adoption of SFAS 123(R). In accordance with
the modified prospective transition method, the Company's condensed consolidated
financial statements for prior periods have not been restated to reflect, and do
not include, the impact of adoption of SFAS 123(R). Stock-based compensation
expense recognized under SFAS 123(R) for the three and six months ended June 30,
2006 was $92,062 and $181,681, respectively. Stock-based compensation expense
related to employee stock options accounted for under APB 25 prior to January
2006 would have been $175,364 and $466,401 during the three and six months ended
June 30, 2005, respectively, if SFAS 123(R) had been adopted.
Share-based compensation expense recognized in the Company's condensed
consolidated statements of operations for the three and six months ended June
30, 2006 includes compensation expense for share-based payment awards
granted prior to, but not yet vested as of December 31, 2005, based on the
grant-date fair value estimated in accordance with the provisions of SFAS 123.
SFAS 123(R) requires forfeitures to be estimated at the time of grant in order
to estimate the amount of share-based awards that will ultimately vest. As there
were only a nominal amount of option holders as of January 1, 2006, management
evaluated each of the grants outstanding upon adoption of SFAS 123(R) to
determine an appropriate forfeiture rate. Based on this evaluation and
considering options which were cancelled during management's evaluation in the
six months ended June 30, 2006, the Company adjusted the value of the options
outstanding as of January 1, 2006 for actual cancellations during the three and
six months ended June 30, 2006. After adjusting for the value such
cancellations, management determined that a forfeiture rate was not required for
the remaining outstanding option grants. This determination was based
principally on the nature of the option holder's involvement with the Company
and the quantity held by such individuals. In the Company's pro forma
information required under SFAS 123 for the periods prior to fiscal year 2006,
the Company accounted for forfeitures as they occurred. Effectively, for all
periods presented forfeitures have been accounted for as they occurred.
On November 10, 2005, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. FAS 123(R)-3 "Transition Election Related to Accounting
for Tax Effects of Share-Based Payment Awards." The Company has elected to adopt
the alternative transition method provided in the FASB Staff Position for
calculating the tax effects of stock-based compensation pursuant to SFAS 123(R).
The alternative transition method includes simplified methods to establish the
beginning balance of the additional paid-in capital pool ("APIC pool") related
to the tax effects of employee stock-based compensation, and to determine the
subsequent impact on the APIC pool and consolidated statements of cash flows of
the tax effects of employee stock-based compensation awards that are outstanding
upon adoption of SFAS 123(R).
The net loss for the three and six months ended June 30, 2005 includes
compensation charges related to options granted to employees based on the
intrinsic value method. The following table illustrates the pro forma effect on
net loss and net loss per common share assuming the Company had applied the fair
value recognition provisions of SFAS 123, as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS
148"), instead of the intrinsic value method under APB No. 25 to stock based
employee compensation for the three and six months ended June 30, 2005:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2005 JUNE 30, 2005
------------------ ------------------
Net loss as reported $ (1,146,102) $ (2,154,032)
Add: Stock-based employee compensation expense included
in reported loss 4,207 22,515
Deduct: Total stock-based compensation expense determined
under the fair value based method (175,364) (466,401)
------------------ ------------------
Net loss pro forma $ (1,317,259) $ (2,597,918)
================== ==================
Loss per Common Share--Basic and Diluted:
As reported $ (0.02) $ (0.05)
Pro forma $ (0.03) $ (0.06)
As of June 30, 2006, the unvested portion of share-based compensation expense
attributable to employees and directors stock options and the period in which
such expense is expected vest and be recognized is as follows:
Remainder of year ending December 31, 2006 $ 186,564
Year ending December 31, 2007 116,077
Year ending December 31, 2008 94,775
Year ending December 31, 2009 53,154
Year ending December 31, 2010 4,883
------------
$ 455,453
============
INCOME TAXES
Deferred income tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Deferred tax assets are reduced by a
valuation allowance if it is more likely than not that the tax benefits will not
be realized. The ultimate realization of deferred tax assets depends upon the
generation of future taxable income during the periods in which those temporary
differences become deductible.
9
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
EARNINGS (LOSS) PER SHARE
The Company calculates earnings (loss) per share in accordance with SFAS No.
128, "Earnings per Share." SFAS No. 128 computes basic earnings (loss) per share
by dividing the net income (loss) by the weighted average number of shares of
common stock outstanding during the period. Diluted earnings (loss) per share is
computed by dividing the net income (loss) by the weighted average number of
shares of common stock outstanding during the period plus the effects of any
potentially dilutive securities. Diluted earnings (loss) per share considers the
impact of potentially dilutive securities except in periods in which there is a
loss because the inclusion of the potential common shares would have an
anti-dilutive effect. The Company's potentially dilutive securities include
common shares which may be issued upon exercise of its stock options, and
warrants and the conversion of convertible debt.
Diluted loss per share for the three and six months ended June 30, 2006 and 2005
exclude potentially issuable common shares of 17,118,624 and
9,287,526, respectively, primarily related to the Company's outstanding stock
options, warrants and convertible debt, because the assumed issuance of such
potential common shares is antidilutive.
SEGMENT REPORTING
The Company determines and discloses its segments in accordance with SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information,"
which uses a "management" approach for determining segments. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of a
company's reportable segments. SFAS No. 131 also requires disclosures about
products or services, geographic areas and major customers.
NOTE 3. DISCONTINUED OPERATIONS
On May 5, 2006, the Company announced its decision to exit from the
hardware-based VoIP communications product line (including resale of transport
services) that is targeted at small to mid-sized businesses. In accordance with
Statement of Financial Accounting Standards No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", ("SFAS No. 144"), the Company
recorded losses from discontinued operations of $234,269 and $474,411 for the
three and six months ended June 30, 2006 respectively. The Company has
reclassified prior period results to conform with the current period
presentation. Accordingly, $637,203 and $1,412,309 for the three and six months
ended June 2005, respectively, have been classified as loss from discontinued
operations. Revenues from VoIP operations have been nominal in all periods
presented and operating expenses are the losses reported.
NOTE 4. INTANGIBLE ASSETS
The Company's intangible assets, consisting of customer contacts and restricted
covenants related to employment agreements, were acquired and initially
accounted for at fair values at the acquisition date using the purchase method
of accounting. The following table summarizes the net asset value for each
intangible asset category as of June 30, 2006:
Gross Asset Accumulated Net Asset
Value Amortization Value
------------ ------------ ------------
Customer relationships $ 1,153,424 $ (216,267) $ 937,157
Covenants not to compete 83,333 (30,781) 52,552
------------ ------------ ------------
$ 1,236,757 $ (247,048) $ 989,709
============ ============ ============
The Company did not have any intangibles prior to the acquisition of UCA
Services in May 2005.
NOTE 5. 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 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.
10
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The purchase price of $14,010,000 consisted of $13,823,000 of common stock and
$187,000 of acquisition costs. The fair value of Holdings' common stock issued
in exchange for the shares of UCA Services was based an independent appraisal of
assets acquired and liabilities assumed.
The determination of the purchase price and its allocation to the fair values of
the assets acquired and liabilities acquired as reflected in the consolidated
financial statements have been based on the Company's valuation, including the
use of an independent appraisal. The fair value of the assets and liabilities
assumed in the acquisition of UCA Services are as follows:
Accounts receivable $ 2,153,968
Property, plant, other assets and equipment 190,602
Customer relationship intangible 1,153,424
Non-compete intangible 83,333
Accounts payable and accrued expenses (2,481,077)
Deferred revenue and advances (1,072,701)
---------------
Net assets acquired $ 27,549
===============
The Company recognized goodwill of $13,982,451 as a result of the cost in excess
of the net assets acquired of UCA Services. Such goodwill is assigned to the
Company's IT services segment. Any charge to expense related such goodwill will
not be deductible for tax purposes.
