UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------------
FORM 10-KSB
(Mark One)
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
for the fiscal year ended December 31, 2006
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission File Number: 0-21419
NETFABRIC HOLDINGS, INC.
(Name of Small Business Issuer in Its Charter)
Delaware 76-0307819
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
Three Stewart Court, Denville, New Jersey 07834
(Address of Principal Executive Offices) (Zip Code)
(973) 887-2785
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Common Stock, $.001 Par Value Over-the-Counter Bulletin Board
Check whether the issuer is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act. |_|
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 |_|
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
State issuer's revenues for its most recent fiscal year. $17,599,303
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked prices of such common
equity, as of a specified date within the past 60 days. $2,231,528 as of March
14, 2007.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. 75,663,883 shares of Common
Stock, $0.001 par value, outstanding as of March 14, 2007.
Transitional Small Business Disclosure Format (Check One): Yes |_| No |X|
PART I
From time to time, including in this annual report on Form 10-KSB, NetFabric
Holdings, Inc. (the "Company", "NetFabric", "our" or "we") may publish
forward-looking statements relating to such matters as anticipated financial
performance, business prospects, future operations, new products, research and
development activities and similar matters. A variety of factors could cause our
actual results to differ materially from the anticipated results or other
expectations expressed in our forward-looking statements. The risks and
uncertainties that may affect the operations, performance, development and
results of our business include, without limitation, the following: general
economic and business conditions, both nationally and in our markets; our
expectations and estimates concerning future financial performance, financing
plans, acquisitions or mergers, and the impact of competition; our ability to
implement our acquisition and growth strategy; anticipated trends in our
business; advances in technologies; and, other risk factors set forth under
"Risk Factors" beginning on page 18 in this report.
ITEM 1. DESCRIPTION OF BUSINESS
We were incorporated in the State of Delaware on August 31, 1989 as Houston
Operating Company. On December 9, 2004, we acquired NetFabric Corporation
("NetFabric Corp.") and on April 19, 2005, we changed our name to NetFabric
Holdings, Inc. On May 20, 2005, we acquired UCA Services, Inc ("UCA").
We are now organized into two distinct divisions. NetFabric Holdings, Inc. is
the holding company that houses the finance and administrative functions and is
responsible for financing transactions and regulatory compliance activities. UCA
provides IT services and solutions to a wide range of clients in the financial
industry as well as the pharmaceutical, healthcare and hospitality sectors.
NetFabric Corp. Acquisition
On December 9, 2004, we entered into an acquisition agreement (the "Acquisition
Agreement") with all of the stockholders of NetFabric Corp. At the closing,
which occurred simultaneously with 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
and not as a result of a material reclassification, merger, consolidation,
purchase or divesture.
Prior to our acquisition of NetFabric Corp., we did not have any operations, and
we were a shell company whose primary business objective was to merge and become
public. Immediately prior to the NetFabric Corp. acquisition, our directors were
Wesley F. Whiting and Redgie Green. Our officers were, Wesley F. Whiting -
President and Redgie Green - Secretary. The directors of NetFabric Corp. were
Jeff Robinson (Chairman), Richard Howard and Charlotte Denenberg. The officers
of NetFabric Corp. were, Jeff Robinson - Chief Executive Officer, Walter Carozza
- - Chief Financial Officer, Philip Barak - Vice President of Finance, and
Victoria Desidero - Vice President of Marketing.
UCA 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 from its
shareholders in exchange for the issuance of 24,096,154 shares of our common
stock.
On February 13, 2006, we entered into an agreement with UCA to amend the terms
of the share exchange agreement between the Company and the UCA shareholders,
dated May 20, 2005. Pursuant to the amendment, we issued an aggregate of nine
million shares of our common stock to the former shareholders of UCA. In return,
the former shareholders of UCA released the Company from the capital raising
covenant of the share exchange agreement. To facilitate the transaction, Mr.
Jeff Robinson, our Chief Executive Officer, surrendered nine million shares of
our common stock owned by him.
2
Discontinued Operations
NetFabric Corp. provided hardware and services to small to mid-sized businesses
("SMBs") that utilized the Internet for telephone communications or Voice over
Internet Protocol ("VoIP"). NetFabric Corp. developed and marketed appliances,
or Customer Premises Equipment ("CPE") that simplified the integration of
standard telephone systems with an IP infrastructure. With minimal revenues from
VoIP operations, we concluded that we could not implement our original business
for VoIP operations within our resources or with the additional capital we could
raise in the near term. On May 5, 2006, our Board of Directors decided that the
Company should exit from the hardware-based VoIP communications product line
(including resale of transport services) targeted at 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 the VoIP business segment have been reclassified as discontinued
operations for all periods presented. After the discontinuation of VoIP
operations, our only operations are that of UCA, which are discussed in more
detail in Item 6 below.
Our Services
We serve the information and communications needs of a wide range of Fortune 500
and SMB clients in the financial markets industry, as well as the
pharmaceutical, health care and hospitality sectors. Our broad range of services
include (i) Managed Services (ii) Professional Services (iii) IT Infrastructure
& Communications Services and Maintenance, and (iv) Application Development and
Maintenance.
Managed Services
In Managed Services, we serve clients seeking to outsource management of some or
all of their IT applications. As a result, their internal management and staff
are able to focus on projects that create and foster initiatives leading to a
competitive advantage for their company. Our services in this area include data
center services, help desk and facilities management. We also provide a fully
managed suite for storage management, information protection (backup and
recovery) and information optimization (archival services) from the data center
to the desktop.
Professional Services
We provide a wide range of IT staffing services to clients in diversified
vertical markets, including financial services, telecommunications,
manufacturing, information technology, pharmaceutical, transportation and health
care. Consultative and staffing resources may be used to undertake a role on a
long-term strategic project or fill a short-term need for a technology skill
set. We deliver qualified consultants and project managers for contract
assignments and full-time employment across many technology disciplines. Areas
of expertise include project management, business analysis, systems architecture
and design, database architecture and design, application code development,
network engineering, quality assurance and testing.
IT Infrastructure & Communications Services
We provide customers with IT infrastructure (such as personal computers,
printers, phone systems, networks, servers and switches) design, development,
deployment services from project planning and implementation to full-scale
network, server and workstation installations. We also provide an end-to-end
solution for automating the deployment/version upgrades of desktop and server
operating systems, including the associated packaging required to migrate a
client's enterprise applications to computers across an organization quickly and
reliably.
3
Application Development and Maintenance
We help organizations plan, develop, integrate and manage custom applications
software, packaged software and industry-specific software solutions. We offer
applications development and maintenance-support solutions for our customers,
including shared risk engagements and fully outsourced projects, managed quality
assurance and testing services, including functional testing, compatibility
tests, performance testing, regression testing and benchmarking. Benefits to
clients using these services can include reduced costs, extended value of
technology investments, information sharing and enhanced ability to adapt to
market changes.
Sales and Marketing
We sell our IT services through a direct sales force located principally in the
New York area. These sales associates, also known as client executives, are
supported by sales support personnel. Currently, we have approximately 14 sales
associates and sales support personnel selling our IT services. We also have
independent sales agents (non-employees), who sell our services on a commission
basis. In addition, three large providers of software and solutions services
market our services as a part of their sales effort to their customers where our
services are part of an overall package. Our marketing strategy is to develop
long-term partnership relationships with existing and new clients that will lead
to us becoming a preferred provider of information technology services. We seek
to employ a cross-selling approach, where appropriate, to expand the number of
services utilized by a single client.
Competition
The information technology services industry is highly competitive and served by
numerous international, national, regional and local firms, all of which are our
existing or potential competitors. Our primary competitors are software
consulting and implementation firms, applications software firms, service groups
of computer equipment companies, general management consulting firms,
programming companies, offshore firms and temporary staffing firms, as well as
the internal information technology staff of our clients. We believe that the
principal competitive factors in the information technology services industry
include the range of services offered, cost, technical expertise, responsiveness
to client needs, speed in delivering information technology solutions, quality
of service and perceived value. A critical component of our ability to compete
in the marketplace is our ability to attract, develop, motivate and retain
skilled professionals. We believe we can compete favorably in hiring such
personnel by offering competitive compensation packages and attractive
assignment opportunities. Many of our competitors have stronger brand
recognition and significantly greater financial, technical, marketing and other
resources than we do. Our share of the market compared to theirs is too small to
quantify.
Seasonality
Our business can be affected by the seasonal fluctuations in corporate IT
expenditures. Generally, expenditures are lowest during the first quarter of the
year when our clients are finalizing their IT budgets. In addition, our
quarterly results may fluctuate depending on, among other things, the number of
billing days in a quarter and the seasonality of our clients' businesses. Our
business is also affected by the timing of holidays and seasonal vacation
patterns, generally resulting in lower revenues and gross margins in the fourth
quarter of each year. In addition, we experience an increase in our cost of
sales and a corresponding decrease in gross profit and gross margin in the first
quarter of each year as a result of resetting certain state and federal
employment tax salary limitations.
Major Customers/ Clients
We currently derive, and we believe we will continue to derive, a significant
portion of our service revenue from a limited number of corporate clients. Our
two largest clients for the year ended December 31, 2006 accounted for 35% and
11%, respectively, of our revenues. The volume of work we perform for specific
clients may vary from year to year, particularly since we typically are not the
only outside service provider for our clients. Thus, a major client in one year
may not provide the same level of revenue in a subsequent year. In certain
cases, clients have reduced their spending on IT services due to economic
conditions and consequently have reduced the volume of business from us.
4
Operations In India
Current global macroeconomic conditions and intense competitive pressures have
forced companies to focus on their core activities and outsource critical but
non-core activities to companies that specialize in such non-core functions.
Outsourcing enables companies to reduce their operating costs, realize benefits
of scale and flexible cost structures and achieve significant process
improvements. Two types of outsourcing important to our business are business
process outsourcing ("BPO") and knowledge process outsourcing ("KPO"). BPO
involves routine information technology processes, including billing, accounting
and other financial services, software research and development and related
support functions such as transaction processing and customer service
operations. KPO involves processes that demand advanced information search,
analytical, interpretation and technical skills as well as some judgment and
decision making. Examples of KPO functions include intellectual property or
patent research, paralegal and medical transcription services, and analytical
services, such as equity research, econometric and financial modeling,
competitive intelligence and industry reports.
In 2006, we established a subsidiary in India, NetFabric Technologies India Pvt.
Ltd. This entity will provide BPO services, software development services and
internal back office support to our existing customers. Prior to 2006, these
services were provided by third party vendors in India, at negligible cost to
us. We transitioned these services from third party vendors to in-house
operations without incurring material expenses for the initial set up of our
operations. In 2006, our operations in India were principally for our own back
office requirements and we did not incur a material amount of expenses. Based on
the initial results of our operations and our customers' requirements for such
services, we plan to increase our operations in the future. In addition, we are
evaluating other options to grow in the BPO and KPO sectors in India. Although
we will need a significant amount of additional capital to grow in the BPO/KPO
space in India, we do not currently have a commitment with anyone to provide us
with such additional capital. Therefore, there can be no assurance that we will
be able to grow in the BPO/ KPO sectors in India.
Employees
On a consolidated basis, we have 117 employees, including 37 employees and 80
billable consultants. We have 14 employees in sales, 15 in service/products
delivery management, and 8 in executive and administrative positions. In
addition to the 80 billable consultants who are employees, we utilize the
services of approximately 125 billable independent contractors. Our subsidiary
in India has 8 additional employees.
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission (the "SEC"). The public
may read and copy any materials that we have filed with the SEC at the SEC's
Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public
may obtain information on the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains
the reports, proxy and information statements and other information regarding
the Company that we have filed electronically with the SEC. The address of the
SEC's Internet site is http://www.sec.gov.
5
ITEM 2. DESCRIPTION OF PROPERTY
Description of Property
We do not own any real property and we lease our main office space through a
sublease. The office space is located at Three Stewart Court, Denville, New
Jersey. The total office space is 13,000 square feet and the term of the
sublease is three years, which expires in July 2008. The annual rent is
approximately $144,000. In December 2006, we entered into a lease for new office
space with a term of 64 months. Accordingly, we have terminated the sublease,
effective April 2007. The new office space, located in Parsippany, New Jersey,
is approximately 6,500 square feet with annual rent of approximately $129,000
with future escalation provisions. We anticipate moving into the new office
space in April 2007.
We also have additional office space in St. Louis, Missouri pursuant to a lease
that expires in March 2010. This office space is approximately 1,000 square feet
with annual rent of approximately $17,000. Our subsidiary in Pune, India has
office space of approximately 3,700 square feet, pursuant to a lease expiring in
November 2009, with annual rent of approximately $42,000.
The Company believes that its leased office spaces are sufficient, in good
condition and are adequately covered by insurance.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to, nor is any of our property the subject of, any pending
legal proceedings other than routine litigation that is incidental to our
business.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None.
6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the NASD's Over-the-Counter Bulletin Board
("OTCBB") under the trading symbol "NFBH". Our common stock has been quoted on
the NASD's OTCBB since March of 2001. 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".
The following table sets forth the high and low bid prices for our common stock
for the periods indicated as reported by the NASDAQ OTCBB. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not represent actual transactions.
High Low
---- ---
YEAR ENDING DECEMBER 31, 2006
First Quarter $0.95 $0.68
Second Quarter $0.90 $0.35
Third Quarter $0.33 $0.09
Fourth Quarter $0.12 $0.10
YEAR ENDED DECEMBER 31, 2005
First Quarter $3.00 $0.90
Second Quarter $1.75 $1.10
Third Quarter $1.50 $0.90
Fourth Quarter $1.15 $0.65
As of March 14, 2007, the number of stockholders of record was approximately 467
(excluding beneficial owners and any shares held in street name or by nominees).
In the past three years, we have not paid any dividends upon our common stock.
The payment of common stock dividends, if any, in the future rests within the
discretion of our Board of Directors and will depend upon, among other things,
our earnings, capital requirements and financial condition, as well as other
relevant factors. In connection with a $3 million financing completed in
February 2006 and pursuant to a Securities Purchase Agreement related thereto
between the Company and Laurus Master Fund, Ltd. ("Laurus"), Laurus restricts
our ability to pay dividends without their prior consent. The financing with
Laurus is discussed in more detail in the notes to Consolidated Financial
Statements set forth below.
Recent Sales of Unregistered Securities; Use of Proceeds From Registered
Securities
During the three months ended December 31, 2006:
We issued 250,000 shares of common stock to Indus Investments, Inc. as
consulting fees.
We issued three individuals warrants to acquire 550,000 shares of our common
stock at an exercise price of $0.01 per share as additional consideration for
borrowings from them pursuant to convertible debentures issued by the Company.
The foregoing shares were issued pursuant to exemptions from registration under
Sections 3(a)(9) and 4(2) of the Securities Act of 1933.
7
Equity Plan Compensation Information
The following table sets forth information as of December 31, 2006 regarding
compensation plans under which our equity securities are authorized for
issuance.
Number of Securities
Remaining Available for
Number of Securities Future Issuance Under
to be Issued Upon Weighted Average Equity Compensation
Exercise of Exercise Price of Plans (Excluding
Outstanding Options, Outstanding Options, Securities Reflected in
Warrants and Rights Warrants and Rights Column (a))
Plan Category (a) (b) (c)
- ------------------------------------------------- --------------------- ------------------------ --------------------------------
Equity Compensation Plans(1) 7,100,085 $0.41 1,899,915
Equity compensation plans not approved by
equity holders(2) 9,192,687 0.30 0
--------------------- ------------------------ --------------------------------
Total 16,232,772 1,899,915
(1) Pursuant to our 2005 Stock Option Plan.
(2) Outstanding warrants to acquire shares of common stock. The warrants expire
at various times through 2011.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis and results 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 13, 2007, on our December 31, 2006 financial statements since we
have experienced net losses since inception and have a working capital
deficiency their 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 consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
CORPORATE HISTORY
We were formerly known as Houston Operating Company and were incorporated in
Delaware on August 31, 1989. On December 9, 2004, we entered into an Acquisition
Agreement with all of the stockholders of NetFabric Corp. At the closing, which
occurred simultaneously with 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."
