UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------
FORM 10-KSB/A
(Amendment No.1)
(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:
Name of Each Exchange on
Title of Each Class 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|
EXPLANATORY NOTE
This Form 10-KSB/A filing amends disclosure in the notes to our consolidated
financial statements and Exhibit 32.2, of the Form 10-KSB filed by NetFabric
Holdings, Inc. (the "Company') on April 16, 2007.
This amendment does not include any material changes in our financial statements
other than expanded footnote disclosure. All other information in the originally
filed Form 10-KSB was presented as of the April 16, 2007 filing date, or earlier
as indicated, and has not been updated in this amended filing.
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)
2
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)*
Exhibit 32.2 Section 1350 Certification (CFO)*
3
* 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
4
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: August 31, 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: August 31, 2007 /s/ FAHAD SYED
----------------------------------------
Fahad Syed, Chairman
and Chief Executive Officer
(principal executive officer)
Date: August 31, 2007 /s/ VASAN THATHAM
----------------------------------------
Vasan Thatham, Chief Financial
Officer (principal accounting officer)
Date: August 31, 2007 /s/ JOSEPH PERNO
----------------------------------------
Joseph Perno, Director
Date: August 31, 2007 /s/ CHARLOTTE G. DENENBERG
----------------------------------------
Charlotte G. Denenberg, Director
5
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
F-1
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
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, 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
F-2
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
PAR PAID-IN
SHARES VALUE 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 equivalents 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 using accepted valuation
methodologies.
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. Pursuant to
accepted valuation methodologies, the Company determined the fair value of
Holdings' common stock issued in exchange for the shares of UCA Services.
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 evaluation using accepted
valuation methodologies. 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 Consolidated 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 accepted valuation methodologies, 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
debt
Principal 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 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.
F-20
NetFabric Holdings Inc. and Subsidiaries Notes to Consolidated Financial
Statements
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 conversion feature 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 vested over
60 day period.. 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. The fair value of the warrants were measured using a Black-Scholes
option-pricing model with the following assumptions: (1) quoted market price of
the Company's common stock at the end of each month during the vesting period
(2) expected volatility of 71% (3) risk-free interest rate in the range of 4.72%
to 5.10% (4) life of 5 years and (5) no dividend,, which resulted in a fair
value of $51516, for the warrants. 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 Weighted
Average Average
Exercise Fair
Options Price 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/A of NetFabric Holdings,
Inc. (the" Company").
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report;
4. The Company's other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d 15 for the Company and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) [Reserved]
c) Evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter ( the Company's fourth fiscal quarter in case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting; and
5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the Company's ability to record, process, summarize
and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal control over
financial reporting.
August 31, 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/A of NetFabric Holdings,
Inc. (the" Company").
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report;
4. The Company's other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d 15(e) for the Company and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) [Reserved]
c) Evaluated the effectiveness of the Company's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) Disclosed in this report any change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter (the Company's fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting; and
5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of the Company's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the Company's ability to record, process, summarize
and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal control over
financial reporting.
August 31, 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-KSB/A 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.
August 31, 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 Annual Report of NetFabric Holdings, Inc. (the "Company")
on Form 10-KSB/A 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.
August 31, 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.
August 31, 2007
Ms. Tia Jenkins
Senior Assistant Chief Accountant
Office of Emerging Growth Companies
Division of Corporate Finance
U.S Securities and Exchange Commission
100 F Street N.E.
Mail Stop 3561
Washington, D.C. 20549-4561
Re: NetFabric Holdings, Inc.
Form 10-KSB
Filed April 16, 2007
File No. 000-31553
Dear Ms. Jenkins:
On behalf of NetFabric Holdings, Inc., ("NetFabric" or the "Company"), we
hereby submit NetFabric's responses to the comments of the staff (the "Staff")
of the Securities and Exchange Commission (the "Commission") set forth in the
Staff's letter, dated August 2, 2007, regarding the above referenced Form
10-KSB.
For the convenience of the Staff, each of the Staff's comments is included
herein and is followed by the corresponding response of NetFabric. References
herein to "we," "us" and "our" refer to NetFabric unless the context indicates
otherwise.
Form 10-KSB For Fiscal Year Ended December 31, 2006
Notes to Consolidated Financial Statements
Note 7 - Acquisition, F-18
1. We note your disclosure regarding an independent valuation of UCA
Services, Inc. in conjunction with the acquisition. Please revise to name
the expert who performed the independent valuation or revise your
disclosures to eliminate all references to the use of experts and/or
independent valuations. Please note that, in the event that an independent
valuation expert or other expert is named herein and you file a Form S-8,
a consent of such expert must be filed.