Summarized below are the pro forma unaudited results of operations for the three
and six months ended June 30, 2005 as if the results of UCA Services were
included for the entire periods presented. 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:
For the three For the six months
months ended ended,
June 30, 2005 June 30, 2005
------------- -----------------
Revenues $ 4,980,848 $ 9,154,682
Net loss (2,031,255) (3,039,185)
Basic and diluted net loss common share $ (0.03) $ (0.05)
Weighted average common shares outstanding 61,748,358 61,140,623
11
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. DEBT FINANCINGS
Debt financings consist of the following as of June 30, 2006 and December 31,
2005:
June 30, 2006
Unamortized Debt
Principal Discount Net
----------- ---------------- -----------
April 2006 Debentures, due September 15, 2006 $ 500,000 $ (114,831) $ 385,169
Convertible debenture payable to stockholder
due August 4, 2006 150,000 (48,219) 101,781
Convertible debentures payable to stockholder and director
due September 15, 2006 50,000 (15,098) 34,902
Laurus Revolving Note due February 10, 2009 1,028,000 (540,175) 487,825
Laurus Convertible Note due February 10, 2009 1,500,000 (1,308,394) 191,606
Loans and advances from officer and directors 52,639 -- 52,639
----------- ---------------- -----------
$ 3,280,639 $ (2,026,717) $ 1,253,922
=========== ================ ===========
During the three and six months ended June 30, 2006, $773,601 and $2,218,130,
respectively, of the debt discounts were amortized into amortization of debt
discounts and debt issuance costs in the accompanying condensed statements of
operations. During the three and six months ended June 30, 2005, $132,353 and
$354,226, respectively, of the debt discounts were amortized into amortization
of debt discounts and debt issuance costs on the accompanying statements of
operations.
December 31, 2005
Unamortized Debt
Principal Discount Net
----------- ----------------- -----------
Macrocom Bridge Loan II, due October 10, 2006 $ 500,000 $ (58,875) $ 441,125
Macrocom Convertible Debenture due April 15, 2006 500,000 (194,444) 305,556
Convertible debentures payable to stockholder and director
due April, 15, 2006 100,000 (38,890) 61,110
Cornell convertible debenture 1,658,160 (1,046,101) 612,059
Note payable issued to officer 200,000 (99,059) 100,941
Loans and advances from officer and directors 202,639 -- 202,639
----------- ----------------- -----------
$ 3,160,799 $ (1,437,369) $ 1,723,430
=========== ================= ===========
APRIL 2006 PRIVATE PLACEMENT
On April 19, 2006, the Company sold Convertible Debentures (the "April 2006
Debentures") in the face amount of $500,000 to five individuals (the "Debenture
Holders" or a "Debenture Holder") including $150,000 face value to an officer
and director, and $50,000 face value to a stockholder. The April 2006 Debentures
bear interest at 8% and were due originally on June 17, 2006. At the option of
the Debenture Holders, the April 2006 Debentures 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 to two Debenture Holders warrants
to acquire an aggregate of 200,000 shares of its common stock with a nominal
exercise price. The warrants expire in three years from the date of issuance.
The remaining three Debenture Holders received an aggregate of 225,000 shares of
the Company's common stock as additional consideration. In connection with the
issuance of the debt to the three Debenture Holders the Company has agreed to
place 3,000,000 shares of its common stock as collateral with an escrow agent.
No collateral has been issued for the debentures issued to the officer
and director and to the stockholder.
12
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company used the proceeds from the sale of the April 2006 Debentures to
repay $500,000 due to the Macrocom pursuant to Macrocom Debenture issued in July
of 2005.
The Company allocated the $500,000 of proceeds received from the April 2006
Debentures based on the computed relative fair values of the debt, warrants and
stock instruments issued. The fair value of the shares issued was $168,750 which
resulted in a relative fair value of $103,271. The warrants issued were valued
using a Black-Scholes option-pricing model with the following assumptions: (1)
common stock fair value of $0.75 per share (2) expected volatility of 71.26%,
(3) risk-free interest rate of 4.86%, (4) life of 3 years and (5) no dividend,
which resulted in a fair value of $148,271 and a relative fair value of $90,739.
Additionally, the resulting relative fair value allocated to the debt component
was used to measure the intrinsic value of the embedded conversion option of the
April 2006 Debentures which resulted in a beneficial conversion feature with a
fair value of $444,010. The relative fair value of $305,990 was 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
April 2006 Debentures. The aggregate amounts allocated to the warrants, stock
instruments and beneficial conversion feature, of $500,000 were recorded as a
debt discount at the date of issuance of the April 2006 Debentures and were
amortized to interest expense using the interest method over the originally
stated term of the April 2006 Debentures. During the three and six months ended
June 30, 2006, $500,000 of discount was accreted and recorded as amortization of
debt discounts and debt issuance costs on the accompanying statements of
operations.
In June 2006, the Company and the Debenture Holders entered into an agreement to
extend the term of the April 2006 Debentures to September 15, 2006. In exchange
for the extension, the Company issued to the holders an aggregate of 150,000
shares of its common stock and warrants to acquire an aggregate of 400,000
shares of its common stock with a nominal exercise price. The warrants expire in
three years from the date of issuance. The fair value of the shares of common
stock and warrants approximated $137,201 and was recorded as additional discount
and is being amortized over the new term of the April 2006 Debentures. For the
three and six months ended June 30, 2006 $22,370 of discount was accreted and
recorded as amortization of debt discounts resulting in carrying value of
$385,169 on the April 2006 Debentures June 30, 2006.
STOCKHOLDER CONVERTIBLE DEBENTURE, DUE AUGUST 2006
On June 8, 2006, the Company sold a Convertible Debenture in the face amount of
$150,000 to a stockholder (the "Stockholder Convertible Debenture"). The
Stockholder Convertible Debenture bears interest at 8% and is due on August 4,
2006. At the option of the holder, the Stockholder Convertible 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 300,000 shares
of its common stock as additional consideration.
The Company allocated the $150,000 of proceeds received from the Stockholder
Convertible Debenture based on the computed relative fair values of the debt and
stock instruments issued. The fair value of the common stock issued was $105,000
which resulted in a relative fair value of $61,764. Additionally, the resulting
relative fair value allocated to the debt component was used to measure the
intrinsic value of the embedded conversion option of the Stockholder Convertible
Debenture which resulted in a beneficial conversion feature of $16,765 recorded
to additional paid-in capital. The aggregate amounts allocated to the stock
instruments and beneficial conversion feature, of $78,529 were recorded as a
debt discount at the date of issuance of the Stockholder Convertible Debenture
and are being amortized to interest expense using the interest method over the
stated term of the Stockholder Convertible Debenture. During the three and six
months ended June 30, 2006, $30,310 of discount was accreted and recorded as
amortization of debt discounts resulting in carrying value of $101,781 on the
Stockholder Convertible Debenture at June 30, 2006.
MACROCOM 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
was payable in cash on the Due Date. Additionally, in connection with the
Financing Agreement the Company issued to Macrocom 250,000 shares of common
stock at a fair value of $144,000 as additional consideration for Loan I in
December 2004. 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. On October 14, 2004, NetFabric and
Macrocom Investors, LLC ("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 could 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 was payable in cash on the Second Due
Date. In addition, in December 2004 the Company issued to Macrocom 250,000
shares of common stock with a fair value of $144,000 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.
13
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As a result of the Loan I and Loan II financing transactions, total debt
discounts of $411,403 were recorded on Loan I and Loan II (the "Bridge Loans")
during 2004, including the value of the beneficial conversion feature of
$187,801 on Loan II. During the three and six months ended June 30, 2005,
$132,353 and $354,226, respectively of the discounts were amortized on the
accompanying consolidated 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 was 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. 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 on Loan II.
On October 10, 2005 Macrocom did not require repayment or conversion of Loan II
to common stock. Company and Macrocom agreed to extend the due date for Loan II
until October 10, 2006. As a result of the modification of the term, a debt
discount of $100,758 was recorded on October 10, 2005 on Loan II which will be
amortized from October 11, 2005 through October 10, 2006. During the three and
six months ended June 30, 2006, $40,982 and $58,875, respectively, of the
discount was amortized on the accompanying consolidated statements of
operations.