8
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 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
and the pharmaceutical, health care and hospitality sectors. UCA delivers a
broad range of IT services in managed services, professional services,
infrastructure builds and maintenance, application development and maintenance
areas. The acquisition was accounted for using the purchase method of accounting
with UCA's results of operations included in our 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.
With minimal revenues from VoIP operations, we concluded that we could not
implement our original business plan for VoIP operations within our resources or
with the additional capital we could raise in the near term. On May 5, 2006, our
Board of Directors decided that the Company should exit 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 the VoIP business segment has been
reclassified as discontinued operations for all periods presented. After the
discontinuation of VoIP operations, our only operations are that of UCA.
OVERVIEW OF UCA BUSINESS
UCA derives revenues primarily from managed IT services, professional services,
application development services and business process management services.
Service arrangements with customers are generally on a time and material basis
or fixed-price, fixed-timeframe revenue basis. UCA's principal operating
expenses are direct employee costs, consultant expenses and selling, general and
administrative expenses. The principal components of selling, general and
administrative expenses are salaries of sales and support personnel, and office
rent. 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 40% of our
consultants are employees and the remainder are subcontractors and independent
contractors.
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.
9
As previously noted, the December 9, 2004 acquisition of NetFabric Corp. 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 Years Ended December 31, 2006 and 2005:
Revenues.
Revenues for the year ended December 31, 2006, increased by $5,058,319 or 40.3%
over the prior year due to the UCA acquisition. If the UCA acquisition had taken
place on January 1, 2006, the Company would have had revenues of $19,422,336
(excluding VoIP operations) for the year ended December 31, 2005. In comparison,
2006 revenues decreased by $1,823,033 or 9.4% from the year ended December 31,
2005. The decrease on a pro forma basis was due to certain one-time projects
undertaken in 2005. The pro forma results may not be indicative of the results
that would have occurred if the acquisition had been completed at the beginning
of the period presented or which may be obtained in the future.
Direct employee compensation and consultant expenses.
Excluding non-cash share based compensation, for the year ended December 31,
2006, our direct employee compensation and consultant expenses increased by
$4,072,746 or 44.0% to $13,330,066. The increase was due to increased revenues
resulting from the UCA acquisition. As a percentage of revenues our direct
employee compensation and consultant expenses was 75.7%, compared to 73.8% in
2005. The increase in employee compensation and consultant expenses as a
percentage of revenues was due to the nature projects performed in 2006.
Selling, general and administrative expenses.
Excluding non-cash share based compensation , our selling, general and
administrative expenses increased for the year ended December 31, 2006 by
$1,135,683, or 25.1%, to $5,665,996. The increase was principally due to the UCA
acquisition. The overall increase was off set by certain expense reductions
implemented in the latter half of 2006 .
Amortization of debt discount.
Amortization of debt discount for the year ended December 31, 2006 increased by
$1,622,012, or 135.5%, to $2,819,289. The increase was 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 December
31, 2006, the aggregate unamortized debt discount was $1,544,506, which will be
amortized and charged to operations over the term of the respective debt.
Depreciation and amortization.
For the year ended December 31, 2006, depreciation and amortization increased by
$172,930, or 100.6%, to $344,846. The increases were due to additional assets
obtained from the UCA acquisition.
Interest expense.
For the year ended December 31, 2006, interest expense increased by $212,551, or
204.6 %, to $316,439, due to increased borrowing levels in 2006.
Derivative Financial Instruments.
In July 2005, we entered into an agreement pursuant to which we sold Cornell
Capital Partners ("Cornell") secured convertible debentures (the "Cornell
Debentures") in the aggregate principal amount of $1,000,000. In October 2005,
we entered into a securities purchase agreement with Cornell whereby both
parties agreed to amend and consolidate all of the convertible debentures issued
to Cornell into one new secured convertible debenture in the principal amount of
$1,658,160 ("October Convertible Debenture"). 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
Debentures became subject to the provisions of SFAS No. 133. 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
10
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 the 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 year ended December 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
consolidated statement of operations. For the year ended December 31, 2005, we
recorded a charge in value for derivative financial instruments of $2,131,109
related to the change in fair value of the embedded conversion feature which is
recorded in the accompanying consolidated statement of operations. In February
2006, we paid the October Convertible Debenture (the "Cornell Repayment") and
accordingly, the value of the embedded conversion future was reclassified to
additional paid-in capital.
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 consolidated statement for operations for the year ended December
31, 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 year ended December 31, 2006.
On May 24, 2006, the Company entered into a Waiver and Agreement to Convert (the
"Waiver Agreement") with Macrocom Investors LLC ("Macrocom"). Pursuant to the
Waiver Agreement, Macrocom agreed immediately to convert a note issued by the
Company due on October 10, 2006 in the principal amount of $500,000 (the
"Note"), 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 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
an additional 1,500,000 shares of restricted common stock to Macrocom. The fair
value of the additional consideration was $1,125,000 and the amount was charged
to operations during the year ended December 31, 2006 as debt extinguishment
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 officer, director and stockholder of the
Company transferred 1,000,000 shares of our common stock owned by him to the
consultant. We accounted for the settlement as an expense in our consolidated
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 year ended December 31, 2006. In February 2006, we
entered into an amendment agreement with the former UCA shareholders. Pursuant
to the amendment agreement, an officer, director and stockholder of the Company
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 on the settlement
date, February 13, 2006.
In process research and development.
In August 2006, the Company entered into an agreement with Utek Corporation
("Utek"), an unaffiliated specialty finance company focused on technology
transfers, to acquire a technology license for intrusion detection software
developed by a university. We anticipate further development and testing of the
technology. Because of the uncertainties surrounding the ultimate commercial
deployment of the technology and due to the technology not having alternative
use, we charged the cost of the license agreement of $160,000 as in process
research and development costs during the year ended December 31, 2006.
11
Discontinued Operations.
On May 5, 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 the VoIP business
segment has been reclassified as discontinued operations for all periods
presented. For the year ended December 31, 2006, loss from discontinued
operations decreased by $1,557,493, or 76.7%, from$2,031,904 in the prior year.
The decreases were due to our scaling back of VoIP operations in 2006 and
eventual exit from the business during 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 year ended December 31, 2006, net loss
increased by $10,288,024, or 151.7%, to a loss of $17,070,009, compared to a net
loss of $6,781,985 in the year ended December 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
On December 31, 2006, our working capital deficiency was $3,767,282, compared to
a working capital deficiency of $2,176,606 on December 31, 2005. The increase in
the working capital deficiency was principally due to operating losses. During
the year ended December 31, 2006, our operating activities from continuing
operations used approximately $1,019,000 of cash, compared to approximately
$1,091,000 used during the year ended December 31, 2005.
During the year ended December 31, 2006, our operating losses, after adjusting
for non-cash items, utilized approximately $1,822,000 of cash, and working
capital items provided approximately $803,000 of cash. The principal component
of these working capital changes was an increase in our accounts payable. During
the year ended December 31, 2005, our operating losses, after adjusting for
non-cash items, utilized approximately $332,000 of cash, and working capital
items used approximately $759,000 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 and 1,000,000
shares of our common stock to Michael Millon, resulting in aggregate proceeds of
$1,000,000 and aggregate per-share proceeds of $0.50. Pursuant to this
arrangement, Macrocom also received warrants to purchase 2,000,000 shares of
common stock for an aggregate 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. Additionally, we repaid $100,000 plus accrued interest to Faisal Syed,
a stockholder of the Company, in full satisfaction of a promissory note issued
to him by UCA, prior to our acquisition of UCA. The promissory note bore
interest at the rate of 6% and was due, together with accrued but unpaid
interest in June 2005.
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 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 Laurus Revolving Note are
collectively referred to as the "Laurus Notes". Availability under the Laurus
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
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, but
not the obligation, at any time until the maturity date, to convert all or any
portion of the Laurus Convertible Note and accrued interest thereon into shares
12
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 to Laurus. We have the option to prepay the Laurus Convertible Note
by paying Laurus the applicable redemption premium. 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 borrowing, we issued to Laurus a common stock purchase
option (the "Option") to purchase up to 4,256,550 shares of our common stock for
nominal consideration. Additionally, we entered into a registration rights
agreement with Laurus (the "Registration Rights Agreement"), covering the
registration of common stock underlying the Laurus Convertible Note and the
Option. Our obligations under the Laurus Notes are secured by first liens on all
of our assets, and Laurus may accelerate all obligations under the Laurus Notes
upon an event of default.
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 the October Convertible Debenture, including a redemption premium.
At December 31, 2006, our availability and borrowing with Laurus was
approximately $2,987,000 (face amount).
On April 19, 2006, we sold Convertible Debentures (the "2006 Convertible
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 2006 Convertible Debentures bear
interest at 8% and were due on June 15, 2006. At the option of the Debenture
holder, the 2006 Convertible 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 our 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. The Company has agreed to place 3,000,000 shares of our common
stock with an escrow agent as collateral for the 2006 Convertible Debentures
held by these three individuals. There will not be any collateral for the 2006
Convertible Debentures issued to Fahad Syed and Fred Nazem. We used the proceeds
from the sale of the 2006 Convertible Debentures to repay $500,000 due to
Macrocom pursuant to a Convertible Debenture issued to Macrocom in July 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 (1,000,000 shares pursuant to a loan
agreement and 1,500,000 shares pursuant to the Waiver Agreement) of restricted
common stock of the Company.
In June 2006, we and the holders of the 2006 Convertible 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 our common stock and warrants to acquire an aggregate of 400,000
shares of our common stock with a nominal exercise price. The warrants expire
three years from the date of issuance. In September 2006, we repaid $100,000 of
the face amount one of the 2006 Convertible Debentures and entered into an
agreement to extend the term of the debentures to December 15, 2006. In exchange
for the extension, we issued to the holders an aggregate of 200,000 shares of
common stock and warrants to acquire 200,000 shares of our common stock with a
nominal exercise price. The warrants expire three years from the date of
issuance.
During the three months ended December 31, 2006, we sold 2006 Convertible
Debentures to three individuals in the aggregate face amount of $300,000. The
2006 Convertible Debentures bear interest at 8% and were due in January 2007. At
the option of the holders, the 2006 Convertible 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, we issued warrants to these three individuals to
acquire an aggregate of 550,000 shares of the Company's common stock with a
nominal exercise price. The warrants expire three years from the date of
issuance.
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In January and February 2007, we repaid five of the seven 2006 Convertible
Debentures in the aggregate face amount of $500,000. In December 2006, Fahad
Syed and Fred Nazem agreed to extend the term of their 2006 Convertible
Debentures in the face amount of $200,000 to April 30, 2007.
In April 2006, Fred Nazem, a stockholder, converted a convertible debenture
issued to him in July 2005 into 100,000 shares of our common stock. We also
extended the maturity date of another convertible debenture held by an entity
affiliated with a former officer of the Company 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 consideration therefor. In September 2006, the holder
converted the convertible debenture into 100,000 shares of our common stock. As
inducement for the conversion, we issued the debenture holder 300,000 shares of
our common stock.
On June 8, 2006, we sold a Convertible Debenture (the "Stockholder Convertible
Debenture") in the face amount of $150,000 to Fred Nazem, a stockholder. 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 our common stock at a conversion price of $.50 per
share. In connection with the sale, we issued 300,000 shares of our common stock
as additional consideration. In August 2006, we extended the due date of the
Stockholder Convertible Debenture to December 15, 2006 and in December 2006; we
extended the due date further, to April 30, 2007.
On August 11, 2006, we entered into an agreement with Utek Corporation ("Utek"),
an unaffiliated specialty finance company focused on technology transfer, to
acquire a technology license for intrusion detection software developed by a
university. To facilitate the transfer of technology, Utek formed a subsidiary,
Intrusion Detection Technologies, Inc. ("ITDI"). IDTI did not have any business
operations and its assets consisted of cash balance of $500,000 and a license
agreement with a university for intrusion detection software owned by the
university. We acquired all of the outstanding shares of IDTI from Utek in
exchange for 7,500,000 shares of our common stock, including 375,000 shares
assigned by Utek to its consultant. The term of the license agreement is 15
years from the date of filing of the licensed patents or the expiration of the
last patent, whichever is longer. The license agreement entitles the university
to royalties in the amount of five percent (5%) of net sales of the licensed
products.
For continued growth, we need capital for both technology investments and
operations. Technology investments will provide 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. Our working capital requirements are principally
related to additional receivables that must be supported by an increased revenue
base resulting from anticipated growth. We believe that the Laurus Revolving
Note will provide us the necessary working capital required for the accounts
receivable growth.
Pursuant to our exit from our VoIP operations, we have reduced our operating
losses and the resulting cash utilization. Cash used in VoIP operations
approximated $454,000 and $1,955,000 in the years ended December 31, 2006 and
2005, respectively.
We have reduced our selling, general and administrative expenses, in part, by
transferring some of our employees to billable consultants. In addition, we have
identified and implemented or will implement additional expense reduction. We
estimate that we have identified approximately $1 million of such expenses, and
part of this was implemented in the year ended December 2006, and the balance
will be implemented in 2007. Based on our expected revenues in 2007, we
anticipate that our operations prior to corporate expenses, interest,
depreciation amortization and debt discount will be profitable. However, there
is no assurance that we will attain the expected revenue levels and that our
operations will be profitable.
14
During 2006, we added large enterprise customers, including Guardian, TD
Ameritrade and Bear Sterns. However, revenues in 2006 from these customers were
not significant. Historically, we have seen revenue growth from new customers
from the second or third year of our relationship with the new customers.
However, there can be no assurance that we will derive significant revenues from
customers added in 2006.
Technology investments will provide 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 with new
skills and paying for their bench time until we obtain projects where they can
be placed on a billable basis. We have a strategic relationship with a new
software company engaged in development of middleware software for
Radio-frequency identification (RFID) based applications. In 2007, through
partnership with the software company, we obtained a pilot project from a large
financial institution for installing a RFID based application and have a
proposal with two other financial institutions for pilot projects. We believe
that there is a tremendous market for RFID based applications with our customers
in the financial sector. However, there can be no assurance that we will in fact
get RFID based applications work with our existing customers and that we will
derive significant revenues from such projects.
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 amount of this will be used to
satisfy our obligations, both from borrowing and vendor accounts payable, as
they become due. 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 the necessary working capital. There is no
assurance that we 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 fiscal year 2007, we need to raise additional
financing and generate cash flows from our operations. Should additional cash
flows not be available, we believe that we will have the ability to restructure
our operations, and if necessary, initiate significant expense reductions. 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.
15
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis and plan of operation 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 the 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 basis. 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.
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 December 31, 2006 and 2005 approximate their
carrying amounts.
We account 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
16
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).
We have 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. We base its fair value
determinations on an evaluation of the facts and circumstances and valuation
techniques that require judgments and estimates.
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 (the "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 consolidated
statements of operations.
17
RISK FACTORS
We Are Subject To Various Risks That May Materially Harm Our Business, Financial
Condition And Results Of Operations
You should carefully consider the risks and uncertainties described below and
the other information in this filing before deciding to purchase our common
stock. If any of these risks or uncertainties actually occurs, our business,
financial condition or operating results could be materially harmed. In that
case, the trading price of our common stock could decline and you could lose all
or part of your entire investment.
Risks Related To Our Business
We Have Historically Lost Money And Losses May Continue In The Future, Which May
Cause Us To Curtail Our Operations
Since our inception we have not been profitable and have lost money. For the
year ended December 31, 2006, we incurred a net loss of $17,910,009. Future
losses are likely to occur as we are dependent on spending money to pay for our
operations. No assurances can be given that we will be successful in reaching or
maintaining profitable operations. Accordingly, we may experience liquidity and
cash flow problems. If our losses continue, our ability to operate may be
severely impacted.