Response:
The Company has revised such disclosure in Note 7 of the Notes to
Financial Statements, page F- 18 of the Form 10-KSB
Note 8 - Technology License Acquisition, F-19
2. We note your disclosure regarding an independent valuation of Intrusion
Detection Technologies, Inc, in conjunction with the acquisition. Please
revise to name the expert who performed the independent valuation or
revise your disclosures to eliminate all references to the use of experts
and/or independent valuations. Please note that, in the event that an
independent valuation expert or other expert is named herein and you file
a Form S-8, consent of such expert must be filed.
Response:
The Company has revised such disclosure in Note 8 of the Notes to
Financial Statements, page F-19 of the Form 10-KSB
Note 9 - Debt Financings
2006 Convertible Debentures, F-2I
3. We note that the termination date for the 2006 Convertible Debentures was
extended twice during 2006. As consideration for each of these extensions,
you issued the holders shares of your common stock and warrants to
purchase shares of your common stock. It appears from your disclosure that
the relative fair value and not the fair value of these instruments were
amortized over the remaining term of the debt. Please cite the specific
authoritative literature you utilized to support your accounting
treatment.
Response:
The instruments extended/ reissued twice in 2006 were convertible debentures.
The Company applied the provisions of EITF 00-27 "Application of Issue No.98-5
to Certain Convertible Instruments" for accounting the extensions of 2006
Convertible Debentures. First, the Company determined the fair value of
detachable instruments issued in the transaction. As a next step, pursuant to
paragraph 5 of EITF 00-27, the Company allocated the proceeds received in the
financing to convertible instruments and other detachable instruments on a
relative fair value basis. Thereafter, the Issue 98-5 Model was applied to the
amount allocated to the convertible instrument, and an effective conversion
price was calculated and used to measure the intrinsic value, if any, of the
embedded conversion option. The Company applied paragraph 7 of EITF 00-27 to
evaluate whether the convertible instrument has intrinsic value, which was
essential to allocate the proceeds on a relative fair value to various
instruments issued in the transaction. This treatment has additional support in
Paragraph 32 of EITF 00-27, where the carrying amount the old debt equals the
proceeds received for the new convertible instrument and any intrinsic value of
the embedded conversion option in the new debt should be measured and accounted
for under Issue 98-5 based on the proceeds received for that instrument.
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Laurus Convertible Non-Convertible Financings, F-23
4. Please provide a detailed discussion of why the debt discount associated
with the Laurus Convertible Debt was recorded at $1,430,500 and not
$1,500,000. It would appear that the value of the beneficial conversion
feature of $1,454,357 would be capped at the relative fair value of the
debt of $581,077, not $511,577, considering the relative fair value of the
options was calculated to be $918,923.
Response:
The Company paid a transaction fee of $139,000 to Laurus Master Fund
("Laurus") and its affiliates, investors. Of this $69,500 was allocated to
the Laurus Convertible Debt. These were fees paid to the investor and not
to third parties other than investor. In accordance with paragraph 22 of
EITF 00-27, amounts paid to the investor when a transaction is consummated
were reduced from the proceeds received by the Company thereby affecting
the calculation of the intrinsic value of the embedded options. Gross
proceeds of $1,500,000 were reduced to $1,430,500 for the transaction fees
of $69,500 allocated. Based on the relative fair values, $511,577 was
allocated to debt and $918,923 to warrants. The intrinsic value of the
embedded conversion option was capped at the amount of debt or $511,577 in
accordance with Paragraph 6 of EITF 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios".
5. It appears that the relative fair value of the options was recorded as a
debt discount from the proceeds of the Laurus Revolving Note. Please note
that when equity instruments are issued to secure borrowing capacity
(i.e., revolving note, line of credit) the full fair value of the equity
instruments should be charged to debt issue costs and amortized over the
term of the loan. Please revise.
Response:
The Company accounted for the options issued to Laurus as a part of Laurus
Revolving Note in accordance with Accounting Principles Board Opinion No.
14 "Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants". The options issued to Laurus were detachable options. In
accordance with paragraph 16 of APB 14, portion of the proceeds of the
debt securities issued with detachable stock purchase options was
allocated to options and treated as paid-in capital and debt discount. The
fair value of the options was determined and as prescribed by Paragraph 16
of APB 14, the allocation was made based on the relative fair values of
the two securities at the time of issuance.