On May 24, 2006 the Company entered into a Waiver and Agreement to Convert
("Agreement") with Macrocom. Pursuant to the Agreement, Macrocom agreed
immediately to elect to convert Loan II issued by the Company in the principal
amount of $500,000, including all interest accrued thereon, into 1,000,000
shares of restricted common stock of the Company. In addition, Macrocom and the
Company agreed to waive and release each other from any claims in connection
with Loan II and all other agreements executed to date between Macrocom and the
Company. In exchange for the waiver and the Loan II conversion, the Company
agreed to issue to Macrocom 1,500,000 shares additional shares of restricted
common stock. The fair value of the additional consideration was $1,125,000 and
the amount was charged to operations during the three months ended June 30, 2006
as debt extinguishment costs.
EMPLOYEE NOTE
An officer of the Company and an employee of UCA Services, advanced $200,000 to
the Company during 2005. In December 2005 the Company and the employee entered
into a Promissory Note (the "Employee Note") related to the advance. The
Employee Note bears interest at a rate of 5% per annum and a fee of $10,000 is
due to the employee at maturity. The principal balance of the Employee Note
together with accrued and unpaid interest and the fee were due and payable in
one installment on January 31, 2006. The Company repaid the balance owed in
February 2006. In connection with the Employee Note, on December 8, 2005 the
Company's Board of Directors authorized for issuance warrants to the employee to
acquire 300,000 shares of our common stock at an exercise price of $1.00 per
share. The warrants were issued on January 24, 2006 and expire on January 24,
2009.
MACROCOM CONVERTIBLE DEBENTURES
On July 19, 2005, the Company issued a convertible debenture in the amount of
$500,000 to Macrocom Investors, LLC ("Macrocom") (the "Macrocom Debenture"). The
Macrocom Debenture bore interest at 5% per annum and was due on April 15, 2006.
At the option of Macrocom, the Macrocom Debenture could have been 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 placed
5,000,000 shares of its common stock with an escrow agent.
14
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company allocated the $500,000 of proceeds received from the Macrocom
Debenture based on the computed relative fair values of the debt, warrants and
stock instruments issued. Additionally, the resulting relative fair value
allocated to the debt component was used to measure the intrinsic value of the
embedded conversion option of the Macrocom Debenture which resulted in a
beneficial conversion feature 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, stock instruments and beneficial conversion feature,
of $500,000 were recorded as a debt discount at the date of issuance of the
Macrocom Debenture and were amortized to interest expense using the interest
method over the stated term of the Macrocom Debenture. During the three and six
months ended June 30, 2006, $27,778 and $194,444, respectively of discount was
accreted and recorded as interest expense on the accompanying statements of
operations. In April 2006, the Macrocom Debenture was repaid in full from the
proceeds of the April 2006 Debenture debt financing.
DIRECTOR AND OFFICER CONVERTIBLE DEBENTURES
On July 19, 2005, the Company agreed with a director, who is also a stockholder,
and an entity affiliated with an officer of the Company, that aggregate advances
of $100,000 made in June 2005 from the director 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 Debentures"). The Related
Party Convertible Debentures were sold on substantially similar terms as the
Macrocom Debenture and, accordingly, bear interest at 5% per annum, and were
originally due on April 15, 2006. At the option of the holder, the Related Party
Convertible Debentures 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 holder 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 for 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 $100,000 of proceeds received from the Related Party
Convertible Debentures based on the computed relative fair values of the debt,
warrant and stock instruments issued. Accordingly, the resulting relative fair
value allocated to the debt component 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 recorded to additional paid-in
capital. The aggregate amounts allocated to the warrants, stock instruments 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 were
amortized to interest expense using the interest method over the original stated
term of the Related Party Convertible Debentures. During the three and six
months ended June 30, 2006, $5,556 and $38,890, respectively, of discount has
been accreted and recorded as interest expense on the accompanying statements of
operations.
In April 2006, one holder of Related Party Convertible Debentures in the face
amount of $50,000 converted the dentures into 100,000 shares of the Company
common stock and the other holders in the face amount of $50,000 entered into an
extension agreement with the Company to extend the due date of the debenture to
September 15, 2006. In connection with the extension, the Company issued 100,000
share of its common stock as additional consideration. The fair value of the
shares of common stock was $75,000 which resulted in a relative fair value of
$30,000 which was recorded as additional discount and are being amortized over
the new term of the debenture. For the three months ended June 30, 2006, $14,902
of discount was accreted and recorded as interest expense resulting in carrying
value of $34,902 on the debentures at June 30, 2006.
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 of the Company. A
$400,000 debenture was funded in July 2005, and a $50,000 debenture was funded
in September 2005 (collectively the "Original Cornell Debentures"). In
connection with the Original 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. The Original Cornell Debentures
could have been 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.
15
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On October 27, 2005, 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 Original Convertible
Debentures, and related accrued interest of $8,160, issued to Cornell through
October 26, 2005 into one new secured convertible debenture in the principal
amount of $1,658,160 (the "October Cornell Debenture"). The October Cornell
Debentures had the same terms and provisions of the Original Cornell Debentures
except that the October Cornell Debentures no longer had a fixed conversion by
the holder but is convertible at the option of the holder at 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. Pursuant to the Securities Purchase Agreement, Cornell funded
the remaining $1,200,000 balance of October Cornell Debenture on October 27,
2005. The October Cornell Debenture was repaid in full in February 2006 (the
"Cornell Repayment"), with the proceeds received from a new debt financing
described below.
As a result of the change in the conversion terms of the October Convertible
Debenture on October 27, 2005, the Company determined that the embedded
conversion feature of the October Cornell Debenture became subject to the
provisions of SFAS No. 133 and therefore the Company accounted for the embedded
conversion feature as a liability in accordance with the guidance of EITF 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock"("EITF 00-19"). Accordingly, the Company
recorded the fair value of the embedded conversion feature of $784,784 as a
non-current liability on its balance sheet as of October 27, 2005 and a portion
of the amounts previously recorded to additional paid-in capital as part of the
Original Cornell Debentures were reclassified from equity to liabilities. For
the three and six months ended June 30, 2006, the Company recorded a gain in
value for derivative financial instruments through the date of repayment of
$201,754 related to the change in fair value of the embedded conversion feature
which is recorded in the accompanying condensed consolidated statement of
operations. As a result of the Cornell Repayment, the value of the embedded
conversion feature was reclassified to additional paid-in capital in February
2006.
After the allocation of value to the embedded conversion feature of the October
Cornell Debenture the Company allocated the remaining $873,376 principal amount
of the total $1,658,160 October Cornell Debenture based on the computed relative
fair values of the debt and warrant components, which resulted in additional
debt discounts of $210,665. As a result of the Cornell Repayment, the remaining
unamortized debt discounts were amortized as of the date of the Cornell
Repayment. Accordingly, $1,045,678 of amortization expense related to discount
on the October Cornell Debentures was recorded in the accompanying condensed
consolidated statement of operations during the three and six months ended June
30, 2006.
As part of the Cornell Repayment, the Company paid an early redemption premium
charge of $248,724, calculated based on 15% of the principal amount redeemed,
which is included in Debt extinguishment costs on the accompanying condensed
consolidated statement of operations for the three and six months ended June 30,
2006. In connection with the Cornell Repayment, the Company also agreed to
reduce the exercise price of the 560,000 warrants previously issued to Cornell
from $0.50 to $0.40. The change in exercise price of the warrants was treated as
a new issuance of warrants and was valued using the Black Scholes option-pricing
model with the following assumptions: (1) common stock fair value of $0.95 per
share, (2) expected volatility of 71.26%, (3) risk-free interest rate of 4.62%,
(4) life of 2.71 years and (5) no dividend. The change in exercise price
resulted in a fair value of $372,353 for the warrants which was charged to debt
extinguishment costs on the accompanying condensed consolidated statement of
operations for the three and six months ended June 30, 2006.
The Company and Cornell entered into a Registration Rights Agreement (the
"Cornell Registration Rights") related to the October Cornell Debenture. As a
result of the Cornell Repayment, the Company's obligations under the Cornell
Registration Rights were terminated.