Our Operating Results May Fluctuate
Our operating results may fluctuate as a result of a number of factors, many of
which are outside of our control. The following factors may affect our operating
results:
o Our ability to compete effectively.
o The amount and timing of operating costs and capital expenditures related to
the maintenance and expansion of our businesses, operations and infrastructure.
o Our focus on long term goals over short-term results.
o The results of our investments in risky projects.
o Our ability to attract, motivate and retain top-quality employees.
o Our ability to upgrade and develop our systems, infrastructure and products.
o Our ability to successfully integrate and manage our acquisitions.
o Geopolitical events such as war, threat of war or terrorist actions.
We Have Been The Subject Of A Going Concern Opinion By Our Independent
Registered Public Accountants Which Has Raised Substantial Doubt As To Our
Ability To Continue As a Going Concern
Our Independent Registered Public Accounting Firm added an explanatory paragraph
to their audit opinion issued in connection with our consolidated financial
statements which states that our financial statements raise substantial doubt as
to our ability to continue as a going concern. We have experienced net losses
from operations of $17,070,009 for the year ended December 31, 2006. In
addition, we had a working capital deficit of $3,767,282 as of December 31,
2006. These factors, among others, raise substantial doubt about our ability to
continue as a going concern. Our consolidated financial statements do not
include any adjustment that might result from the outcome of this uncertainty.
Assurances cannot be given that adequate financing can be obtained to meet our
capital needs. If we are unable to generate profits and unable to continue to
18
obtain financing to meet our working capital requirements, we may have to
curtail our business sharply or cease operations altogether. Our continuation as
a going concern is dependent upon our ability to generate sufficient cash flow
to meet our obligations on a timely basis to retain our current financing, to
obtain additional financing and, ultimately, to attain profitability. Should any
of these events not occur, we will be adversely affected and we may have to
cease operations.
We Had A Working Capital Deficit, Which Means That Our Current Assets On
December 31, 2006 Were Not Sufficient To Satisfy Our Current Liabilities And,
Therefore, Our Ability To Continue Operations Is At Risk
We had a working capital deficit of $3,767,282 as of December 31, 2006, which
means that our current liabilities exceeded our current assets on December 31,
2006 by $3,767,282. Current assets are assets that are expected to be converted
to cash within one year and, therefore, may be used to pay current liabilities
as they become due. Our working capital deficit means that our current assets on
December 31, 2006 were not sufficient to satisfy all of our current liabilities
on those dates. If our ongoing operations do not begin to provide sufficient
profitability to offset the working capital deficit, we may have to raise
additional capital or debt to fund the deficit or curtail future operations.
Our Principal Stockholders Can Control Our Board Of Directors Which Means That
Such Stockholders Could Exercise Certain Control Over The Decisions Made By The
Board
Five of our principal stockholders, including directors and officers, own
approximately 70.5% of our outstanding common stock. They can effectively elect
a majority of our directors and thereby control our management.
We May Incur Significant Operating Losses In The Future Which Could Adversely
Affect Our Business And Cause Us To Cease Operations
Our business does not have an established record of profitability and we may not
be profitable in the future. If our revenue does not grow to offset our
operating losses, we will not be profitable. You should not consider past
revenue and earnings as indicative of our future performance. In future
quarters, our revenue or earnings could decline or fail to grow. Furthermore, if
our operating expenses exceed our expectations, our financial performance will
be adversely affected.
If We Are Unable To Retain Or Motivate Key Personnel Or Hire Qualified
Personnel, We May Not Be Able To Grow Effectively.
Our performance is largely dependent on the talents and efforts of
highly-skilled individuals. Our future success depends on our continuing ability
to identify, hire, develop, motivate and retain highly-skilled personnel for all
areas of our organization, as well as to identify, contract with, motivate and
retain contract personnel, on an outsourced basis, for special projects.
Competition in our industry for qualified employees is intense. Our continued
ability to compete effectively depends on our ability to attract new employees
and to retain and motivate our existing employees and to retain contract
personnel.
As we become a more mature company, we may find our recruiting efforts more
challenging. If we do not succeed in attracting excellent personnel or retaining
or motivating existing personnel, we may be unable to grow effectively.
We May Not Be Able To Increase Revenues Or Otherwise Successfully Operate Our
Business, Which Could Have A Significant Negative Impact On Our Financial
Condition
We believe that the key to our success is to increase revenues and our services
offerings, thereby increasing our available cash. Our success in this regard
will depend in large part on widespread market acceptance of our services
offerings and our efforts to educate potential customers and sell our services.
There can be no assurance that we will be able to increase our revenues or
effectively operate our business. To the extent we are unable to achieve growth
in revenues, we may continue to incur losses. We cannot assure you that we will
be successful or make progress in the growth and operation of our business. Our
current and future expense levels are based on our operating plans and estimates
of future revenues and are subject to increase as we implement our strategy.
Accordingly, any significant shortfall in revenues would likely have an
19
immediate material adverse effect on our business, operating results and
financial condition. Further, if we should substantially increase our operating
expenses to increase sales and marketing, and such expenses are not subsequently
followed by increased revenues, our operating performance and results would be
adversely affected and, if sustained, could have a material adverse effect on
our business. To the extent we implement cost reduction efforts to align our
costs with revenue, our revenue could be adversely affected.
Our Information Systems Are Critical To Our Business And A Failure Of Those
Systems Could Materially Harm Us
We depend on our ability to store, retrieve, process and manage a significant
amount of information. If our information systems fail to perform as expected,
or if we suffer an interruption, malfunction or loss of information processing
capabilities, it could have a material adverse effect on our business.
Our Service Revenue Depends To A Large Extent On A Small Number Of Clients, And
Our Revenue Could Decline If We Lose A Major Client, Which Could Cause Us To
Curtail Our Operations Due To A Lack of Revenue
We currently derive, and believe we will continue to derive, a significant
portion of our service revenue from a limited number of corporate clients. The
loss of a major client or a significant reduction in the service performed for a
major client could result in a reduction of our revenue.
Our two largest clients for the year ended December 31, 2006 accounted for 35%
and 11%, respectively, of our revenues. Our major customers in 2006, were BNP
Paribas, Cendent Corporation, Dresdner Bank, Instinet and Reuters. The volume of
work we perform for specific clients may vary from year to year, particularly
since we typically are not the only outside service provider for our clients.
Thus, a major client in one year may not provide the same level of revenue in a
subsequent year.
There are a number of factors, other than our performance, that could cause the
loss of a client and that may not be predictable. In certain cases, clients have
reduced their spending on IT services due to economic conditions and
consequently have reduced the volume of business from us. If we were to lose one
of our major clients or incur a significantly lower volume of business with
them, our revenue and profitability could be reduced.
Our Failure To Complete Fixed-price, Fixed-timeframe Contracts On Budget And On
Time May Negatively Affect Our Profitability, Which Could Decrease The Value Of
Our Shareholders' Investment
We offer a portion of our services on a fixed-price, fixed-timeframe basis.
Although we use specified software engineering processes and our past project
experience to reduce the risks associated with estimating, planning and
performing fixed-price, fixed-timeframe projects, we bear the risk of cost
overruns, completion delays and wage inflation in connection with these
projects. If we fail to accurately estimate the resources and time required for
a project, future rates of wage inflation and currency exchange rates, or if we
fail to complete our contractual obligations within the contracted timeframe,
our profitability may suffer.
20
We May Be Unable To Manage Growth, Which May Impact Our Potential Profitability
Successful implementation of our business strategy requires us to manage our
growth. Growth could place an increasing strain on our management and financial
resources. To manage growth effectively, we will need to:
o Establish definitive business strategies, goals and objectives; and
o Maintain a system of management controls.
Risks Related to Our Stock Being Publicly Traded
Our stock price may be volatile.
Our common stock has been trading in the public market since March, 2001. We
cannot predict the extent to which a trading market will develop for our common
stock or how liquid that market might become. The trading price of our common
stock has been and is expected to continue to be highly volatile as well as
subject to wide fluctuations in price in response to various factors, some of
which are beyond our control. These factors include:
o Quarterly variations in our results of operations or those of our competitors.
o Announcements by us or our competitors of acquisitions, new products,
significant contracts, commercial relationships or capital commitments.
o Disruption to our operations.
o The emergence of new sales channels in which we are unable to compete
effectively.
o Our ability to develop and market new and enhanced products on a timely basis.
o Commencement of, or our involvement in, litigation.
o Any major change in our board or management.
o Changes in governmental regulations or in the status of our regulatory
approvals.
o Changes in earnings estimates or recommendations by securities analysts.
o General economic conditions and slow or negative growth of related markets.
In addition, the stock market in general has experienced extreme price and
volume fluctuations that have often been unrelated or disproportionate to the
operating performance of companies. These broad market and industry factors may
seriously harm the market price of our common stock, regardless of our actual
operating performance. In addition, in the past, following periods of volatility
in the overall market and the market price of a company's securities, securities
class action litigation has often been instituted against companies. Such
litigation, if instituted against us, could result in substantial costs and a
diversion of our management's attention and resources.
We do not intend to pay dividends on our common stock.
We have never declared or paid any cash dividend on our capital stock. We
currently intend to retain any future earnings and do not expect to pay any
dividends in the foreseeable future.
We have and will continue to incur increased costs as a result of being a public
company.
21
As a public company, we have and will continue to incur significant legal,
accounting and other expenses that we did not incur as a private company. We
will incur costs associated with our public company reporting requirements. We
also anticipate that we will incur costs associated with recently adopted
corporate governance requirements, including requirements under the
Sarbanes-Oxley Act of 2002, as well as new rules implemented by the SEC and the
NYSE and NASDAQ. We expect these rules and regulations to increase our legal and
financial compliance costs and to make some activities more time-consuming and
costly. We also expect that these new rules and regulations may make it more
difficult and more expensive for us to obtain director and officer liability
insurance and we may be required to accept reduced policy limits and coverage or
incur substantially higher costs to obtain the same or similar coverage. As a
result, it may be more difficult for us to attract and retain qualified
individuals to serve on our Board of Directors or as executive officers. We are
currently evaluating and monitoring developments with respect to these new
rules, and we cannot predict or estimate the amount of additional costs we may
incur or the timing of such costs.
You may experience dilution if we raise funds through the issuance of additional
equity and/or convertible securities.
If we raise additional funds through the issuance of equity securities or
convertible securities, you may experience dilution of your percentage
ownership. This dilution may be substantial. In addition, these securities may
have powers, preferences and rights that are senior to the holders of our common
stock and may further limit our ability to pay dividends on our common stock.
Because the market for and liquidity of our shares is volatile and limited, and
because we are subject to the "Penny Stock" rules, the level of trading activity
in our common stock may be reduced.
Our common stock is quoted on the OTCBB. The OTCBB is generally considered to be
a less efficient market than the established exchanges or the NASDAQ markets.
While we anticipate seeking to be listed on the NASDAQ Small-Cap Market at some
time in the future, it is impossible at this time to predict when, if ever, such
application will be made or whether such application will be successful. While
our common stock continues to be quoted on the OTCBB, an investor may find it
more difficult to dispose of, or to obtain accurate quotations as to the price
of our common stock, compared to if our securities were traded on NASDAQ or a
national exchange. In addition, our common stock is subject to certain rules and
regulations relating to "penny stocks" (generally defined as any equity security
that is not quoted on the NASDAQ Stock Market and that has a price less than
$5.00 per share, subject to certain exemptions). Broker-dealers who sell penny
stocks are subject to certain "sales practice requirements" for sales in certain
nonexempt transactions (i.e., sales to persons other than established customers
and institutional "accredited investors"), including requiring delivery of a
risk disclosure document relating to the penny stock market and monthly
statements disclosing recent bid and offer quotations for the penny stock held
in the account, and certain other restrictions. If the broker-dealer is the sole
market maker, the broker-dealer must disclose this, as well as the
broker-dealer's presumed control over the market. For as long as our securities
are subject to the rules on penny stocks, the liquidity of our common stock
could be significantly limited. This lack of liquidity may also make it more
difficult for us to raise capital in the future.
22
ITEM 7. FINANCIAL STATEMENTS
Reference is made to page F-1 herein for the Index to the Financial Statements.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As previously reported in the Company's Form 8-K on March 31, 2005, as a
consequence of the change in management of the Company, resulting from the
acquisition of NetFabric Corp., on March 28, 2005, Michael Johnson & Co. LLC
("MJC") was dismissed as the independent registered public accounting firm for
the Company by the Audit Committee of its Board of Directors.
MJC's reports on the Company's financial statements for the past two fiscal
years did not contain an adverse opinion, disclaimer of opinion, nor were they
qualified or modified as to audit scope or accounting principles. The report was
qualified as to uncertainty about the Company's ability to continue as a going
concern unless it was able to generate sufficient cash flow to meet its
obligations and sustain its operations.
During the Company's two fiscal years prior to March 28, 2005, there were no
disagreements with MJC on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of MJC, would have caused it
to make reference to the subject matter of the disagreements in connection with
this report. No reportable events of the type described in Item 304(a)(1)(iv)(B)
of Regulation S-B occurred during this period.
Effective March 28, 2005, J.H. Cohn LLP ("JHC") was appointed as the new
independent registered public accounting firm for the Company. The audit report
of JHC on the financial statements of the Company as of and for the fiscal year
ended December 31, 2005 did not contain any adverse opinion or disclaimer of
opinion, nor was it qualified or modified as to audit scope or accounting
principles. The report contains an explanatory paragraph about the Company's
ability to continue as a going concern.
During the Company's December 31,2005 fiscal year and through January 24, 2007,
there were no disagreements with JHC on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of JHC, would have caused
them to make reference to the subject matter of the disagreements in connection
with their reports. During our two most recent fiscal years, and the subsequent
interim period through the date JHC was dismissed, JHC did not advise the
Company as to any reportable events of the type described in Item
304(a)(1)(iv)(B) of Regulation S-B.
As previously reported in the Company's Form 8-K filed on January 26, 2007, the
Board of Directors of the Company dismissed JHC as the Independent Registered
Public Accounting Firm of the Company on January 24, 2007.
On January 24, 2007, the Company hired Goldstein Golub Kessler LLP ("GGK") to
serve as the Company's Independent Registered Public Accounting Firm. During the
period that JHC had acted as the Company's independent accountants, the Company
did not consult with GGK on any matter that (i) involved the application of
accounting principles to a specific completed or contemplated transaction, or
the type of audit opinion that might be rendered on the Company's financial
statements, in each case where written or oral advice was provided, that was an
important factor considered by the Company in reaching a decision as to the
accounting, auditing or financial reporting issue; or (ii) was either the
subject of a disagreement or event, as that term is described in Item
304(a)(1)(iv)(A) of Regulation S-B.
23
ITEM 8A. CONTROLS AND PROCEDURES
Our disclosure controls and procedures are designed to ensure that material
information relating to the Company is made known by others within the Company
to our Chief Executive Officer ("CEO"), Chief Financial Officer ("CFO") and
others in the Company involved in the preparation of our annual report and our
quarterly reports. The Company has evaluated, with the participation of the CEO
and CFO, the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of December 31, 2005, pursuant to Exchange
Act Rule 15d-15. Based upon that evaluation, the CEO and CFO concluded that the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company required to be included in
the Company's periodic filings with the Commission.
There have been no changes in the Company's internal controls over financial
reporting that occurred during the three month period ending December 31, 2006
that has materially affected, or is reasonably likely to materially affect the
Company's internal control over financial reporting.
ITEM 8B. OTHER INFORMATION
None.
24
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE
GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The following table sets forth the names and positions of our executive officers
and directors. Our directors serve for one year or until successors are elected
and qualify. Our Board of Directors elect our officers, and their terms of
office are at the discretion of the Board, except to the extent governed by an
employment contract.
As of March 14, 2007, our directors and executive officers, their age,
positions, the dates of their initial election or appointment as directors or
executive officers, and the expiration of their terms are as follows:
Name Age Position With Company Since
---- --- -------- ------------------
Fahad Syed 39 Chairman and Chief Executive Officer May 2005
Vasan Thatham 49 Chief Financial Officer June 2005
Charlotte G. Denenberg 59 Director November 2004
Joseph Perno 64 Director April 2006
Below are the biographies of each of our officers and directors as of March 14,
2007.