LAURUS CONVERTIBLE AND NON CONVERTIBLE FINANCINGS
On February 14, 2006, the Company entered into a Security Agreement, dated
February 10, 2006 with Laurus Master Fund, Ltd ("Laurus"). Under the Security
Agreement, Laurus purchased from the Company a Secured Convertible Note (the
"Laurus Convertible Note"), with a maturity date of February 10, 2009, in the
aggregate principal amount of $1,500,000 and a Secured Non-Convertible Revolving
Note (the "Laurus Revolving Note"), in the aggregate principal amount of
$1,500,000. The Laurus Convertible Note and the Laurus Revolving Note are
collectively the "Laurus Notes". The Company's ability to receive financing
under the Laurus Notes is based on an advance rate equal to 90% of eligible
accounts receivable, as defined. However, Laurus has agreed to provide the
Company an over advance until July 30, 2007. Through June 30, 2006 $1,500,000
was advanced for the Laurus Convertible Note and $1,028,000 was advanced for the
Laurus Revolving Note.
16
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Laurus Convertible Note has a three-year term, and bears interest at 1%
above the prime rate, with a minimum interest rate of 8%. Laurus has the option,
at any time until February 9, 2009 to convert all or any portion of the Laurus
Convertible Note and accrued interest into shares of the Company's common stock
at a conversion price of $0.91 per share. The Company has the option, to repay
the Laurus Convertible Note by paying Laurus the principal amount, accrued
interest and a certain redemption premium, as defined.
The Laurus Revolving Note has a three-year term and bears interest at 1% above
the prime rate, with a minimum interest rate of 8%.
In connection with the Laurus Notes, the Company issued to Laurus an option (the
"Laurus Option") to purchase up to 4,256,550 shares of the Company's common
stock at an exercise price of $0.001 per share. Additionally, the Company and
Laurus entered into a registration rights agreement (the " Laurus Registration
Rights Agreement") covering the registration of common stock underlying the
Laurus Convertible Note and the Laurus Option.
The Company's obligations under the Laurus Notes are secured by first liens on
all assets of the Company, and Laurus may accelerate all obligations under the
Laurus Notes upon an event of default.
The Company allocated the $1,500,000 of proceeds from the Laurus Convertible
Note based on the computed relative fair values of the debt and stock
instruments issued. The Laurus Options were valued using a Black-Scholes
option-pricing model with the following assumptions: (1) common stock fair value
of $0.95 per share (2) expected volatility of 71.26%, (3) risk-free interest
rate of 4.59%, (4) life of 10 years and (5) no dividend, which resulted in a
fair value of $2,569,546 for the Laurus Options. The resulting relative fair
value of the Laurus Options was $918,923. Accordingly, the resulting relative
fair value allocated to the debt component of $511,577 was used to measure the
intrinsic value of the embedded conversion option of $1,054,357 which resulted
in a beneficial conversion feature of $511,577 recorded to additional paid-in
capital. The aggregate amounts allocated to the Laurus Options and beneficial
conversion feature, of $1,430,500 were recorded as a debt discount at the date
of issuance of the Laurus Convertible Notes and are being amortized to interest
expense using the interest method over the three-year term. For the three and
six months ended June 30, 2006, $124,544 and $191,606 respectively of
amortization expense was recorded in the accompanying condensed consolidated
statement of operations.
The Company allocated the $1,028,000 of proceeds from the Laurus Revolving Note
based on the computed relative fair values of the debt and Laurus Options. The
Laurus Options were valued using a Black-Scholes option-pricing model with the
following assumptions: (1) common stock fair value of $0.95 per share (2)
expected volatility of 71.26%, (3) risk-free interest rate of 4.59%, (4) life of
10 years and (5) no dividend, which resulted in a fair value of $1,471,494 for
the options. The resulting relative fair value of the Laurus Options was
$513,820. Accordingly, the resulting relative fair value allocated to the debt
component was $275,680. The aggregate amount allocated to the options of
$513,820 was recorded as a debt discount at the date of issuance of the Laurus
Notes and are being amortized to interest expense using the interest method
three-year term.
Transaction fees of $139,000 paid to Laurus and its affiliates in connection
with the Laurus Notes were netted against the proceeds and considered in the
calculation of the beneficial conversion feature. Financing costs of $20,696
paid to third parties associated with the Laurus Notes are included as debt
issuance costs in other assets and amortized over the term of the debt.
The Company utilized approximately $1.9 million of the initial borrowing from
Laurus to repay all amounts owed under the October Cornell Debenture.
NOTE 7. STOCKHOLDERS' EQUITY
COMMON STOCK
The Company issued 50,000 shares of common stock to Macrocom in January 2006 in
settlement of accrued interest of $25,000 for the Macrocom Bridge Loan II due on
October 10, 2006.
In January 2006, the Company issued 10,526 shares to a vendor to offset
outstanding trade payables of $10,000.
In May 2006, the Company entered into a consulting agreement with an
unaffiliated entity that agreed to provide new technology acquisition services
to the Company. Pursuant to the agreement, the Company issued the consultant
160,000 shares of its common stock that vest over the one year term of the
agreement. The fair value of the vested shares is charged to operations as
consulting expense. For the three and six months ended June 30, 2006 $4,667 was
charged to operations.
17
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONTRACT TERMINATION
In January 2006, the Company and a consultant to the Company terminated a
services arrangement whereby the consultant was to provide services to the
Company over a certain future period. In connection with the termination of this
arrangement, an individual who is an officer, director and stockholder of the
Company transferred one million shares of the Company's common stock owned by
the officer, director and stockholder into escrow. The shares will be held in
escrow for a period of up to five years during which the consultant will have
the option to purchase the shares for an aggregate of $10,000 or $0.01 per
share. As a result, the consultant released the Company from all liabilities.
The Company has accounted for the settlement as an expense in the Company's
financial statements as a non-cash charge for dispute settlements based on the
value of the option of $0.94 per share on the date of settlement, with a
corresponding credit to contributed (paid-in) capital from the officer, director
and stockholder during the three months ended March 31, 2006. The option was
valued using a Black-Scholes option-pricing model with the following
assumptions: (1) common stock fair value of $0.95 per share, (2) expected
volatility of 71.26%, (3) risk-free interest rate of 4.59%, (4) life of 5 years
and (5) no dividend, which resulted in a fair value of $942,070.
EXCHANGE AGREEMENT AMENDMENT
During January and February 2006, the former shareholders of UCA Services with
whom the Company had entered into an Exchange Agreement related to the purchase
of UCA Services (See Note 5) and the Company entered into negotiations related
to a dispute over compliance with the provisions of the Exchange Agreement.
In connection with the discussions, the Company and the former UCA shareholders
entered into an Amendment to the Exchange Agreement ("Exchange Amendment") which
was executed in February 2006. The Exchange Amendment provides that an
individual who is an officer, director and stockholder of the Company transfer
9,000,000 shares (fair value of approximately $8,500,000) of the Company's
common stock owned by such individual to the former shareholders of UCA. This
arrangement was structured whereby the individual surrendered his shares to the
Company, and the Company reissued such shares to former UCA shareholders.
Since the settlement was not a contingency associated with the acquisition of
UCA Services, the Company accounted for the shares transferred by the
individuals as an expense, based on the value of the shares, in the Company's
consolidated financial statements with a corresponding credit to contributed
(paid-in) capital by the individual during the three months ended March 31,
2006. Management determined the fair value of the shares issued based on the
quoted market price of the Company's common stock on the date of settlement.
OTHER SECURITIES
Outstanding warrant and option securities issued in connection with financings
consist of the following at June 30, 2006 and December 31, 2005:
June 30, 2006
----------------------------------------------------
Warrants Exercise Price Expiration
---------- ---------------- ----------------------
Laurus 4,256,550 $ 0.001 n/a
Macrocom warrants 2,000,000 $ 0.75 12/9/2006
Macrocom warrants 1,000,000 $ 1.50 7/19/2008
Cornell warrants 560,000 $ 0.50 10/27/2008
Officer and directors warrants,
including former officers
and directors 664,805 $0.50 to $1.50 12/3/2008 to 12/8/2008
other 2,213,832 $0.01 to $0.50 1/1/2009 to 6/14/2009
----------
10,695,187
==========
18
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
----------------------------------------------------
Warrants Exercise Price Expiration
---------- -------------- ----------------------
Macrocom warrants 2,000,000 $ 0.75 12/9/2006
Macrocom warrants 1,000,000 $ 1.50 7/19/2008
Cornell warrants 560,000 $ 0.50 10/27/2008
Officer and director warrants,
including former officers
and directors 664,805 $0.50 to $1.50 12/3/2008 to 12/8/2008
other 988,832 $ 0.50 1/1/2009 to 1/29/2009
----------
5,213,637
==========
Since the conversion of the October Cornell Debenture could result in a
conversion into an indeterminable number of common shares, in October 2005 the
Company determined that under the guidance of EITF 00-19, the Company could not
conclude that it had sufficient authorized and unissued shares to settle any
warrants or options issued to non-employees. Therefore in October 2005, the
Company reclassified the fair value of all warrants and options issued to
non-employees that were outstanding as of October 27, 2005 from equity to
liabilities. The fair value of the Company's warrants and options issued to
non-employees was estimated at approximately $3,065,000 on October 27, 2005
using a Black-Scholes option pricing model for each of the individual
securities. As a result, the Company incurred a charge of approximately
$2,035,000 on October 27, 2005, which was computed based on the difference
between the fair value of the securities and the value of the securities as of
October 27, 2005 which had previously been recorded to additional paid-in
capital. On December 31, 2005, the fair value of the warrants and options issued
to non-employees was re-measured and estimated at $2,940,000 using a
Black-Scholes option pricing model for each of the individual securities. For
the three months ended March 31, 2006, the Company recorded a gain of $336,352
on derivative financial instruments related to the change in the fair value of
the warrants through the repayment date. The liability for warrants and options
issued to non-employees was reclassified to additional paid-in capital upon the
Cornell Repayment in February 2006, which terminated Cornell's conversion
rights.
In June 2006, the Company entered into a consulting agreement with an
unaffiliated entity that agreed to provide investment banking services to the
Company. Pursuant to the agreement, the Company issued the consultant warrants
to acquire 625,000 share of its common stock at $0.82 per share that vest over
the term specified in the agreement. The warrants expire five years from the
date of issuance. The fair value of the vested warrants is being charged to
operations as consulting expense. For the three months ended June 30, 2006,
$12,616 was charged to operations for such services.
NOTE 8. STOCK-BASED COMPENSATION
As a result of the Share Exchange on March 3, 2005, the Board of Directors
adopted the 2005 Stock Option and Grant Plan (the "Plan"). The purpose of the
Plan is to encourage and enable the employees, directors and consultants of the
Company upon whose judgment, initiative and efforts the Company largely depends
for the successful conduct of its business to acquire a proprietary interest in
the Company. The Plan became effective on April 19, 2005 and was authorized with
9,000,000 shares of the Company's common stock.
From time to time, the Company issues stock-based compensation to its officers,
directors, employees and consultants. The maximum term of options granted is
generally 10 years and generally options vest over a period of one to four
years. However, the Board of Directors of the Company may and has approved other
vesting schedules. The Company has issued options to employees and non-employees
under stock option agreements. Options may be exercised in whole or in part.
The exercise price of stock options granted is generally the fair market value
of the Company's common stock as determined by the Board of Directors on the
date of grant.
19
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the Company's stock option activity for the six
months ended June 30, 2006:
Weighted Average Aggregate
Options Exercise Price Intrinsic Value
---------- ---------------- ---------------
Outstanding, December 31, 2005 3,869,010 0.63
Options granted 125,000 0.75
Options exercised --
Options cancelled (618,925) 1.57
---------- ---------------- ---------------
Outstanding, June 30, 2006 3,375,085 0.47 $ 1,190,025
========== ================ ===============
Exercisable, June 30, 2006 2,668,851 $ 0.39 $ 734,572
========== ================ ===============
The options outstanding at June 30, 2006 have a weighted average remaining
contractual life of approximately 7.9 years. The options exercisable at June 30,
2006 have a weighted average remaining contractual life of approximately 7.7
years. No options have been exercised to date.
The fair value of the options granted during the three and six months ended June
30, 2006 was estimated as of the date of the grant using the Black Scholes
option pricing model, based on the following weighted average assumptions: (1)
common stock fair value of $0.75 per share (2) expected volatility of 71.26%,
(3) risk-free interest rate of 4.92%, (4) life of 5 years and (5) no dividend.
NOTE 9. RELATED PARTY TRANSACTIONS
Loans and advances payable to stockholders and directors on the accompanying
condensed consolidated balance sheet at June 30, 2006 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 financings arrangements.
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
Global's office facility. Rent and occupancy expenses incurred by the Company
under this agreement, which commenced on May 20, 2005, were $31,875 and $63,750
during the three and six months ended June 30, 2006, respectively, and $6,114
during the three and six months ended June 30, 2005, and are included in
selling, general and administrative expenses.
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 Systems and the Company. For the six months ended June
30, 2006, the Company has not provided any services to Systems.
20
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the normal course of business, the Company performs services for an entity
affiliated with certain significant stockholders. The Company charged
approximately $13,000 and $63,000 for such services during the three and six
months ended June 30, 2006, respectively. At June 30, 2006, approximately
$227,000 was owed to the Company, including amounts owed to UCA Services prior
to the acquisition.
NOTE 10. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
For the Six Months ended June 30,
---------------------------------
2006 2005
-------------- --------------
Settlement of bridge loan with common stock $ 500,000 $ 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 revolving note relating to warrants $ 513,820 $ --
Discount on convertible note relating to warrants $ 918,923 $ --
Discount on convertible debt relating to beneficial
conversion feature $ 511,577 $ 67,500
Issuance of common shares in connection with settlement of $ 35,000 $ --
payables
Discount on convertible debenture due to officer relating to
common stock $ 30,000 $ --
Discount on convertible debenture due to a stockholder
relating to common stock $ 61,765 $ --
Discount on convertible debenture due to a stockholder
relating to beneficial conversion feature $ 16,765 $ --
Discount on April 2006 Debentures relating to common stock $ 103,272 $ --
Discount on April 2006 Debentures relating to warrants $ 90,739 $ --
Discount on April 2006 Debentures relating to beneficial
conversion feature $ 305,990 $ --
Discount on April 2006 Debentures extension relating to
warrants $ 99,107 $ --
Discount on April 2006 Debentures extension relating to
common stock $ 38,094 $ --
Conversion of convertible debenture issued to officer with
common stock $ 50,000 $ --
NOTE 12. SUBSEQUENT EVENTS
On August 11, 2006 the Company entered into an Agreement and Plan of Acquisition
("Agreement") with Intrusion Detection Technologies, Inc. ("IDTI") and Utek
Corporation ("UTEK"). Pursuant to the Agreement, the Company acquired all the
issued and outstanding shares of IDTI from UTEK in exchange for 7,500,000
restricted shares of the Company's common stock. IDTI holds a license from a
university for software technology that has the potential of allowing binary
programs to be encrypted and making them difficult to comprehend by an
adversary. The term of the licensing agreement is until the later of 15 years
from the date of filing of the licensed Patents or the expiration of the last to
expire patent of the licensed Patents. IDTI will pay the university a royalty in
an amount equal to five percent of the net sales of licensed products. In
connection with the transaction, the Company paid a consultant $50,000 of cash
and issued 750,000 shares of its common stock for services rendered.
21
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of our financial condition and plan of
operation should be read in conjunction with the consolidated financial
statements and accompanying notes and the other financial information appearing
elsewhere in this report and reports included herein by reference. The following
discussion contains forward-looking statements that reflect our plans, estimates
and beliefs. Our actual results could differ materially from those discussed in
the forward-looking statements.