FAHAD SYED. Mr. Syed has been the Chairman and Chief Executive Officer of the
Company since May 2006. Mr. Syed has been a Director of the Company since May
2005. Mr. Syed is an entrepreneur and co-founder of UCA Services, Inc. and has
more than 14 years of experience in Global Services. Mr. Syed is an expert in
the development of best practices in IT, channel and direct sales strategies and
effective service delivery models. Mr. Syed was the Managing Director of UCA
Services, Inc, from June 2003 to May 2005 and he is currently the Chief
Executive Officer of UCA Services, Inc. Prior to that, Mr. Syed was Vice
President of IT services with UCA Computer Systems, Inc., a system integrator,
from December 1998 to May 2003. Previously, Mr. Syed held prominent positions in
development and management of financial products at the Housing Development
Finance Corporation (HDFC), a pioneer private sector housing finance institution
in India. Mr. Syed holds a Masters Degree in Development Sciences from Tata
Institute of Social Sciences, Mumbai, India, a Bachelors degree in Sociology
from Aligarh University, India and a Diploma in Systems from National Institute
of Information Technology, Mumbai, India.
VASAN THATHAM. Vasan Thatham has been Vice President and Chief Financial Officer
of the Company since June 2005. Prior to joining the Company, from February 1999
through June 2005, Mr. Thatham was Vice President and Chief Financial Officer of
Provo International, Inc., a company engaged in providing Internet and
telecommunications services. Prior to that, Mr. Thatham held various positions
with Esquire Communications, Ltd., Strings Ltd., Ernst & Young in Kuwait and
KMPG Peat Marwick in India. Mr. Thatham is a chartered accountant under the laws
of India.
CHARLOTTE G. DENENBERG. Ms. Denenberg has been a Director of the Company since
November 2004. She received a BA in Psychology and Mathematics with Highest
Distinction, Phi Beta Kappa, from Northwestern University, and an MS and a PhD
in Mathematics from the Illinois Institute of Technology. For the past two years
she has consulted for a variety of companies in the telecommunications industry.
From 1998 to 2002, she worked for Metromedia Fiber Network Services, Inc. (MFN)
as Vice President, Optical Infrastructure (December 1998 to June 2000) and as
Vice President and Chief Technology Officer (July 2000 to June 2002). MFN was
engaged in the design, installation and maintenance of inter-city and intra-city
optical fiber networks.
25
JOSEPH PERNO. Mr. Perno has been a Director of the Company since April 2006.
Since his retirement in March 2003, he has been a consultant to emerging
technology companies. From March 1994 to March 2003, he was Senior Vice
President of Technology at Chubb Corporation, a provider of property and
casualty insurance to businesses and individuals worldwide. Prior to that, he
was associated for 18 years with Chubb Corporation and Crum and Foster Insurance
Organizations in various capacities. Mr. Perno has been a member of the LOMA
Property and Casualty Systems Committee for twenty three years, serving as
Chairman of that organization from 1991 to 1992. He also served on the Boards of
Directors of ACORD, IVANS, the North River Insurance Company, US Fire Insurance
Company, The Westchester Insurance Company and the agency systems vendor,
Redshaw, Inc.
Family Relationships
There are no family relationships among the directors or executive officers of
the Company.
Involvement In Certain Legal Proceedings
None of our officers, directors, promoters or control persons have been involved
in the past five years in any of the following:
(1) Any bankruptcy petition filed by or against any business of which such
person was a general partner or executive officer either at the time of the
bankruptcy or within two years prior to that time;
(2) Any conviction in a criminal proceeding or being subject to a pending
criminal proceeding (excluding traffic violations and other minor offenses);
(3) Being subject to any order, judgment or decree, not subsequently reversed,
suspended or vacated, or any court of competent jurisdiction, permanently or
temporarily enjoining, barring, suspending or otherwise limiting his involvement
in any type of business, securities or banking activities; or
(4) Being found by a court of competent jurisdiction (in a civil action), the
Commission or the Commodity Futures Trading Commission to have violated a
federal or state securities or commodities law, and the judgment has not been
reversed, suspended, or vacated.
Code of Ethics
On March 3, 2005, we adopted a Code of Ethics (the "Code") that applies to the
Company, our principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions. The
text of the Code will be provided, without charge, upon request to sent to our
Secretary at Three Stewart Court, Denville, NJ 07834.
Audit Committee
The Audit Committee is responsible for making recommendations to the Board of
Directors as to the selection and independence of our independent registered
public accounting firm (the "Independent Auditor"), maintaining communication
with the Independent Auditor, reviewing the annual audit report submitted by the
Independent Auditor and determining the nature and extent of problems, if any,
presented by such audit warranting consideration by our Board of Directors.
Currently, the Company does not have an audit committee and in accordance with
ss.3(a)(58)(B) of the Securities Exchange Act of 1934, the entire Board of
Directors is acting as the Company's Audit Committee.
26
Compensation Committee
The Compensation Committee is a standing committee of the Board of Directors and
is authorized to review and make recommendations to the Board of Directors on
all matters regarding the remuneration of our executive officers, including the
administration of our compensation plans. The Compensation Committee is intended
to be comprised of at least three members. Currently, the Compensation Committee
is comprised of only Ms. Charlotte G. Denenberg.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires a company's directors, officers and
stockholders who beneficially own more than 10% of any class of equity
securities of the Company registered pursuant to Section 12 of the Exchange Act,
collectively referred to herein as the Reporting Persons, to file initial
statements of beneficial ownership of securities and statements of changes in
beneficial ownership of securities with respect to the company's equity
securities with the SEC. All Reporting Persons are required by SEC regulation to
furnish us with copies of all reports that such Reporting Persons file with the
SEC pursuant to Section 16(a). Based solely on our review of the copies of such
reports and upon written representations of the Reporting Persons received by
us, we believe that all Section 16(a) filing requirements applicable to such
Reporting Persons have been met for 2006.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth information regarding all cash and non-cash
compensation earned by or paid to all of the executive officers of the Company
who served during the fiscal year ended December 31, 2006, for services in all
capacities to the Company:
Summary Compensation Table
Nonqualified
Non-Equity Deferred
Stock Option Incentive Plan Compensation All Other
Salary Bonus Awards Awards(3) Compensation Earnings Compensation Total
Name and Principal Position Year ($) ($) ($) ($) ($) ($) ($) ($)
Fahad Syed 2006 195,366 195,366
Chief Executive Officer (1)
Jeff Robinson 2006 96,756 96,756
Chief Executive Officer (2)
Vasan Thatham 2006 147,053 80,125 227,178
Chief Financial Officer
(1) Effective May 5, 2006, Fahad Syed was appointed CEO and elected Chairman.
(2) Effective May 5, 2006, Jeff Robinson resigned as Chairman and CEO of the
Company.
(3) Value of option awards is the dollar amount recognized for financial
statements reporting purposes with respect for fiscal year 2006.
See Note 11 to Consolidated Financial Statements.
27
Employment Agreements
UCA entered into an employment agreement with Fahad Syed in June of 2003 which
will expire in May 2008, subject to automatic successive one year renewals
unless either the Company or Mr. Syed give notice of intention not to renew the
agreement. The agreement provides for an annual base salary of $150,000, with
specified annual increases to the base salary. Pursuant to the employment
agreement, if we terminate Fahad Syed's employment without cause or good reason,
as defined in the employment agreement, we are obligated to pay a termination
benefit equal to the remaining annual base salary during the initial term of the
employment agreement.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
- ------------------------------------------------------------------------------------------------------------------------------------
Option Awards Stock Awards
- ------------------------------------------------------------------------------------------------------------------------------------
Equity
Equity Incentive
Incentive Plan
Plan Awards:
Awards: Market or
Equity Number of Payout
Incentive Unearned Value of
Number of Plan Awards: Market Shares, Unearned
Securities Number of Number of Number of Value of Units or Shares,
Underlying Securities Securities Shares or Shares or Other Units or
Unexercised Underlying Underlying Units of Units of Rights Other
Options Unexercised Unexercised Option Option Stock That Stock That That Have Rights That
(#) Options (#) Unearned Exercise Expiration Have Not Have Not Not Vested Have Not
Name Exercisable Unexercisable Options (#) Plan ($) Date Vested (#) Vested ($) (#) Vested ($)
- ------------------------------------------------------------------------------------------------------------------------------------
Fahad Syed - - - - - - - - -
(CEO)
- ------------------------------------------------------------------------------------------------------------------------------------
Vasan Thatham 75,000 225,000 - $1.40 06/22/15 - - - -
(CFO)
- ---------------- ------------ -------------- -------------- ---------- ----------- ------------ ------------ ----------- -----------
Compensation Of Directors
The following table sets forth information with respect to director's
compensation for the fiscal year ended December 31, 2006.
28
DIRECTORS COMPENSATION
Fees
Earned
or Non-Equity Nonqualified
Paid Incentive Deferred
in Stock Option Plan Compensation All Other
Cash Awards Awards Compensation Earnings Compensation Total
($) ($) ($) ($) ($) ($)
Name
Charlotte G. Denenberg
(1 & 2) $6,000 $85,684 $91,684
Joseph Perno
(1 & 2) $3,000 $19,533 $22,533
(1) Cash payments made in fiscal year 2006.
(2) Value of option awards is the dollar amount recognized for financial
statements reporting purposes with respect for fiscal year 2006.
See Note 11 to Consolidated Financial Statements.
Our non executive directors will receive an initial grant of stock options to
purchase 125,000 shares of common stock with an exercise price equal to the fair
market value. The options shall vest into 15,625 shares of common stock on the
date of grant and thereafter into 15,625 shares every three months for as long
as the board member is a member of our Board of Directors as of such date. The
option shall have a term of ten years from the date of grant. Every member of
the Board of Directors who is not an employee shall be entitled to a bi-annual
grant of Stock Options to purchase 125,000 shares of common stock on the two
year anniversary of the initial grant date and for every two year anniversary of
such date thereafter for as long as the member is a member of the Board of
Directors. The options shall vest into 15,625 shares of common stock on the date
of grant and into 15,625 shares of common stock every three months thereafter.
The options shall have a term of ten years. The exercise price shall be the fair
market value on the date of grant. Independent directors are also reimbursed for
out-of-pocket expenses in connection with attendance at board meetings and
committee meetings. In April 2006, we granted Joseph Perno stock options to
purchase 125,000 shares of our common stock. In March 2005, we granted each of
our then three non executive directors, Charlotte G. Denenberg, Richard R.
Howard and Madelyn M. DeMatteo, stock options to purchase 125,000 shares of
common stock. Each of our non-employee directors are entitled to receive 12,000
in 2006 for attending board Meetings
2005 Stock Option Plan
In March 2005, our Board of Directors and stockholders adopted our 2005 Stock
Option Plan, pursuant to which 9,000,000 shares of common stock were reserved
for issuance upon exercise of options. Our stock option plan is designed to
serve as an incentive for retaining qualified and competent employees, directors
and consultants. Our Board of Directors or a committee of our Board of Directors
administers our stock option plan and is authorized, in its discretion, to grant
options under our stock option plan to all eligible employees, including our
officers, directors (whether or not employees) and consultants. Our stock option
plan provides for the granting of both "incentive stock options" (as defined in
Section 422 of the Internal Revenue Code of 1986, as amended) and non-qualified
stock options. Options can be granted under our stock option plan on such terms
and at such prices as determined by the Board of Directors or its committee,
except that the per share exercise price of options will not be less than the
fair market value of the common stock on the date of grant. In the case of an
incentive stock option granted to a stockholder who owns stock possessing more
29
than 10% of the total combined voting power of all of our classes of stock, the
per share exercise price will not be less than 110% of the fair market value on
the date of grant. The aggregate fair market value (determined on the date of
grant) of the shares covered by incentive stock options granted under our stock
option plan that become exercisable by a grantee for the first time in any
calendar year is subject to a $100,000 limit. Options granted under our stock
option plan will be exercisable during the period or periods specified in each
option agreement. Options granted under our stock option plan are not
exercisable after the expiration of 10 years from the date of grant (five years
in the case of incentive stock options granted to a stockholder owning stock
possessing more than 10% of the total combined voting power of all of our
classes of stock) and are not transferable other than by will or by the laws of
descent and distribution.
30
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
PRINCIPAL STOCKHOLDERS
The table below sets forth information with respect to the beneficial ownership
of our common stock as of March 14, 2007 for (i) persons who own more than 5% of
our outstanding common stock; (ii) each of our directors or those nominated to
be directors, and executive officers; and (iii) all of our directors and
executive officers as a group.
- ------------------------------------ ----------------------- -------------------
Name and Address Amount and Nature of Percentage
of Beneficial Owner Beneficial Ownership of Class(1)
- ------------------------------------ ----------------------- -------------------
Fred Nazem 15,807,477 (2) 20.8%
44 East 73rd Street
New York, NY 10021
- ------------------------------------ ----------------------- -------------------
Faisal Syed 13,238,462 17.5%
12 Kings Brook Court
Mendham, NJ 07945
- ------------------------------------ ----------------------- -------------------
Mohamed Asif 13,238,462 17.5%
53 Burnet Hill Road
Livingston, NJ 07039
- ------------------------------------ ----------------------- -------------------
Fahad Syed 7,331,731 (3) 9.6%
c/o NetFabric Holdings, Inc
3 Stewart Court
Denville, NJ 07834
- ------------------------------------ ----------------------- -------------------
Jeff Robinson 4,832,476 6.4%
Five Tomaselli Court
Ballston Spa, NY 12020
- ------------------------------------ ----------------------- -------------------
Vasan Thatham 75,000 (4) *
c/o NetFabric Holdings, Inc.
3 Stewart Court
Denville, NJ 07834
- ------------------------------------ ----------------------- -------------------
Charlotte G. Denenberg 125,000 (5) *
c/o NetFabric Holdings, Inc.
3 Stewart Court
Denville, NJ 07834
- ------------------------------------ ----------------------- -------------------
Joseph Perno 78,125 (6) *
c/o NetFabric Holdings, Inc.
3 Stewart Court
Denville, NJ 07834
- ------------------------------------ ----------------------- -------------------
Laurus Master Fund, Ltd. 5,904,902 (7) 7.2%
c/o Laurus Capital Management, LLC
825 Third Avenue, 14th Floor
New York, NY 10022
- ------------------------------------ ----------------------- -------------------
UTEK Corporation 7,165,000 (8) 9.5%
2109 Palm Avenue
Tampa, FL 33605
- ------------------------------------ ----------------------- -------------------
All Directors and Executive
Officers as a Group (4 persons) 7,609,856 (9) 9.9%
- ------------------------------------ ----------------------- -------------------
* Less than 1%.
(1) Applicable percentage of ownership is based on 75,663,883 shares of common
stock outstanding as of March 14, 2007 for each stockholder. Beneficial
ownership is determined in accordance with the rules of the SEC and generally
includes voting of investment power with respect to securities. Shares of common
stock subject to securities exercisable or convertible into shares of common
stock that are currently exercisable or exercisable within 60 days of March 14,
2007 are deemed to be beneficially owned by the person holding such options for
the purpose of computing the percentage of ownership of such persons, but are
not treated as outstanding for the purpose of computing the percentage ownership
of any other person.
(2) Includes 100,000 shares issuable upon exercise of warrants, 400,000 shares
issuable upon the conversion convertible debentures, and 6,592,212 shares held
by the Fred F. Nazem Children's Trust, whose trustees are Alexander Nazem,
Farhad Nazem and Sohelya Gharib. Fred Nazem disclaims beneficial ownership of
these securities.
31
(3) Includes 300,000 shares issuable upon exercise of warrants and 300,000
shares issuable upon conversion of convertible debt.
(4) Includes 75,000 shares issuable upon exercise of options.
(5) Includes 125,000 shares issuable upon exercise of options.
(6) Includes 78,125 shares issuable upon exercise of options.