Our independent registered public accounting firm has indicated in their report
dated April 17, 2006 on our December 31, 2005 financial statements that we had
net losses from inception and have a working capital deficiency. The report
indicates that these matters raise substantial doubt about our ability to
continue as a going concern. Our 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. ("Holdings" "our", "we" or the "Company") were formerly
known as Houston Operating Company and were incorporated in Delaware in August
of 1989. On December 9, 2004, we entered into an Acquisition Agreement with all
of the stockholders of NetFabric Corp ("the "Acquisition agreement"). At the
closing, which occurred at the same time as the execution of the Acquisition
Agreement, we acquired all of the issued and outstanding capital stock of
NetFabric Corp. from the stockholders in exchange for an aggregate of 32,137,032
newly-issued shares of our common stock. The acquisition was accounted for as a
reverse merger whereby NetFabric Corp. was treated as the acquirer. NetFabric
Corp. was incorporated in the State of Delaware on December 17, 2002, as a new
corporation. On April 19, 2005, our name was changed from Houston Operating
Company to NetFabric Holdings, Inc. and our stock symbol was changed from "HOOC"
to "NFBH."
UCA SERVICES, INC. ACQUISITION
On May 20, 2005, we entered into and closed on a share exchange agreement,
whereby we 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 our common stock. UCA is an IT services and solutions company that
serves the information needs of a wide range of Fortune 500 clients in the
financial markets industry as well as the pharmaceutical, health care and
hospitality sectors. UCA delivers a broad range of IT services in managed
services, professional services, infrastructure builds and maintenance and
application development and maintenance areas.
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.
DISCONTINUED OPERATIONS
Prior to acquiring NetFabric Corp., Houston Operating Company did not have any
operations, and we were a shell company whose primary business objective was to
merge and become public. NetFabric Corp., a Delaware corporation incorporated on
December 17, 2002, began operations in July 2003. NetFabric Corp. was a provider
of hardware and services to small to mid-sized businesses ("SMBs") that utilized
the Internet for telephone communications or Voice over Internet Protocol
("VoIP"). It developed and marketed appliances or Customer Premises Equipment
("CPE") that simplified the integration of standard telephone systems with an IP
infrastructure. In addition, it resold transport services of a third party VoIP
transport provider. Our operations, prior to the UCA acquisition, consisted of
developing VoIP appliances, including research and product development
activities. We also hired additional personnel for sales and marketing and
developed our sales and marketing programs.
Our revenues from VoIP operations were minimal. We have concluded that we cannot
implement our original business for VoIP operations within resources we have or
with the additional capital we can raise in the near term. On May 3, 2006, our
Board of Directors decided to exit from the hardware-based VoIP communications
product line (including resale of transport services) that is targeted to SMBs.
In accordance with Statement of Financial Accounting Standards No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets", ("SFAS No.
144"), the results of operations from its VoIP business segment has been
reclassified as discontinued operations for all periods presented. Discontinued
operations as discussed in more detail in note 3 to the condensed consolidated
financial statements. After the discontinuation of VoIP operations, our only
operations are that of UCA's.
OVERVIEW
UCA derives revenues primarily from managed IT services, professional 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. UCA's principal operating
expenses are direct employee costs and consultant expenses and selling, general
and administrative expenses. Direct employee cost and consultant expenses are
comprised primarily of the costs of consultant labor, including employees,
subcontractors and independent contractors, and related employee benefits.
Approximately 50% of our consultants are employees and the remainder are
subcontractors and independent contractors.
22
We compensate most of our consultants only for the hours that we bill to our
clients for projects undertaken, which allows us to better match our labor costs
with our revenue generation. With respect to our consultant employees, we are
responsible for employment-related taxes, medical and health care costs and
workers' compensation. Labor costs are sensitive to shifts in the supply and
demand of IT professionals, as well as increases in the costs of benefits and
taxes. The principal components of selling, general and administrative expenses
are salaries of sales and support personnel, and office rent.
As previously noted, the December 9, 2004 acquisition was accounted for as a
reverse merger whereby NetFabric Corp. was treated as the acquirer. Accordingly,
the historical financial statements of NetFabric Corp. have been presented for
all periods required. NetFabric Corp. began operations in January 2003 and was a
development stage company until the UCA acquisition. The UCA acquisition was
accounted for 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.
COMPARISON OF THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005:
Revenues. Revenues for the three and six months ended June 30, 2006, increased
by $2,026,628 or 89.1% and by $ 6,125,074 or 269.4%, respectively, compared to
the same periods of the prior year. This increase due to the UCA acquisition. We
anticipate that our revenues will increase for fiscal year 2006 due to the full
year impact of the UCA acquisition. For the three and six months ended June 30,
2006, on a pro forma basis, UCA had revenues of $4,980,848 and $9,154,682 ,
respectively. For the three and six months ended June 30, 2006 revenues
decreased by 14% and 8%, respectively, compared to pro forma 2005 revenues due
to non replacement of certain one-time projects undertaken in 2005.
Direct employee compensation and consultant expenses. For the three months ended
June30, 2006, our direct employee compensation and consultant expenses increased
by $1,417,247 or 79.6% to $3,198,055. . For the six months ended June30, 2006,
our direct employee compensation and consultant expenses increased by $4,414,350
or 247.9% to $6,195,158. The increases were due to increased revenues resulting
from the UCA acquisition. We anticipate direct employee compensation and
consultant expenses to increase for fiscal year 2006 in line with the
anticipated increase in our revenues.
Selling, general and administrative expenses. Our selling, general and
administrative expenses increased for the three months ended June 30, 2006 by
$697,292 or 89.9% to $1,472,958. For the six months ended June 30, 2006, our
selling, general and administrative expenses increased by $2,118,351 or 273.1%
to $2,894,017. The increases were due to the UCA acquisition.
Amortization of debt discount. Amortization of debt discount for the three
months ended June 30, 2006 increased by $651,428 or 492.2% to $783,781. For the
six months ended June 30, 2006 amortization of debt discount increased by
$1,882,202 or 531.4% to $2,236,428. The increases were due to the amortization
of debt discount resulting from the allocation of value to certain equity
instruments issued in connection with debt issued in 2006 and 2005. At June 30,
2006 the aggregate unamortized debt discount was $2,026,717, which will be
amortized and charged to operations over the term of the respective debt.
Depreciation and amortization. For the three months ended June 30, 2006
depreciation and amortization increased by $34,351 or 90.6% to $72,259. For the
six months ended June 30, 2006, depreciation and amortization increased by
$104,519 or 275.7% to $142,427. The increases were due to additional assets
arising from the UCA acquisition.
Interest expense. For the three and six months ended June 30, 2006 interest
expense increased by $68,010 and $134,291, respectively, due to increased
borrowing levels in 2006.
Derivative Financial Instruments. As a result of the change in the conversion
terms of the October Convertible Debentures on October 27, 2005, we determined
that the embedded conversion feature of the October Cornell Debenture became
subject to the provisions of SFAS No. 133 and therefore we accounted for the
embedded conversion feature as a liability in accordance with the guidance of
EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock"("EITF 00-19"). Accordingly, we
recorded the fair value of the embedded conversion feature of $784,784 as a
non-current liability on its balance sheet as of October 27, 2005 and a portion
of the amounts previously recorded to additional paid-in capital as part of the
Original Cornell Debentures were reclassified from equity to liabilities. For
the three months ended March 31, 2006 we recorded a gain in value for derivative
financial instruments of $336,352 related to the change in fair value of the
embedded conversion feature which is recorded in the accompanying condensed
consolidated statement of operations. As a result of the Cornell Repayment, the
value of the embedded conversion future was reclassified to additional paid-in
capital.
23
Debt extinguishment costs. As part of the Cornell Repayment we paid an early
redemption charge of 15% of the principal amount redeemed or $248,724 which
charge is included on the accompanying statement for operations for the six
months ended June 30, 2006. In connection with the Cornell repayment we also
agreed to reduce the exercise price of the 560,000 warrants from $0.50 to $0.40.
The change in exercise price of the warrants was treated as a new issuance of
warrants and was valued using the Black Scholes option-pricing model. The
reduction in exercise price resulted in a fair value of $372,353 for the
warrants, which was charged to operations for the six months ended June 30,
2006.
On May 24, 2006 the Company entered into a Waiver and Agreement to Convert
("Agreement") with Macrocom Investors LLC ("Macrocom"). Pursuant to the
Agreement, Macrocom agreed immediately to convert a note issued by the Company
in the principal amount of $500,000 and due on October 10, 2006, including all
interest accrued thereon, into one million shares of restricted common stock of
the Company. In addition, Macrocom and the Company agreed to waive and release
each other from any claims in connection with the Note and all other agreements
executed to date between Macrocom and the Company. In exchange for the waiver
and the early conversion, the Company agreed to issue to Macrocom one million
and five hundred thousand shares additional shares of restricted common stock.
The fair value of the additional consideration was $1,125,000 and the amount was
charged to operations during the three months ended June 30, 2006 as debt
repayment/ conversion costs.
Non cash charge for dispute settlement. In January 2006, we entered into a
termination agreement with a consultant. In connection with the termination, an
individual who is our officer, director and stockholder transferred on 1,000,000
shares of our common stock to the benefit of the consultant. We accounted for
the settlement expense, based on the value of the shares of our shares on the
settlement date ($0.95) during the six months ended June 30, 2006. In February
2006, we entered into an amendment agreement with the former UCA shareholders.
Pursuant to the amendment agreement, an individual who was our officer, director
and stockholder transferred 9,000,000 shares of our common stock owned by him to
the former UCA shareholders. Since the settlement was not a contingency
associated with the acquisition of UCA Services, we accounted for the shares
transferred by the individual as an expense, based on the value of the shares,
during the six months ended June 30, 2006.
.. Discontinued Operations n May 3, 2006, our Board of Directors decided to exit
from the hardware-based VoIP communications product line (including resale of
transport services) that is targeted to SMBs. In accordance with Statement of
Financial Accounting Standards No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets", ("SFAS No. 144"), the results of operations from
its VoIP business segment has been reclassified as discontinued operations for
all periods presented. For the three months ended June 30, 2006, loss from
discontinued operations decreased by $402,394 or 63.2% to $234,269 and for the
six months ended June 30, 2006, loss from discontinued operations decreased by
$937,898 or 66.4%. The decreases were due to our scaling back of VoIP operations
in 2006. Revenues from VoIP operations have been nominal in all periods
presented and operating expenses are the losses reported.
Net loss. As a result of the foregoing, for the three months June 30, 2006, net
loss increased by $1,623,000 or 141.6% to a loss of $2,769,102, compared to a
net loss of $1,146,102 in the three months ended June 30, 2006. For the six
months ended June 30, 2006, net loss increased by $12,641,389 to net a loss of
$14,795,421 compared to a net loss of $2,154,032 in the six months ended June
30, 2006.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2006, our working capital deficiency was $3,149,814 compared to a
working capital deficiency of $2,176,606 at December 31, 2005. The increase in
the working capital deficiency was principally due to operating losses. During
the six months ended June 30, 2006, our operating activities from continuing
operations provided cash of approximately $193,000 compared to approximately
$215,000 provided during the six months ended June 30, 2005.
During the six months ended June 30, 2006, our operating losses, after adjusting
non cash items utilized approximately $1,024,000 of cash, and working capital
items provided approximately $1,217,000 of cash. The principal component of
working capital was a decrease in our accounts receivables and increase of
deferred revenue or customer advance. During the six months ended June 30, 2005,
our operating losses after adjusting for non cash items utilized approximately
$317,000 of cash and working capital items provided approximately $532,000 of
cash.
Pursuant to a financing commitment, in two separate closings in January and
March 2005, we sold 1,000,000 shares of common stock to Macrocom Investors,
LLC.("Macrocom") and 1,000,000 shares of common stock to Michael Millon,
resulting in aggregate proceeds of $1,000,000 for $0.50 per share. Additionally,
under this arrangement, Macrocom received warrants to purchase 2,000,000 shares
of common stock at a purchase price of $1,500,000. The warrants expire in
December 2006. We also issued 250,000 shares to Michael Millon as consideration
for arranging the Macrocom financing.
In February 2006, we repaid $ 70,000 owed to Fred Nazem, a stockholder of the
Company and $200,000 owed to Fahad Syed, an officer and director of the Company.
In addition, we repaid $100,000 due to Faisal Syed, a stockholder of the
Company. Prior to our acquisition of UCA, UCA issued a promissory note to Faisal
Syed for $100,000. The note bore interest at the rate of 6%. The promissory note
together with accrued but unpaid interest, was due in June 2005.
24
In February 2006, we along with our subsidiaries, entered into a Security
Agreement, dated February 10, 2006 ( the `Security Agreement")with Laurus Master
Fund, Ltd., a Cayman Islands company ("Laurus"). Under the Security Agreement,
Laurus purchased us a Secured Convertible Note, with a maturity date of February
10, 2009, in the aggregate principal amount of $1,500,000 and a Secured
Non-Convertible Revolving Note (the "Revolver") in the aggregate principal
amount of $1,500,000. Availability under the notes is based on an advance rate
equal to 90% of eligible accounts receivable, and Laurus has agreed to provide
us an over advance for a specified period. The Secured Convertible Note has a
three-year term, and bears interest at 1% above the prime rate, with a minimum
interest rate of 8%. Laurus shall have the option, but not the obligation, at
any time until the maturity date, to convert all or any portion of the Secured
Convertible Note and accrued interest into shares of our common stock at an
exercise price of $0.91 per share. If converted in full we would be obligated to
issue an aggregate of 1,648,352 shares of our common stock. We have the option,
to prepay the Secured Convertible Note by paying Laurus the applicable
redemption premium. The Revolver has a three-year term, and bears interest at 1%
above the prime rate, with a minimum interest rate of 8%.
In connection with the borrowing, we issued to Laurus a common stock purchase
option ("Option") to purchase up to 4,256,550 shares of our common stock for
nominal consideration. Additionally, we entered into a registration rights
agreement ("Registration Rights Agreement"), covering the registration of common
stock underlying the Secured Convertible Note and the Option. Our obligations
under the Secured Convertible Note and the Revolver are secured by first liens
on all of our assets, and Laurus may accelerate all obligations under the notes
upon an event of default.
25
Our initial borrowing was approximately $2,300,000 and we utilized approximately
$1,900,000 of the initial borrowing to repay all amounts owed to Cornell
pursuant to a Secured Convertible Debenture, including an applicable redemption
premium. At June 30, 2006, our availability and aggregate borrowings with Laurus
was approximately $2,500,000 (face amount).
On April 19, 2006, we sold Convertible Debentures (the "April 2006 Debentures")
in the face amount of $500,000 to five individuals including $150,000 face value
to Fahad Syed, an officer and director, and $50,000 face value to Fred Nazem, a
stockholder. The Debentures bear interest at 8% and were due on June 17, 2006.
At the option of the Debenture holder, the Debentures can be converted into
shares of our common stock at a conversion price of $.50 per share. In
connection with the sale, we issued two individuals warrants to acquire an
aggregate of 200,000 shares of its common stock with a nominal exercise price.
The warrants expire in three years from the date of issuance. For the other
three individuals, we issued an aggregate of 225,000 shares of our common stock
as additional consideration. For the three individuals, the Company has agreed
to place 3,000,000 shares of its common stock as collateral with an escrow
agent. There will not be any collateral for the Debentures issued to Fahad Syed
and Fred Nazem. We used the proceeds from the sale of the Debentures to repay
$500,000 due to Macrocom pursuant to Macrocom Convertible Debenture issued in
July of 2005.
On May 24, 2006 Macrocom converted a note issued by the Company in the principal
amount of $500,000 and due on October 10, 2006, including all interest accrued
thereon, into 2.5 million shares ( 1 million shares pursuant to initial
agreement and 1.5 million pursuant to waiver and agreement to convert) of
restricted common stock of the Company.