(7) Includes 4,256,550 shares issuable upon exercise of warrants and 1,648,352
shares issuable upon conversion of convertible debenture. Laurus Capital
Management, LLC manages Laurus Master Fund Ltd. Eugene Grin and David Grin,
through other entities, are the controlling principals of Laurus Capital
Management, LLC and share sole voting and investment power over the securities
owned by Laurus Master Fund Ltd.
(8) Dr. Clifford M. Gross, PhD, Chairman and Chief Executive Officer, Ms. Carole
R. Wright, Chief Financial Officer and Mr. Douglas Schaedler, Chief Operating
Officer, make the investment decisions on behalf of Utek Corporation.
(9) Includes 278,125 shares issuable upon exercise of options, 300,000 shares
issuable upon exercise of warrants and 300,000 shares issuable upon conversion
of convertible debt.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
In April 2006, we sold the 2006 Convertible Debentures in the face amount of
$150,000 to Fahad Syed, an officer and director and in the face amount of
$50,000 to Fred Nazem, a stockholder (For the purposes of this paragraph, Mr.
Syed and Mr. Nazem are collectively referred to as the "Debenture Holders"). The
2006 Convertible Debentures bear interest at 8% and were due originally on June
17, 2006. At the option of the Debenture Holders, the 2006 Convertible
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, we issued
warrants to the two Debenture Holders for an aggregate amount of 150,000 shares
of the Company's common stock as additional consideration. In December 2006, the
Debenture Holders extended the maturity of the 2006 Convertible Debentures to
April 2007.
In June 2006, we sold a Stockholder Convertible Debenture in the face amount of
$150,000 to Fred Nazem. The Stockholder Convertible Debenture bears interest at
8% and was 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, we issued
300,000 shares of its common stock as additional consideration. In December
2006, Fred Nazem extended the maturity of the Stockholder Convertible Debenture
to April 2007.
We have a sublease with UCA Global, Inc., an entity affiliated with Faisal Syed,
a stockholder . The lease is for an office of 13,000 square feet for a three
year term through July 2008 with an annual rent of $144,000. The sublease rent
was determined by the landlord based on the area of usage and we pay our share
of rent directly to the landlord.
Prior to our acquisition of UCA, UCA issued a promissory note to Faisal Syed, a
stockholder, in the principal amount of $100,000. The note bears interest at the
rate of 6%. The promissory note, together with accrued but unpaid interest, was
due on June 16, 2005. We repaid the promissory note in February 2006.
In June 2005, Fred Nazem, a stockholder, advanced $70,000 to the Company for
working capital. The loan was interest free and not subject to any written
agreement and did not have any formal due date. We paid the note in February
2006.
In June 2005, Fahad Syed, an officer and director, advanced $200,000 to the
Company for working capital. Initially, the loan was interest free and not
subject to any written agreement. In December 2005, we issued a promissory note
to formalize our borrowing. The note bore interest at 5% and it was due in
January 2006. We paid the note in February 2006. In December 2005, we also
issued a warrant to acquire 300,000 shares of our common stock at $1.00 per
share to Fahad Syed as additional consideration. The warrant expires in January
2009.
32
In July 2005, we sold convertible debentures to a stockholder, Fred Nazem, and
to CCS Group, LLC. ("CCS"), an entity affiliated with Walter Carozza, our former
officer, in the face amounts of $50,000 each, repayable in April 2006. The
convertible debentures can be converted into 100,000 shares of our common stock
at a conversion price of $.50 per share. In connection with the sale, we issued
each of them warrants to acquire 100,000 shares of our common stock at an
exercise price of $1.50 per share. The warrants expire three years from the date
of issuance. We also issued to Mr. Nazem and CCS 37,500 shares each of our
common stock as additional consideration. Fred Nazem converted the debenture
into 100,000 shares of common stock in April 2006. The maturity date of the
convertible debenture held by CCS was extended to September 2006. In September,
CCS converted the convertible debenture into 100,000 shares of common stock. As
consideration for the conversion, we issued CCS 300,000 shares of our common
stock.
In the normal course of business, the Company performed services for and billed
Clear to Close, Inc., an entity affiliated with the Company's stockholders, in
the amounts of $ 68,000 and $141,000, respectively, during the years ended
December 31, 2006 and 2005. As of December 31, 2006, approximately $235,000 was
owed to the Company by Clear to Close, Inc. including amounts owed to UCA prior
to the acquisition and a full allowance is provided due to uncertainty over the
recovery of the amount.
Charlotte G. Denenberg is not considered an independent director.
ITEM 13. EXHIBITS.
A. Exhibits
--------------- ---------------------------------------------------------------
Exhibit 2.1 Share Exchange Agreement between the Company, NetFabric,
NetFabric's shareholders and Littlehampton LLC, dated December
9, 2004. (1)
Exhibit 2.2 Share Exchange Agreement between the Company, UCA Services,
Inc. and all of the Shareholders of UCA Services, Inc.
dated 20, 2005. (4)
Exhibit 3.1 Articles of Incorporation (12)
Exhibit 3.2 By-Laws. (7)
Exhibit 10.1 Letter Agreement between Houston Operating Company, NetFabric
Corporation, Macrocom Investors, LLC and Littlehampton
Investments, LLC, dated March 25, 2005. (3)
Exhibit 10.2 Financing Agreement between NetFabric and Macrocom, dated July
22, 2004. (1)
Exhibit 10.3 Loan Agreement between NetFabric and Macrocom, dated October
14, 2004. (1)
Exhibit 10.4 Amendment to Financing and Loan Agreement between NetFabric
and Macrocom, dated December 2, 2004. (1)
Exhibit 10.5 Distribution Agreement between NetFabric and Williams, dated
November 29, 2004. (1)
Exhibit 10.6 Lease Agreement between NetFabric and Silvermine, dated
January 1, 2004. (1)
Exhibit 10.7 2005 Stock Option Plan. (2)
Exhibit 10.8 Agreement with Macrocom Investors, LLC for Convertible
Debentures dated July 19, 2005. (5)
Exhibit 10.9 Warrant, dated as October 27, 2005, issued by the Company to
Cornell Capital Partners, LP. (6)
Exhibit 10.10 Securities Purchase Agreement, dated as of October 27, 2005,
by and between the Company and Cornell Capital Partners, LP.
(6)
Exhibit 10.11 Investor Registration Rights Agreement, dated as of October
27, 2005, by and between the Company and Cornell Capital
Partners, LP. (6)
33
Exhibit 10.12 Escrow Agreement, dated as of October 27, 2005, by and among
the Company, Cornell Capital Partners, LP and David Gonzalez,
Esq., as escrow agent pursuant to the Securities Purchase
Agreement. (6)
Exhibit 10.13 Amended and Restated Security Agreement, dated as of October
27, 2005, by and between the Company and Cornell Capital
Partners, LP. (6)
Exhibit 10.14 Amended and Restated Security Agreement, dated as of October
27, 2005, by and between the Company and Cornell Capital
Partners, LP. (6)
Exhibit 10.15 Amended and Restated Security Agreement, dated as of October
27, 2005, by and between UCA Services, Inc. and Cornell
Capital Partners, LP. (6)
Exhibit 10.16 Officer Pledge and Escrow Agreement, dated as of October 27,
2005, by and among the Company, Cornell Capital Partners, LP
and David Gonzalez, Esq., as escrow agent. (6)
Exhibit 10.17 Form of Secured Convertible Debenture issued to Cornell
Capital Partners, LP dated October 27, 2005. (6)
Exhibit 10.18 Employment Agreement with Fahad Syed. (7)
Exhibit 10.19 Amendment of The Share Exchange Agreement dated February 13,
2006 by and among NetFabric, Holdings, Inc. UCA Services, Inc.
and UCA Shareholders. (8)
Exhibit 10.20 Security Agreement, dated February 10, 2006, by and between
the Company and Laurus Master Fund, Ltd.
Exhibit 10.21 Secured Convertible Note, dated February 10, 2006, by and
between the Company and Laurus Master Fund, Ltd. (9)
Exhibit 10.22 Secured Non-Convertible Note, dated February 10, 2006, by and
between the Company and Laurus Master Fund, Ltd. (9)
Exhibit 10.22 Option, dated February 10, 2006, by the Company. (9)
Exhibit 10.23 Registration Rights Agreement, dated February 10, 2006, by and
between the Company and Laurus Master Fund, Ltd. (9)
Exhibit 10.24 Subsidiary Guaranty, dated February 10, 2006 from NetFabric
Corporation and UCA Services, Inc. (9)
Exhibit 10.25 Letter agreement, dated February 10, 2006 between the Company
and Laurus Master Fund. (9)
Exhibit 10.27 Form of Convertible Debenture dated April 19, 2006 issued by
the Company. (10)
Exhibit 10.28 Form of Warrant, dated April 19, 2006 issued by the Company.
(10)
Exhibit 10.28 Agreement and Plan of Acquisition by and between Intrusion
Detection Technologies, Inc., UTEK Corporation and NetFabric
Holdings, Inc. (11)
Exhibit 14.1 Code of Business Conduct and Ethics. (3)
Exhibit 21.1 Subsidiaries of the Registrant*
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification (CEO)*
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification (CFO)*
Exhibit 32.1 Section 1350 Certification (CEO)*
34
Exhibit 32.2 Section 1350 Certification (CFO)*
* Filed herewith.
(1) Filed as an Exhibit to the Company's 8-K filed on December 15, 2004.
(2) Filed with Schedule 14C Information on March 21, 2005.
(3) Filed as an Exhibit to the Company's 10K/A filed on December 19, 2005.
(4) Filed as an Exhibit to the Company's Form 8-K on May 26, 2005
(5) Filed as an Exhibit on the Company's 8-K filed on July 25, 2006.
(6) Filed as an Exhibit on the Company's SB-2 on November 2, 2005
(7) Filed as an Exhibit on the Company's 10KSB filed on April 15, 2006
(8) Filed as an Exhibit to the Company's Form 8_8K filed on February 15, 2006
(9) Filed as an Exhibit to the Company's Form 8-K filed on February 15, 2006
(10) Filed as an Exhibit to the Company's Form 8-K filed on April 19, 2006
(11) Filed as an Exhibit to the Company's Form 8-K filed on August 16, 2006
(12) Filed with Schedule 14C Information on October 24, 2006
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Through September 30, 2005, Goldstein Golub Kessler LLP (the "Firm") had a
continuing relationship with American Express Tax and Business Services Inc.
("TBS") from which it leased auditing staff who were full time, permanent
employees of TBS and through which its partners provided non-audit services.
Subsequent to September 30, 2005 this relationship ceased and the Firm
established a similar relationship with RSM McGladrey, Inc. The Firm has no full
time employees, and, therefore, none of the audit services performed were
provided by permanent, full-time employees of the Firm. The Firm manages and
supervises the audit and audit staff and is exclusively responsible for the
opinion rendered in connection with its examination.
Audit Fees
The aggregate fees billed or to be billed for professional services rendered by
our independent registered public accounting firm for the audit of our annual
financial statements, review of financial statements included in our quarterly
reports and other fees that are normally provided by the accounting firm in
connection with statutory and regulatory filings or engagements for the fiscal
years ended December 31, 2006 and 2005 were $160,000 and $181,000, respectively.
For 2006, $100,000 of fees were billed or to be billed by our current
independent registered public accounting firm GGK and $60,000 were billed by
JHC, our former independent registered public accounting firm. For 2005, all
fees were billed by JHC.
Audit Related Fees
The aggregate fees billed or to be billed for audit related services by our
independent registered public accounting firm that are reasonably related to the
performance of the audit or review of our financial statements, other than those
previously reported in this Item 14, for the fiscal years ended December 31,
2006 and 2005 were $0 and $53,000, respectively. All these amounts were billed
by JHC.
35
Tax Fees
The aggregate fees billed for professional services rendered by our independent
registered public accounting firm for tax compliance, tax advice and tax
planning for the fiscal years ended December 31, 2006 and 2005 were $0 and
$$8,000, respectively. All these amounts were billed by JHC.
All Other Fees
There were no other fees billed for services by our independent registered
public accounting firm for either audit related or non audit services for the
fiscal years ended December 31, 2006 and 2005.
The Audit Committee considered and determined that the services performed are
compatible with maintaining the independence of the independent registered
public accounting firm.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit
Services of Independent Auditor
The Audit Committee is responsible for pre-approving all audit and permitted
non-audit services to be performed for us by our Independent Registered Public
Accounting Firm as outlined in its Audit Committee charter. Prior to engagement
of the Independent Registered Public Accounting Firm for each year's audit,
management or the Independent Registered Public Accounting Firm submits to the
Audit Committee for approval an aggregate request of services expected to be
rendered during the year, which the Audit Committee pre-approves. During the
year, circumstances may arise when it may become necessary to engage the
Independent Registered Public Accounting Firm for additional services not
contemplated in the original pre-approval. In those circumstances, the Audit
Committee requires specific pre-approval before engaging the Independent
Registered Public Accounting Firm. The Audit Committee does not delegate to
management its responsibility to pre-approve services performed by the
Independent Registered Public Accounting Firm.
36
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: April 13, 2007 /s/ FAHAD SYED
-----------------
Fahad Syed, Chairman and
Chief Executive Officer
(principal executive officer)
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Date: April 13, 2007 /s/ FAHAD SYED
-----------------
Fahad Syed, Chairman
and Chief Executive Officer
(principal executive officer)
Date: April 13, 2007 /s/ VASAN THATHAM
-----------------
Vasan Thatham, Chief Financial
Officer (principal accounting officer)
Date: April 13, 2007 /s/ JOSEPH PERNO
----------------
Joseph Perno, Director
Date: April 13, 2007 /s/ CHARLOTTE G. DENENBERG
--------------------------
Charlotte G. Denenberg, Director
37
NETFABRIC HOLDINGS INC AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm......................F-1
Report of Independent Registered Public Accounting Firm......................F-2
Consolidated financial statements:
Consolidated Balance Sheet, December 31, 2006.............................F-3
Consolidated Statements of Operations, for the years
ended December 31, 2006 and 2005..........................................F-4
Consolidated Statements of Stockholders' Equity
(Deficit), for the years ended December 31, 2006 and 2005.................F-5
Consolidated Statements of Cash Flows, for the years
ended December 31, 2006 and 2005..........................................F-6
Notes to Consolidated financial statements.........................F-7 - F-36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
NetFabric Holdings, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of NetFabric
Holdings, Inc. and Subsidiaries as of December 31, 2006, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
NetFabric Holdings, Inc. and Subsidiaries as of December 31, 2006 and their
consolidated results of operations and their cash flows for the year then ended,
in conformity with United States generally accepted accounting principles.
As discussed in Note 11 to the consolidated financial statements, the Company
changed the manner in which it accounts for stock-based compensation in 2006.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has had net losses from inception
and has a working capital deficiency. These matters raise substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
April 13, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
NetFabric Holdings Inc. and Subsidiaries
We have audited the accompanying consolidated statements of operations,
stockholders' equity (deficit) and cash flow of NetFabric Holdings Inc. and,
subsidiaries, formerly Houston Operating Company ("NetFabric") for the year
ended December 31, 2005. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
an perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, NetFabric's results of operations, and cash
flows for the year ended December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying 2005 consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the 2005 consolidated financial statements, the Company has had net losses
from inception and has a working capital deficiency. These matters raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The 2005
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ J.H. Cohn LLP
Jericho, New York
April 17, 2006 except for Note 3
as to which the date is March 30, 2007
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
2006
--------------
ASSETS
Cash $ 13,437
Trade accounts receivable, net 2,149,680
Due from related party --
Prepaid expenses and other current assets 5,110
------------
Total current assets 2,168,227
Property and equipment, net 197,215
Goodwill 13,982,451
Other intangibles, net 879,702
Other assets 55,028
------------
TOTAL ASSETS $ 17,282,623
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bridge loans, net of unamortized discount $ --
Convertible debentures, net of unamortized discounts 685,169
Note payable to officer, net of unamortized discount 150,001
Loans and advances from officer and stockholders --
Accounts payable and accrued liabilities 3,747,807
Accrued compensation 338,283
Deferred revenues and customer advances --
Revolving note, net of unamortized discount 1,014,249
------------
Total current liabilities 5,935,509
------------
Derivative financial instruments --
Convertible debentures, net of unamortized discount --
Convertible note, net of unamortized discount 443,430
------------
Total liabilities 6,378,939
------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common Stock, $.001 par value, authorized shares 200,000,000 and
100,000,000 respectively, 75,023,883 and 62,44,357 shares issued and
outstanding,respectively 75,024
Additional paid-in capital 36,201,479
Deferred employee compensation
Accumulated deficit (25,372,819)
------------
Total stockholders' equity 10,903,684
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,282,623
============
The accompanying notes should be read in conjunction with the consolidated financial statements.