In June 2006, we and the holders of the April 2006 Debentures entered into an
agreement to extend the term of the debentures to September 15, 2006. In
exchange for the extension, we issued to the holders an aggregate of 150,000
shares of its common stock and warrants to acquire an aggregate of 400,000
shares of its common stock with a nominal exercise price. The warrants expire in
three years from the date of issuance.
In April 2006, Fred Nazem, a stockholder, converted a convertible debenture
issued to him in July 2005 to 100,000 shares of our common stock. We also
extended the maturity of another convertible debenture in the face amount of
$50,000 to September 15, 2006 and we issued 100,000 shares of our common stock
to the debenture holder as additional consideration.
On June 8, 2006, we sold a Convertible Debenture (the "Stockholder Convertible
Debentures") in the face amount of $150,000 to Fred Nazem, a stockholder. The
Debentures bear interest at 8% and are due on August 4, 2006. At the option of
the Debenture holder, the Debentures can be converted into shares of our common
stock at a conversion price of $.50 per share. In connection with the sale, we
issued 300,000 shares of its common stock as additional consideration.
Currently, we are in negotiation with the stockholder to extend the due date of
the debenture.
For continued growth, we need capital for both technology investments and
working capital. Technology investments will improve our consultants with new
skills thereby enabling us to obtain additional projects from our existing
customers and from new customers. We can accomplish this either through
investment and strategic partnership with new software companies or through
hiring consultants and paying for their bench time until we obtain projects
where they can be placed on a billable basis. We are in discussion with new
software companies and anticipate such an investment to amount to approximately
$500,000 in 2006. However, we have not finalized any agreement and there is no
assurance that we will finalize any agreement and invest additional amounts.
Working capital requirements are principally for additional receivables that
need to be supported by an increased revenue base resulting from anticipated
growth. We believe that the Revolver with Laurus will provide us the necessary
working capital required for the accounts receivable growth.
On August 11, 2006 we entered into an Agreement and Plan of Acquisition
("Agreement") with Intrusion Detection Technologies, Inc. ("IDTI") and Utek
Corporation ("UTEK"). Pursuant to Agreement, we acquired all the issued and
outstanding shares of IDTI from UTEK in exchange for 7,500,000 restricted shares
of the Company's common stock. IDTI holds a license from a university for
software technology that has the potential of allowing binary programs to be
encrypted and making them difficult to comprehend by an adversary. The term of
the licensing agreement is until the later of 15 years from the date of filing
of the Licensed Patents or the expiration of the last to expire patent of the
Licensed Patents. IDTI will pay the university a royalty in an amount equal to
five percent of the net sales of licensed products.
We anticipate our recurring capital expenses for 2006 to range between $50,000
and $100,000 including for additional software applications to support our back
office functions that we have identified. In order to execute our business plan
and achieve our objectives for the near future, management believes it will
require approximately $2,000,000 over the next 12 months for working capital. A
significant component of this is for satisfying our obligations as they become
due, both borrowing and vendor payables. Our ability to continue as a going
concern and our future success are dependent upon our ability to raise capital
in the near term to satisfy our current obligations. 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. There
is no assurance that the Company will be successful in completing the financing.
The accompanying consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
To fund our operations for the remainder of fiscal year 2006, we need to raise
additional financing and generate cash flows from our operations. Should
additional cash flows not be available, we believe that we would have the
ability to restructure our operations, and if necessary, initiate significant
reductions in expenses. In addition, we will have to negotiate with our lenders
to extend the repayment dates of our indebtedness. There can be no assurance,
however, that we will be able to successfully restructure our operations or debt
obligations in the event we fail to obtain additional financing.
26
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial conditions and results of
operations is based upon our 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 us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, 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. We
base our estimates on historical experience and on various other assumptions
that we believe 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.
We believe the following critical accounting policies affect the judgment and
estimates used in preparation of our consolidated financial statements.
REVENUE RECOGNITION
We derive revenue as a provider of IT services.
In accordance with Securities and Exchange Commission ("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.
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 for fixed-price,
fixed-timeframe services is recognized as the service is performed. Revenue from
fixed-price, fixed-timeframe service contracts is recognized ratably over the
term of the contract, as per the proportional performance method. When we
receive 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our 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. We perform credit evaluations of
our customers' financial condition on a regular basis.
27
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
"Disclosure about Fair Value of Financial Instruments", presented in the
consolidated balance sheets as of June30, 2006 and December 31, 2005 approximate
their carrying amounts.
GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles represent the allocation, pursuant to an
independent appraisal of the cost to acquire UCA Services, in excess of the fair
value of 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. We will perform a goodwill impairment test
annually, as well as when a triggering event indicates impairment may have
occurred. Application of the goodwill impairment test requires significant
judgments including estimation of future cash flows, which is dependent on
internal forecasts, estimation of the long-term rate of growth, the useful life
over which cash flows will occur, and determination of cost of capital. Changes
in these estimates and assumptions could materially affect the determination of
fair value and/or conclusions on goodwill impairment. Intangible assets are
accounted for under the provisions of SFAS No. 142. Intangible assets arise from
business combinations and consist of customer relationships and restricted
covenants related to employment agreements that are amortized, on a
straight-line basis, over periods of up to six years. The Company follows the
impairment provisions and disclosure requirements of SFAS No. 142. Accordingly
intangible assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable.
STOCK-BASED COMPENSATION
Beginning January 1, 2006, we account for stock-based compensation in accordance
with the fair value recognition provisions of SFAS 123R. Under the fair value
recognition provisions of SFAS 123R, share-based compensation cost is measured
at the grant date based on the value of the award and is recognized as expense
over the vesting period. Stock-based compensation expense is calculated using
the Black Scholes option pricing model on the date of grant. This option
valuation model requires input of highly subjective assumptions. These
assumptions include estimating the length of time employees will retain their
vested stock options before exercising them ("expected term"), the estimated
volatility of our common stock price over the expected term, and the number of
options that will ultimately not complete their vesting requirements
("forfeitures"). Changes in these assumptions can materially affect the estimate
of the fair value of employee stock options and consequently, the related amount
of stock-based compensation expense recognized in the condensed consolidated
statements of operations.
28
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
are accumulated and communicated to management, including the Chief Executive
Officer ("CEO") and Chief Financial Officer ("CFO") , 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 CEO and CFO, 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 CEO and CFO
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 during
the most recent fiscal quarter that have materially affected or are reasonably
likely to materially affect our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
NONE
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
During the three months ended June 30, 2006;
The Company issued 100,000 shares of common stock to Fred Nazem, a stockholder,
upon his conversion of a convertible debenture.
The Company issued three individuals an aggregate of 225,000 shares of common
stock, including 37,500 shares to Fred Nazem, a stockholder and 112,500 share to
Fahad Syed, officer and director as additional consideration for borrowing from
them.
The Company issued 2,500,000 shares of common stock to Macrocom Investors, LLC
upon conversion of convertible loan.
The Company issued 250,000 shares of common stock to two holders of convertible
debenture as consideration for extending the due date of the borrowings from
them.
The Company issued 300,000 shares of common stock to Fred Nazem, a stockholder,
as additional consideration for borrowing from him.
The foregoing shares were issued pursuant to exemptions from registration under
Sections 3(a)(9) and 4(2) of the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(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)
29
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: August 21, 2006 By: /s/ Fahad Syed
----------------------------
Fahad Syed
Chairman and Chief
Executive Officer
By: /s/ Vasan Thatham
----------------------------
Vasan Thatham
Principal Financial Officer and
Vice President
30
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, Fahad Syed, 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 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) [Reserved]
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.
August 21, 2006
/s/ Fahad Syed
--------------------------------
Name: Fahad Syed
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) 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) [Reserved]
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.
August 21, 2006
/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 June 30, 2006 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Fahad
Syed Chairman and 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.
August 21, 2006
/s/ Fahad Syed
--------------------------------
Name: Fahad Syed 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 June 30, 2006 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.
August 21, 2006
/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.