F-3
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED YEAR ENDED
DECEMBER 31,2006 DECEMBER 31, 2005
---------------- -----------------
Revenues $ 17,599,303 $ 12,540,984
------------ ------------
OPERATING EXPENSES:
Direct employee compensation and
consultant expenses (includes share based compensation
of $22,792 and $0) 13,352,858 9,257,320
Selling, general and administrative expenses (includes
share based compensation of $606,574 and $0) 6,272,570 4,530,313
Non-cash charge for dispute settlements 9,492,070 --
In process research and development 160,000 --
Depreciation and amortization 344,846 171,916
------------ ------------
Total operating expenses 29,622,344 13,959,549
------------ ------------
Loss from operations (12,023,041) (1,418,565)
OTHER INCOME / (EXPENSE):
Amortization of debt discounts and debt
issuance costs (2,819,289) (1,197,277)
Interest and bank charges (316,439) (103,888)
Gain/(charge) on derivative financial instruments 336,352 (2,131,109)
Debt extinguishment costs (1,773,181) 100,758
------------ ------------
Total other income / (expense) (4,572,557) (3,331,516)
------------ ------------
Loss before provision for income taxes (16,595,598) (4,750,081)
Provision for income taxes -- --
------------ ------------
LOSS FROM CONTINUING OPERATIONS (16,595,598) (4,750,081)
------------ ------------
DISCONTINUED OPERATIONS:
Loss from operations of discontinued operations (474,411) (2,031,904)
------------ ------------
NET LOSS $(17,070,009) $ (6,781,985)
============ ============
Net loss from continuing operations
per common share, basic and diluted $ (0.24) $ (0.09)
============ ============
Net loss from discontinued operations
per common share, basic and diluted $ (0.01) $ (0.04)
============ ============
Net loss per common share, basic and
diluted $ (0.25) $ (0.13)
============ ============
Weighted average number of shares
outstanding, basic and diluted 68,056,366 52,735,122
============ ============
The accompanying notes should be read in conjunction with the consolidated financial statements.
F-4
NETFABRIC HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
` COMMON STOCK
ADDITIONAL
SHARES PAR VALUE PAID-IN CAPITAL
Balances at December 31, 2004 34,652,204 $ 34,652 $ 1,216,523
Sale of common stock to investors, net of offerings costs $368,683 2,000,000 2,000 629,317
Settlement of bridge loan with common stock 1,000,000 1,000 499,000
Issuance of shares in connection with acquisition 24,096,154 24,096 13,798,904
Allocation of value to warrants in connection with bridge loan 392,196
Deferred employee stock option compensation 67,500
Amortization of deferred employee stock option compensation
Issuance of shares in connection with SEDA, net 249,999 250 349,313
Issuance of shares in connection with convertible debentures 450,000 450 155,608
Issuance of warrants in connection with convertible debentures 395,333
Allocation of value of beneficial conversion feature in connection with
convertible debentures 416,509
Reclassification of financial instrument
Net loss
------------------------------------------------
Balances at December 31, 2005 62,448,357 62,448 16,657,804
------------------------------------------------
Issuance of common shares in connection with settlement of payables 60,526 61 57,439
Value of contributions from shareholder in connection with
settlement of disputes - - 9,492,070
Employee share-based compensation - - 493,762
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 500,000 500 129,500
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 - - 133,969
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 - - 115,908
Allocation of value of common shares issued in connection with extension -
of convertible debentures 350,000 350 55,992
Issuance of common shares for services 290,000 290 40,744
Issuance of warrants for services - - 51,516
Issuance of shares for licensing agreement acquisition, cash and services 8,250,000 8,250 801,750
Net loss - -
------------------------------------------------
BALANCES AT December 31, 2006 75,023,883 75,024 36,201,479
================================================
[TABLE CONTINUED]
TOTAL
DEFERRED ACCUMULATED STOCKHOLDERS'
COMPENSATION DEFICIT EQUITY
Balances at December 31, 2004 ($ 1,520,825) $ (269,650)
Sale of common stock to investors, net of offerings costs $368,683 631,317
Settlement of bridge loan with common stock 500,000
Issuance of shares in connection with acquisition 13,823,000
Allocation of value to warrants in connection with bridge loan 392,196
Deferred employee stock option compensation (67,500) -
Amortization of deferred employee stock option compensation 31,022 31,022
Issuance of shares in connection with SEDA, net 349,563
Issuance of shares in connection with convertible debentures 156,058
Issuance of warrants in connection with convertible debentures 395,333
Allocation of value of beneficial conversion feature in connection with
convertible debentures 416,509
Reclassification of financial instrument
Net loss (6,781,985) (6,781,985)
------------------------------ ---------------
Balances at December 31, 2005 (36,478) (8,302,810) 8,380,964
------------------------------ ---------------
Issuance of common shares in connection with settlement of payables 57,500
Value of contributions from shareholder in connection with
settlement of disputes 9,492,070
Employee share-based compensation 493,762
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 130,000
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 133,969
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 115,908
Allocation of value of common shares issued in connection with extension
of convertible debentures 56,342
Issuance of common shares for services 41,034
Issuance of warrants for services 51,516
Issuance of shares for licensing agreement acquisition, cash and services 810,000
Net loss (17,070,009) (17,070,009)
------------------------------ ---------------
BALANCES AT December 31, 2006 - (25,372,819) 10,903,684
============================== ===============
The accompanying notes should be read in conjunction with the consolidated financial statements.
F-5
NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended Year ended
December December
2006 2005
------------------ ---------------
OPERATING ACTIVITIES
Net loss $(17,070,009) $(6,781,985)
Loss from discontinued operations 474,411 2,031,904
Adjustments to reconcile net loss to net cash used in
operating activities:
Non-cash charge for common stock issued for rent 50,000
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 1,152,104 --
Non-cash charge for in process R&D 160,000 --
Non-cash charge for reissuance of warrants in connection with
debt extinguishment 372,353 --
Non-cash charge for shares issued in connection with the SEDA 349,563
Non-cash charge for share based compensation 629,366 51,648
Common stock issued for services 150,000
Non-cash gain on debt extinguishment (32,638) (100,758)
Non-cash gain on derivative financial instrument (336,352) 2,131,109
Allowance for bad debts 107,344 206,694
Allowance for inventory obsolescence 248,742
Impairment of fixed assets 111,536
Amortization of debt discounts 2,819,289 1,197,277
Depreciation and amortization 344,846 171,916
Changes in operating assets and liabilities:
Inventory (176,717)
Trade accounts receivable (59,479) (124,643)
Due from related party 84,712 (192,056)
Prepaid expenses and other current assets 29,956 30,139
Other assets (47,098) 22,864
Accounts payable and accrued liabilities 796,496 553,988
Accrued compensation (42,439) 160,357
Deferred revenues and advances (66,019) (1,032,648)
------------ -----------
Net cash provided by continuing operations (1,018,587) (1,091,070)
Net cash used in discontinued operations (454,344) (1,954,879)
------------ -----------
Net cash used in operating activities (1,472,931) (3,045,949)
------------ -----------
INVESTING ACTIVITIES
Direct acquisition costs of UCA Services -- (187,000)
Purchases of property and equipment (132,667) (120,845)
------------ -----------
Net cash provided by (used in) investing activities (132,677) (307,845)
------------ -----------
FINANCING ACTIVITIES
Proceeds from issuance of common stock -- 1,000,000
Loans and advances from stockholders and officers -- 270,000
Repayment of note to officer (200,000) --
Convertible debentures issued 950,000 100,000
Repayments of bridge loans (500,000) --
Proceeds (repayment) of convertible debentures (1,658,160) 1,951,160
Cash received for issuance of stock 500,000
Proceeds from issuance of revolving note, net 1,417,852 --
Proceeds from issuance of convertible note, net 1,430,500 --
Debt issuance costs (60,697) (25,545)
Repayment of convertible debenture (100,000)
Repayment of loans from officer and director (170,000) --
------------ -----------
Net cash provided by financing activities 1,609,495 3,295,615
------------ -----------
Net increase in cash 3,897 (58,179)
Cash at beginning of year 9,540 67,719
------------ -----------
Cash at end of year $ 13,437 $ 9,540
============ ===========
Supplemental cash flow information:
Cash paid for interest expense $ 261,000 $ 31,250
============ ===========
Cash paid for income taxes $ -- $ --
============ ===========
The accompanying notes should be read in conjunction with the consolidated financial statements.
F-6
NetFabric Holdings Inc. and Subsidiaries
Notes to 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) was incorporated under the laws of the State of
Delaware on August 31, 1989. On December 9, 2004, Holdings entered into an
Exchange Agreement (the "Acquisition Agreement" or "Share Exchange") with all of
the stockholders of NetFabric Corporation ("NetFabric") whereby Holdings
acquired all of the issued and outstanding capital stock of NetFabric and
NetFabric became a wholly-owned subsidiary of Holdings. Upon completion of the
merger, the NetFabric stockholders controlled approximately 95% of the then
issued and outstanding stock. NetFabric's business activities were the
activities of the merged company and Holdings was a shell corporation without
any operations. As a result of these factors, this transaction was treated as a
reverse merger for financial reporting purposes
NetFabric, a Delaware corporation incorporated on December 17, 2002, began
operations in July 2003. NetFabric developed and marketed Voice Over Internet
Protocol ("VoIP") appliances that simplified 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 ("SMB's"). 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 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"), a New Jersey company,
from its shareholders in exchange for the issuance of 24,096,154 shares of
common stock of Holdings (see Note 7). 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 and communications needs of a wide range of
Fortune 500 and small to mid-size business clients in the financial markets
industry as well as the pharmaceutical, health care and hospitality sectors. UCA
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 consolidated financial statements have been prepared on a going
concern basis. As shown in the accompanying consolidated financial statements,
the Company has incurred accumulated losses totaling $25,372,819 and has a
working capital deficit of $3,767,282 at December 31, 2006. These factors, among
others, indicate that the Company may be unable to continue as a going concern.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
F-7
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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
throughout fiscal 2007 and continue its business development efforts.
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
the necessary working capital. There is no assurance that the Company will be
successful in completing the financing. To fund the Company's operations for
fiscal year 2007, the Company needs to raise additional financing and generate
cash flows from its operations. Should additional cash flows not be available,
the Company believes that it will have the ability to restructure its
operations, and if necessary, initiate significant expense reductions. 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.
NOTE 2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND
PRACTICES
Basis of Presentation of Consolidated Financial Statements and Estimates
The consolidated financial statements include the accounts of Holdings and its
wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated. The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles in the
United States of America 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 the value and allocation of purchase
price in business combinations, provisions for bad debts,
depreciable/amortizable lives, impairment of goodwill and other long-lived
assets, the fair value of common stock and options issued for services as well
as the allocation of proceeds from the bridge loan to and financial instruments
and other reserves. Because of the uncertainty inherent in such estimates,
actual results may differ from these estimates.
Reclassifications
Certain reclassifications have been made in the 2005 consolidated financial
statements to conform to the current presentation.
Revenue Recognition
In accordance with the 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.
The Company 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 is 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.
F-8
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Billings and collections in excess of revenue recognized are classified as
deferred revenue.
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
recorded allowances for bad debts of $107,344 and $206,694 during years ended
December 31, 2006 and 2005, respectively. As of December 31, 2006 and 2005,
doubtful allowance balances were $321,555 and $206,694, respectively
Cash and Cash Equivalents
The Company considers all investments with an original maturity of three months
or less when purchased to be cash equivalents.
Property and Equipment
Property and equipment, consisting principally of computer equipment and
furniture and fixtures, are recorded at cost. Depreciation and amortization are
provided for on a straight line basis over the following useful lives:
Equipment 3 years
Purchased software 3 years
Furniture and fixtures 7 years
Leasehold improvements Lesser of life of lease or useful life
Repairs and maintenance are charged to operations as incurred. When assets are
retired or otherwise disposed of, the cost and accumulated depreciation and
amortization are removed from the accounts and any resulting gain or loss is
reported in the period realized.
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. During
2005, the Company recognized approximately $112,000 of impairments of fixed
assets in selling, general and administrative expenses for the year ended
December 31, 2005.
F-9
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash and cash equivlents and accounts
receivable. The Company reduces credit risk by placing its cash and cash
equivalents 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 in a variety of industries. During the year ended December 31,
2006, the Company had revenues from 2 clients representing 46% (35% and 11%,
respectively) of the revenues during the year. The Company had revenues from 2
clients representing 40% (30% and 10%, respectively) of revenues during the year
ended December 31, 2005.
The Company generally does not require its clients to provide collateral.
Additionally, the Company is subject to a concentration of credit risk with
respect to its accounts receivable. At December 31, 2006, the Company had one
client accounting for 36% of total gross accounts receivable. The Company had 3
clients accounting for 45% (25%, 10% and 10%, respectively) of total gross
accounts receivable as of December 31, 2005.
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 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 reporting units, 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 is dependent on internal forecasts, estimation of the
long-term rate of growth for UCA Services, period 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. Goodwill at
December 31, 2006 and 2005 was $13,982,451.
Intangibles
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. Intangible assets at December 31, 2006 and 2005 were $879,702 and
$1,099,717, respectively.
F-10
NetFabric Holdings Inc. and Subsidiaries
Notes to 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 approximate their carrying or principal amounts presented in the balance
sheets at December 31, 2006 and 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.
Share-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 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 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.
The historical volatility of Company's stock is used as the basis for the
volatility assumption. The Company has never paid cash dividends, and does not
currently intend to pay cash dividends, and thus assumed a 0% dividend yield
F-11
NetFabric Holdings Inc. and Subsidiaries
Notes to 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 consolidated
financial statements as of and for the year ended December 31, 2006 reflect the
impact of adoption of SFAS 123(R). In accordance with the modified prospective
transition method, the Company's consolidated financial statements for prior
periods have not been restated to reflect, and do not include, the impact of
adoption of SFAS 123(R).
Share-based compensation expense recognized under SFAS 123(R) for the year ended
December 31, 2006 was $493,762. Share-based compensation expense recognized in
the Company's consolidated statements of operations for the year ended December
31, 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
year ended December 31, 2006, the Company adjusted the value of the options
outstanding as of January 1, 2006 for actual cancellations during the year ended
December 31, 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 holders' 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.
F-12
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 net loss for the year ended December 31, 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 year
ended December 31, 2005:
Year ended December 31, 2005
----------------------------
Net loss, as reported $(6,781,985)
Stock-based employee compensation recorded 31,022
-----------
Sub-total (6,750,963)
Stock-based employee compensation expense
determined under fair value method 648,890
-----------
Pro forma net loss, as adjusted $(7,399,853)
===========
Loss per share:
Basic and diluted- as reported $ (0.13)
Basic and diluted- pro forma $ (0.14)
F-13
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Income Taxes
Deferred income tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Deferred tax assets are reduced by a
valuation allowance if it is more likely than not that the tax benefits will not
be realized. The ultimate realization of deferred tax assets depends upon the
generation of future taxable income during the periods in which those temporary
differences become deductible.
Earnings (Loss) Per Share
The Company calculates earnings (loss) per share in accordance with SFAS No.
128, "Earnings per Share." SFAS No. 128 computes basic earnings (loss) per share
by dividing the net income (loss) by the weighted average number of shares of
common stock outstanding during the period. Diluted earnings (loss) per share is
computed by dividing the net income (loss) by the weighted average number of
shares of common stock outstanding during the period plus the effects of any
dilutive securities. Diluted earnings (loss) per share considers the impact of
potentially dilutive securities except in periods in which there is a loss
because the inclusion of the potential common shares would have an anti-dilutive
effect. The Company's potentially dilutive securities include common shares
which may be issued upon exercise of its stock options, exercise of warrants or
conversion of convertible debt.
Diluted earnings (loss) per share for the years ended December 31, 2006 and 2005
exclude potentially issuable common shares of approximately 19,581,124 and
12,940,807, 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.
F-14
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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. In 2006, we
discontinued VoIP segment and operate in one segment. Accordingly, 2005
financial statement presentation has been reclassified.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework for using fair
value to measure assets and liabilities, and expands disclosures about fair
value measurements. The Statement applies whenever other statements require or
permit assets or liabilities to be measured at fair value. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007. We are currently
evaluating the impact this Statement will have on our consolidated financial
statements.
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements," which provides interpretive
guidance regarding the consideration given to prior year misstatements when
determining materiality in current year financial statements. SAB No. 108 is
effective for fiscal years ending after November 15, 2006 and had no impact on
our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation No. (FIN) 48,
"Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement
No. 109" (FIN 48), which clarifies the accounting for uncertainty in income
taxes recognized in accordance with SFAS No. 109, "Accounting for Income Taxes."
This Interpretation prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken,
or expected to be taken, on a tax return. This Interpretation also provides
guidance on derecognition, classification, interest, penalties, accounting in
interim periods, disclosure and transition. The evaluation of a tax position in
accordance with this Interpretation is a two-step process. The first step will
determine if it is more likely than not that a tax position will be sustained
upon examination and should therefore be recognized. The second step will
measure a tax position that meets the more likely than not recognition threshold
to determine the amount of benefit to recognize in the financial statements.
This Interpretation is effective for fiscal years beginning after December 15,
2006. We do not expect the impact of this Statement to have a material effect on
our consolidated financial statements.
F-15
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 SMB's. 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 loss from
discontinued operations of $474,411 for the year ended December 31, 2006. The
Company has reclassified prior period results to conform with the current period
presentation. Accordingly, $2,031,904 for the year ended December 2005, has 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 PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consists of the following at December 31, 2006 and
2005:
2006 2005
--------- ---------
Equipment $ 443,029 $ 395,664
Lease improvements 54,631 54,631
Furniture and fixtures 103,490 59,498
--------- ---------
601,149 509,793
Less: Accumulated depreciation and amortization (403,934) (344,809)
--------- ---------
$ 197,215 $ 164,984
========= =========
A depreciation and amortization expense was $80,369 and $111,901 for the years
ended December 31, 2006 and 2005, respectively.
NOTE 5. INTANGIBLE ASSETS
The Company's intangible assets consisting of customer contacts and restricted
covenants related to employment agreements were acquired and accounted for using
the purchase method of accounting. The following table summarizes the net asset
value for each intangible asset category as of December 31, 2006:
Net
Amortization Gross Asset Accumulated Asset
Period Value Amortization Value
----------- ----------- ------------ ---------
Customer relationship 6 years $1,153,424 ($312,385) $841,039
Covenants not to compete 3 years 83,333 (44,670) 38,663
----------- ---------- --------
$1,236,757 ($357,055) $879,702
=========== ========== ========
F-16
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes the net asset value for each intangible asset
category as of December 31, 2005:
Amortization Gross Asset Accumulated Net Asset
Period Value Amortization Value
------------ ----------- ----------- -----------
Customer relationships 6 years $ 1,153,424 $ (120,148) $ 1,033,276
Covenants not to compete 3 years 83,333 (16,892) 66,441
----------- ----------- -----------
$ 1,236,757 $ (137,040) $ 1,099,717
=========== =========== ===========
Amortization expense was $ 220,015 and $137,040 for the years ended December 31,
2006 and 2005, respectively.
The Company did not have any intangibles prior to the acquisition of UCA
Services in May 2005.
Estimated amortization expense related to intangible assets subject to
amortization at December 31, 2006 for each of the years in the five-year period
ending December 31, 2011:
2007 $220,015
2008 203,122
2009 192,237
2010 192,237
2011 72,091
------------
$879,702
============
NOTE 6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at December
31, 2006 and 2005:
2006 2005
---------- ----------
Trade accounts payable $3,435,748 $2,693,113
Accrued professional fees 218,000 168,741
Accrued interest payable 94,059 126,556
---------- ----------
$3,747,807 $2,988,410
========== ==========
Accounts payable and accrued expenses related to discontinued operations
approximate $163,000 and $191,000 at December 31, 2006 and 2005, respectively.
F-17
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 7. 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 the Company. The acquisition was
accounted for as a business combination with the Company as the acquirer. Under
the purchase method of accounting, the assets and liabilities of UCA Services
acquired by the are recorded as of the acquisition date at their respective fair
values, and added to those of the Company, and the results of UCA Services have
been included with those of the Company since the date of acquisition.
The purchase price of $14,010,000 consists of $13,823,000 of common stock,
$187,000 of acquisition costs, the assumption of $1,209,208 of net liabilities
and the recognition of $1,236,757 of intangibles assets associated with customer
relationships and non-compete covenants of employment agreements. 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 assumed 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 acquired and
liabilities assumed in the acquisition of UCA Services are as follows:
Accounts receivable $ 2,153,968
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 recorded goodwill of $13,982,451 as a result of the cost in excess
of the net assets acquired of UCA Services. 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 year
ended December 31, 2005 as if the results of UCA Services were included for the
entire period 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 year
ended
December 31,
2005
--------------
Revenues $ 19,422,620
Net loss (7,666,058)
Basic and diluted net loss common share $ (0.12)
Weighted average common shares outstanding 61,911,465
F-18
NetFabric Holdings Inc. and Subsidiaries
Notes to Conolidated Financial Statements
NOTE 8. TECHNOLOGY LICENSE ACQUISITION
On August 11, 2006, the Company entered into an agreement with Utek Corporation
("Utek"), an unaffiliated specialty finance company focused on technology
transfers, to acquire a technology license for intrusion detection software
developed by a university. To facilitate the transfer of technology; Utek formed
a subsidiary, Intrusion Detection Technologies, Inc. ("ITDI"). IDTI did not have
any business operations and its assets consisted of cash and a license agreement
with a university for intrusion detection software by the university. The
Company acquired all of the outstanding shares of IDTI from Utek for
consideration of 7,500,000 shares of the Company's common stock, including
375,000 shares assigned by Utek to its consultant. In addition, the Company had
a consultant for the transaction to whom it paid $50,000 of cash and issued
750,000 shares of its common stock. The term of the license agreement is until
the later of 15 years from the date of filing of the licensed patents or the
expiration of the last patent.
The university requires a royalty in the amount of five percent of net sales of
the licensed products. In the university requires certain minimum royalty from
2009 onwards.
Pursuant to an independent appraisal, the Company valued the transaction
at $660,000, including related expense. Net of cash acquired ($500,000 prior to
related expense); $160,000 was allocated to the licensing agreement. The cash
paid to the consultant and the fair value of the shares issued to the consultant
approximated $200,000, and was charged to selling general and administrative
expenses during the year ended December 31, 2006. The Company anticipates
further development and testing of the technology. Because of the uncertainties
surrounding the ultimate commercial deployment of the technology and due to the
technology not having alternative use, the Company charged the cost of the
license agreement as in process research and development costs during the year
ended December 31, 2006.
F-19
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 9. DEBT FINANCINGS
Debt financings consist of the following as of December 31, 2006 and 2005:
2006
-------------- ---------------- --------------
Unamortized
debt
Principal discount Net
-------------- ---------------- --------------
2006 Convertible Debentures, due at various
Dates between December 2006 and April 2007 $700,000 ($14,832) $685,168
Convertible Debenture payable to stockholder
due in April 2007 150,000 150,000
Laurus Revolving Note Due in February 2009 1,487,353 (473,104) 1,014,249
Laurus Convertible Note Due in February 2009 1,500,000 (1,056,570) 443,430
-------------- ---------------- --------------
$3,837,353 ($1,544,506) $2,292,847
============== ================ ==============
2005
-------------- ---------------- --------------
Unamortized
Principal debt discount Net
-------------- ---------------- --------------
Macrocom Bridge Loan II, due October 2006 $500,000 ($58,875) $441,125
Macrocom Convertible Debenture 500,000 (194,444) 305,556
Convertible Debenture payable to stockholder and officer 100,000 (38,890) 61,110
Cornell Convertible Debenture 1,658,160 (1,046,101) 612,059
Note payable to officer 200,000 (99,059) 100,941
Loans and advances from stockholders 202,639 202,639
-------------- ---------------- --------------
$3,160,799 ($1,437,369) $1,723,430
============== ================ ==============
2006 Convertible Debentures
On April 19, 2006, the Company sold Convertible Debentures (the " 2006
Convertible 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 of the Company.
The 2006 Convertible Debentures bear interest at 8% and were due originally on
June 15, 2006. At the option of the Debenture Holders, the 2006 Convertible
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 warrants to two Debenture Holders 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
F-20
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 2006 Convertible Debentures issued to the officer and
director and to the stockholder.
The Company used the proceeds from the sale of the April 2006 Debentures to
repay $500,000 due to the Macrocom Investors, LLC ("Macrocom") pursuant to a
Macrocom Debenture (herein defined) issued in July of 2005.
The Company allocated the $500,000 of proceeds received from the 2006
Convertible Debentures to debt, warrants and stock instruments issued based on
the then computed relative fair values. 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 2006 Convertible 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 2006 Convertible 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 2006 Convertible Debentures and were amortized to interest
expense using the interest method over the originally stated term of the 2006
Convertible Debentures. During the year ended December 31, 2006, $500,000 of
discount was accreted and recorded as amortization of debt discounts and debt
issuance costs included in the accompanying consolidated statements of
operations.
In June 2006, the Company and the Debenture Holders entered into an agreement to
extend the term of the 2006 Convertible 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 relative 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 2006
Convertible Debentures. For the year December 31, 2006, $137,201 of debt
discount was accreted and recorded as amortization of debt discounts.
In September 2006, the Company repaid 2006 Convertible Debentures in the face
amount of $100,000 and entered into an agreement with other Debenture Holders to
extend the term of the remaining 2006 Convertible Debentures to December 15,
2006. In exchange for the extension, the Company issued to the holders an
aggregate of 200,000 shares of its common stock and 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 relative fair
value of the shares of common stock and warrants approximated $35,049 and was
recorded as additional discount and is being amortized over the new term of the
2006 Convertible Debentures. For the year ended December 31, 2006, $35,049, of
debt discount was accreted and recorded as amortization of debt discounts
F-21
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
During the three months ended December 31, 2006, the Company sold to three
individuals Convertible Debentures in the aggregate face amount of $300,000. The
Debentures bear interest at 8% and are due in January 2007. At the option of the
Debenture holder, the 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 warrants to individuals to acquire an aggregate of
400,000 shares of the Company's common stock with a nominal exercise price. The
warrants expire three years from the date of issuance. The relative fair value
of the shares of common stock and warrants approximated $43,230 and was recorded
as additional discount and is being amortized over the new term of the 2006
Convertible Debentures. For the year ended December 31, 2006, $28,398, of debt
discount was accreted and recorded as amortization of debt discounts.
In January and February of 2007, the Company repaid five of the seven 2006
Convertible Debentures in the aggregate face amount of $500,000. In December
2006, the Company and the officer and director and the stockholders agreed to
extend the term of two of 2006 Convertible Debentures in the face amount of
$200,000 to April 30, 2007.
Stockholder Convertible Debenture
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 was 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 year s ended
December 31, 2006, $78,529, of debt discount was accreted and recorded as
amortization of debt discounts. In August 2006, the Company and the stockholder
agreed to extend the maturity of the Stockholder Convertible Debenture to
December 15, 2006 without any additional consideration. In December 2006, the
Company and the stockholder agreed to further extend the maturity of the
Stockholder Convertible Debenture to April 30, 2007 without any additional
consideration.
Laurus Convertible 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 from the
Company with a maturity date of February 10, 2009 (the "Laurus Convertible
Note") in the aggregate principal amount of $1,500,000 and a Secured
Non-Convertible Revolving Note ("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.
F-22
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
However, Laurus has agreed to provide the Company an over advance until July 30,
2007. Through December 31, 2006 $1,500,000 was advanced for the Laurus
Convertible Note and $1,487,353 was advanced for the Laurus Revolving Note.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 year ended
December 31, 2006, $443,431 of debt discount was accreted and recorded as
amortization of debt discounts.
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. For the year ended December 31, 2006, $110,217 of debt discount
was accreted and recorded as amortization of debt discounts.
F-23
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 and accreted over the term of
notes. 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.
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 of
$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.
On October 27, 2005, at the same time as the Termination Agreement for the SEDA
(Note 10), 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 year ended December 31, 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 consolidated statement of operations. Through
December 31, 2005 the Company recorded a charge for derivative financial
instruments of $221,277 related to the change in fair value of the embedded
conversion feature which is recorded in the accompanying consolidated statement
of operations. The fair value of the embedded conversion feature liability was
$1,006,061 as of December 31, 2005. As a result of the Cornell Repayment, the
value of the embedded conversionfeature was reclassified to additional paid-in
capital in February 2006.
F-24
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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, $1,046,101 of amortization expense related to discount
on the October Cornell Debentures was recorded in the accompanying consolidated
statement of operations during the year December 31, 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 consolidated
statement of operations for the year ended December 31, 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 consolidated statement of operations for the year
ended December 31, 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.
Macrocom Convertible Debentures
On July 19, 2005, the Company issued a convertible debenture in the amount of
$500,000 to Macrocom (the "Macrocom Debenture"). The Macrocom Debenture 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.
The Company allocated the $500,000 of proceeds received from the Macrocom
Debenture to the debt, warrants and stock instruments issued based on the then
computed relative fair values. 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 charged to interest expense using the interest
method over the stated term of the Macrocom Debenture. During the year ended
December 31, 2006, $194,444 of debt discount was accreted and recorded as
amortization of debt discounts. During year ended December 31, 2005, $305,556 of
discount was accreted and recorded as debt discount resulting in a carrying
value of $305,556 on the Macrocom Debenture at December 31, 2005. In April 2006,
the Macrocom Debenture was repaid in full from the proceeds of the April 2006
Debenture debt financing.
F-25
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Macrocom Bridge Loans
In July 2004, Macrocom provided a loan ("Loan I of the "First Loan") to the
Company in the amount of $500,000 due in January of 2005. The Company had the
option to repay the principal in cash or in kind by issuing 1,000,000 common
shares. In January, the Company repaid the loan by issuing 1,000,000 shares of
common stock.
On October 14, 2004, NetFabric and Macrocom entered into a loan agreement which
was amended on December 2, 2004 (the "Loan Agreement"), whereby Macrocom agreed
to loan $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 its
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 of such debt into shares of the Company's
common stock.
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 years ended December 31, 2005, $250,341 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
Second Loan 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
into shares of the Company's common stock. The 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 was being amortized from October 11, 2005 through
October 10, 2006. During the year ended December 31, 2006, $58,875, of debt
discount was accreted and recorded as amortization of debt discounts. During the
year ended December 31, 2005, $41,883 of the discount was amortized in the
accompanying consolidated statements of operations.
On May 24, 2006 the Company entered into a Waiver and Agreement to Convert (the
"Waiver Agreement") with Macrocom. Pursuant to the Waiver Agreement, Macrocom
agreed 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 Agreement and the Loan II conversion, the Company
agreed to issue to an additional 1,500,000 shares additional shares of its
restricted common stock. The fair value of the additional consideration was
$1,125,000 and the amount was charged to operations during the year December 31,
2006 as debt extinguishment costs.
F-26
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Stockholder And Officer Convertible Debentures
On July 19, 2005, the Company agreed with a stockholder, and an entity
affiliated with a former officer of the Company, that aggregate advances of
$100,000 made in June 2005 from the stockholder and an entity affiliated with
the former 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 year ended December
31, 2006, $38,890 of debt discount was accreted and recorded as amortization of
debt discounts. During year ended December 31, 2005, $61,112 of debt discount
was accreted and recorded as amortization of debt discount resulting in a
carrying value of $61,112 on the Related Party Convertible Debentures at
December 31, 2005.
In April 2006, one holder of Related Party Convertible Debentures in the face
amount of $50,000 converted the Related Party Debentures into 100,000 shares of
the Company's 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 Related Party Convertible Debentures.
For the year ended December 31, 2006, $30,000, of debt discount was accreted and
recorded as amortization of debt discounts.
In September 2006, the holder which the Company entered into a previous
extension of Related Party Convertible Debentures in the face amount of $50,000
converted the Related Party Convertible Debentures into 100,000 shares of the
Company common stock. In exchange for the conversion, the Company issued to the
holder of Related Party Convertible Debentures an additional 300,000 shares of
restricted common stock of the Company to the holder. The fair value of the
additional consideration was $27,104 and the amount was charged to operations
during the year ended December 31, 2006 as debt extinguishment costs.
F-27
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note Payable Officer
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 principal and
interest 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. During the year ended December 31, 2005, $42,796 of the
discount was amortized on the accompanying consolidated statements of
operations.
NOTE 10. STOCKHOLDERS' EQUITY
COMMON STOCK
Pursuant to a financing commitment, in two separate closings in January and
March 2005, the Company sold 1,000,000 shares of common stock to Macrocom and
1,000,000 shares of its 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 expired in December 2006.
We also issued 250,000 shares to Michael Millon as consideration for arranging
the Macrocom financing.
On July 5, 2005, the Company entered into a Standby Equity Distribution
Agreement (the "SEDA") with Cornell. Pursuant to the SEDA, the Company was, at
its discretion, to periodically sell to Cornell shares of common stock, for a
total purchase price of up to $10,000,000). On July 5, 2005, in connection with
the SEDA, Cornell received a commitment fee of 680,000 shares of common stock
from the Company. In addition, the Company issued to Newbridge Securities
Corporation ("Newbridge") 7,142 shares of common stock under a placement agent
agreement in connection with the SEDA. In October 2005, the Company and Cornell
agreed to terminate the SEDA and for Cornell to provide only financing to the
Company through the issuance of the October Cornell Debentures (see Note 9). The
Company and Cornell entered into a Termination Agreement on October 27, 2005
(the "Termination Agreement") which terminated all of the rights and obligations
of both the Company and Cornell under the SEDA. Pursuant to the Termination
Agreement, the Company agreed to allow Cornell to retain 242,857 shares of the
Company's common stock that was previously issued to Cornell as part of the
commitment fee under the SEDA and Cornell agreed to return the balance of the
commitment fee consisting of certificates representing 437,143 shares of the
common stock of the Company within ten (10) business days of the Termination
Agreement.
The $340,000 fair value of the 242,857 commitment shares issued and retained by
Cornell was accounted for as a terminated offering expense and charged to
selling, general and administrative expense for the year ended December 31,
2005. Similarly the $10,000 fair value of the common stock issued to Newbridge
was charged to operations during the year ended December 31, 2005.
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. Based on the fair value of shares, $22,500 was charged to
operations as additional interest.
In January 2006, the Company issued 10,526 shares of its Common Stock to a
vendor to offset outstanding trade payables of $10,000.
F-28
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 and amended the consulting agreement in August 2006. Pursuant to
the consulting agreement, the Company issued the consultant 40,000 shares of its
common stock. The Company had initially issued the consultant 160,000 shares of
common stock but the consultant surrendered 120,000 of the previously issued
shares pursuant to an amendment of the agreement. The fair value of the shares
is charged to operations as consulting expense. For the year ended December 31,
2006, $11,034 was charged to operations.
In November 2006, the Company entered into a consulting agreement with an
unaffiliated entity. Pursuant to the consulting agreement, the Company issued
the consultant 250,000 shares of its common stock. The fair value of the shares
$30,000 was charged to operations as consulting expense during the year ended
December 31, 2006.
In October 2006, the Company's board of directors approved an amendment to the
Certificate of Incorporation to increase the number authorized common stock to
200 million shares. The change will become effective on or about November 16,
2006 following a written consent of the shareholders.
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 year ended December 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 previously entered into an Exchange Agreement related to the
acquisition of UCA Services (See Note 7) 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 $8,550,000) 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 the former UCA shareholders.
F-29
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 year ended December 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.
Warrants
Outstanding warrant securities consist of the following at December 31, 2006 and
2005:
December 31, 2006
Exercise
Warrants Price Expiration
---------------------- ------------------------ -------------------------------------
Laurus 4,256,550 $0.001 See (1)
Macrocom 1,000,000 $1.50 July 2008
Cornell Warrants 560,000 $0.40 October 2008
2006Convertible Debenture Financing 1,350,000 $0.01 April to November 2009
Others including officer,
director and stockholder 1,966,137 $0.15 to $0.82 December 2008 to June 2011
----------------------
9,132,687
======================
December 31, 2005
Exercise
Warrants Price Expiration
---------------------- ------------------------ -------------------------------------
Macrocom 3,000,000 $0.75 to $1.50 December 2006 to July 2008
Cornell Warrants 560,000 $0.40 October 2008
Others including officer,
director and stockholder 1,653,637 $0.15 to $1.50 December 2008 to January 2009
----------------------
5,213,637
======================
(1) No expiration.
Since the conversion of the October Cornell Debenture (see Note 9) could result
in a conversion into an indeterminable number of shares common stock, 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.
F-30
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 year December 31, 2006, the
Company recorded a gain of $134,598 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 312,500 share of its common stock at $0.82 per share that vest over
the term specified in the consulting agreement. The warrants expire five years
from the date of issuance. The fair value of the vested warrants is being
charged to operations as a consulting expense. For the year ended December 31,
2006, $51,516 was charged to operations for such services.
NOTE 11. 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") pursuant to which
9,000,000 shares of common stock were reserved for issuance upon exercise of
options. 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.
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 approve 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, considering factors such as the sale of stock, results of
operations, and consideration of the fair value of comparable private companies
in the industry.
The fair value of each stock option award is estimated using a Black-Scholes
option pricing model based on the assumptions in the table below. The assumption
for expected term is based on evaluations of expected future employee exercise
behavior. The risk-free interest rate is based on the U.S. Treasury rates at the
date of grant with maturity dates approximately equal to the expected term at
the grant date. The historical volatility of comparables companies' stock is
used as the basis for the volatility assumption. The Company has never paid cash
dividends, and does not currently intend to pay cash dividends, and thus assumed
a 0% dividend yield.
F-31
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Years ended
December 31, December 31,
2006 2005
---------------------- ----------------------
Expected dividend yield 0.0% 0.0%
Expected stock price volatility 71.260% 100.000%
Risk-free interest rate 4.59% to 4.92% 3.97% to 4.21%
Expected life of options (in years) 5 5
The following is a summary of the Company's stock option activity for the years
ended December 31, 2006 and 2005:
Weighted Average Weighted Average
Options Exercise Price Fair value
Outstanding, December 31, 2004 4,008,889 $0.15 $0.12
Options granted 1,125,000 1.81 1.38
Options exercised
Options cancelled (1,264,879) 0.15 0.12
---------------- --------------------- --------------------
Outstanding, December 31, 2005 3,869,010 0.63 0.48
---------------- --------------------- --------------------
Options granted 3,850,000 0.36 0.21
Options exercised
Options cancelled (618,925) 1.57 1.19
---------------- --------------------- --------------------
Outstanding, December 31, 2006 7,100,085 $0.41 $0.27
================ ===================== ====================
Exercisable, December 31, 2006 2,824,578 $0.41 $0.31
================ ===================== ====================
Exercisable, December 31, 2006 1,868,741 $0.43 $0.33
================ ===================== ====================
F-32
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2005
Outstanding Exercisable
------------------------------------------- ----------------------------------------------
Average Weighted Average Weighted
Range of exercise Number Exercise remaining Number exercise remaining
Price of options Price contractual life of options price contractual life
- ------------------------- ------------- ------------- --------------- --------------- -------------- ---------------
$0.15 to $0.34 2,575,085 $0.15 7.0 2,343,328 $0.15 7.0
$0.35 to $0.50 3,725,000 $0.35 9.6
$0.51 and above 800,000 $1.49 8.4 481,250 $1.67 8.3
------------- ------------- --------------- --------------- -------------- ---------------
7,100,085 $0.41 8.5 2,824,578 $0.41 7.2
============= ============= =============== =============== ============== ===============
Nonvested share activity under the Plans was as follows:
Average grant
Options date fair value
----------------- ----------------
Nonvested at December 31, 2005 2,000,269 $0.63
Granted 3,850,000 $0.21
Vested (992,918) $0.39
Cancelled (581,844) $1.27
-----------------
Nonvested at December 31, 2006 4,275,507 $0.25
-----------------
As of December 31, 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 to vest and be recognized is as follows:
Year ending December 31, 2007 $370,982
Year ending December 31, 2008 349,680
Year ending December 31, 2009 180,607
Year ending December 31, 2010 4,883
--------
$906,153
========
As of December 31, 2006 options outstanding and vested did not have any
intrinsic value.
F-33
NetFabric Holdings Inc. and Subsidiaries
Note to Consolidated Financial Statements
12. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases three office spaces under operating leases. The future
minimum cash commitments as of December 31, 2006 under such operating leases are
as follows:
2007 $152,448
2008 190,185
2009 191,254
2010 142,058
2011 138,997
Thereafter 138,997
------------
$953,939
============
As discussed in Note 13, the Company subleases certain office space under an
agreement with UCA Global, Inc. ("Global"), whereby the Company pays rent based
on the proportion of square footage occupied by the Company in the Global office
facility. The agreement provides that the sublease term of three years begins on
August 2, 2005. Pursuant to entering into a lease for a new office premises, the
Company has terminated the sublease arrangement effective April 2007.
The Company has an employment agreement with an officer which will expire in May
2008, subject to automatic successive one year renewals unless either we or the
employee gives notice of intention not to renew the agreement. The agreement
provides for an annual base salary of $150,000, with specified annual increases
to the base salary. Pursuant to the employment agreement, if the Company
terminates the officer's employment without cause or good reason, as defined in
the employment agreement, the Company will be obligated to pay a termination
benefit equal to the remaining annual base salary during the initial term of the
employment agreement.
Rent expense incurred with Global during the years ended December 31, 2006 and
2005 was $127,500 and $79,123, respectively, and is included in selling, general
and administrative expense on the accompanying statements of operations. Rent
expense inclusive of rent paid to Global was $221,250 and $212,080 for the years
ended December 31, 2006 and 2005, respectively
NOTE 13. RELATED PARTY TRANSACTIONS
Loans and advances payable to stockholders and directors on the accompanying
consolidated balance sheet at December 31, 2005 represent amounts owed to
stockholders and directors of the Company for advances of cash provided to the
Company. Convertible debentures payable to stockholders and directors represent
amounts received by the Company pursuant to a financing arrangement (see Note
9).
F-34
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The Company subleases certain office space and incurs occupancy related costs
under an agreement with UCA Global, Inc. ("Global"), an entity affiliated with a
shareholder of the Company, whereby the Company pays rent and other occupancy
costs based on the proportion of square footage occupied by the Company in the
Global's office facility. Rent and occupancy expenses incurred by the Company
under this agreement, which commenced on May 20, 2005, during the years ended
December 31, 2006 and 2005 was, $127,500 and $79,123, respectively, and is
included in selling, general and administrative expense on the accompanying
statements of operations.
In the normal course of business, the Company performed services and an entity
affiliated with the Company' stockholders, in the amount of $ 68,000 and
$141,000, respectively during the years ended December 31, 2006 and 2005. As of
December 31, 2006 approximately $235,000 was owed to the Company, including
amounts owed to UCA Services prior to the acquisition and a full allowance is
provided due to uncertainty of the recovery of the amount.
NOTE 14. INCOME TAXES
A reconciliation of the statutory U.S. federal income tax rate to the Company's
effective tax was as follows:
2006 2005
---- ----
Statutory U.S. rate 34.0% 34.0%
State income taxes, net of federal benefit 4.0% 4.0%
Effect of valuation allowance (38.0%) (38.0%)
------ ------
Total income tax expense (benefit) 0.0% 0.0%
====== ======
Significant components of the Company's future tax assets at December 31, 2006
and 2005 are as follows:
2006 2005
---- ----
Operating loss carryforwards $ 6,740,000 $2,560,000
Reserves and allowances 627,000 43,706
Valuation allowance (7,367,000) (2,603,706)
----------- ------------
Net deferred tax assets $ -- $ --
============ ============
The Company had net operating loss carryforwards of approximately $6,700,000 at
December 31, 2006, which expire through 2026. The tax benefit of these losses
has been completely offset by a valuation allowance due to the uncertainty of
its realization. Internal Revenue Code Section 382 provides for limitations on
the use of net operating loss carryforwards in years subsequent to a more than
50% change in ownership (as defined by Section 382), which limitations can
significantly impact the Company's ability to utilize its net operating loss
carryforwards. As a result of the sale of the shares in private offering and
issuance of shares for acquisition and other transactions, and changes in
ownership may have occurred which might result in limitations on the utilization
of the net operating loss carryforwards. The extent of any limitations as a
result of changes in ownership has not been determined by the Company.
F-35
NetFabric Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 15. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
For the Years ended
December 31,
--------------------------
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 $ -- $13,823,000
Discount on bridge loans relating to warrants -- $ 392,196
Discount on convertible debentures relating to warrants -- $ 392,897
Deferred employee stock option compensation -- $ 67,500
Discount on convertible debentures relating to shares -- $ 156,058
Discount on convertible debentures relating to beneficial
Conversion feature -- $ 142,709
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 --
Issuance of common shares in connection with settlement of
payables $ 35,000 $ --
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 2006 Debentures relating to common stock $ 103,272 $ --
Discount on 2006 Debentures relating to warrants $ 133,969 $ --
Discount on 2006 Debentures relating to beneficial
conversion feature $ 305,990 $ --
Discount on 2006 Debentures extension relating to
warrants $ 115,908 $ --
Discount on 2006 Debentures extension relating to
common stock $ 56,342 $ --
Conversion of convertible debenture issued to stockholder
and officer with common stock $ 130,000 $ --
Common stock issued for technology licensing acquisition $ 660,000 --
Discount on note payable issued to officer -- $ 141,855
Gain on modification of debt -- $ 100,758
Options issued to employees $ 489,480
Common Stock issued for services $ 41,034
Warrants and options issued for services $ 55,798
Common Stock issued for inducement to convert bridge loan $1,125,000
Derivative financial instrument related
beneficial conversion feature credited $ 804,307
Derivative financial instrument related to warrants $2,946,858
Common stock issued for services $ 150,000
NOTE 16. SUBSEQUENT EVENTS (unaudited)
In February 2007, the Company entered into a placement agency agreement with an
unaffiliated entity and consulting agreement with an unaffiliated individual.
Pursuant to the agreements, the Company issued an aggregate of 640,000 shares of
its common stock.
F-36
Exhibit 21.1
Subsidiaries Of NetFabric Holdings, Inc.
Name Jurisdiction of Incorporation
- ----------------------------------------- --------------------------------
NetFabric Corporation Delaware
UCA Services, Inc. New Jersey
Intrusion Detection Technologies, Inc. Florida
NetFabric Technologies India PVT Limited. India
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 annual report on Form 10-KSB 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.
April 13, 2007
/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 annual report on Form 10-KSB 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.
April 13, 2007
/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 Annual Report of NetFabric Holdings, Inc. (the" Company")
on Form 10-QKB for the fiscal year ended December 31, 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.
April 13, 2007
/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-QKSB for the fiscal year ended December 31, 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.
April 13, 2007
/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.