Further, the options were issued to investors and not to a third party and
is not considered an issuance cost. Therefore, it was valued as a
component of the transaction along with other instruments pursuant to
paragraph 22 of EITF 00-27.
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Stockholder and Officer Convertible Debentures, F-27
6. We note that the termination date for one of the Related Party Convertible
Debentures was extended to September 15, 2006. As consideration for the
extension, you issued the holder 100,000shares of your common stock. It
appears from your disclosure that the relative fair value and not the fair
value of the common stock was amortized over the remaining term of the
debt. Please cite the specific authoritative literature you utilized to
support your accounting treatment.
Response:
The Company applied the provisions of EITF 00-27 "Application of Issue
No.98-5 to Certain Convertible Instruments" for accounting the extension
of the Related Party Convertible Debenture. First the Company determined
the fair value of detachable instruments issued in the transaction. As a
next step, pursuant to paragraph 5 of EITF 00-27, the Company allocated
the proceeds received in the financing to convertible instruments and
other detachable instruments on a relative fair value. Thereafter, the
Issue 98-5 Model was applied to the amount allocated to the convertible
instrument, and an effective conversion price was calculated and used to
measure the intrinsic value, if any, of the embedded conversion option.
The Company applied paragraph 7 of EITF 00-27 to evaluate whether the
convertible instrument has intrinsic value, which was essential to
allocate the proceeds on a relative fair value to various instruments
issued in the transaction. This treatment has additional support in
Paragraph 32 of EITF 00-27, where the carrying amount the old debt equals
the proceeds received for the new convertible instrument and any intrinsic
value of the embedded conversion option in the new debt should be measured
and accounted for under Issue 98-5 based on the proceeds received for that
instrument.
Note 10 -Stockholders' Equity
Warrants, F-31
7. We note that, in June 2006, you entered into a consulting agreement with
an unaffiliated entity to which you issued warrants to acquire 312,500
shares of your common stock. Please provide a detailed discussion of how
the company determined the measurement date for the warrants considering
the number of warrants issued may not be fixed as they vest over a
specified term in the consulting agreement. In addition, please disclose
the valuation model utilized and the process for estimating the fair value
of these instruments under the fair value approach. Please refer to the
guidance in EITF 96-18 and SFAS No. 123(R).
4
Response:
In June 2006, the Company entered into a consulting agreement with an
unaffiliated entity to provide services to the Company. Pursuant to the
agreement, the Company issued the consultant warrants to acquire 312,500 shares
of its common stock that vested over 60 day period. In accordance with EITF
96-18 "Accounting for Equity Instruments That Are Issued to Other Than Employees
for Acquiring or in Conjunction with Selling, Goods or Services" ("EITF 96-18"),
the vesting period per agreement was used to determine the measurement date, the
date at which the consultant's performance of services was complete. This was a
situation where quantity and terms were known up front. Based on the guidance
provided in EITF 96-18, the Company recognized the cost of the services during
the financial reporting periods as the warrants were vested. The fair warrants
were valued using a Black-Scholes option-pricing model with the following
assumptions: (1) quoted market price of the Company's stock at the end of each
month during the vesting period (2) expected volatility of 71%, (3) risk-free
interest rate that ranged from 4.72% to 5.10% (4) life of 5 years and (5) no
dividend, which resulted in a fair value of $51,516 for the warrants.
The Company has revised such disclosure in Note 10 of the Notes to Financial
Statements, page F-31 of the Form 10-KSB.
Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
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Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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8. Please amend Exhibit 32.2 to state that the certification signed by Vasan
Thatham, Chief Financial Officer, is for the annual report of NetFabric
Holdings, Inc. on Form I0-KSB for the fiscal year-ended December 31, 2006.
Response:
The Company has amended Exhibit 32.2 to comply with the Staff comments.
Exchange Act Filings
9. Please amend your other Exchange Act filings to reflect comments above.
Response:
The Company has amended its filings as noted above.
5
The Company hereby acknowledges the following:
o the Company is responsible for the adequacy and accuracy of the
disclosure in the filing;
o Staff comments or changes to disclosure in response to Staff
comments do not foreclose the Commission from taking any action with
respect to the filing; and
o the Company may not assert Staff comments as a defense in any
proceeding initiated by the Commission or any person wider the
federal securities laws of the United States.
Sincerely,
/s/ Vasan Thatham
----------------------------------------
Vasan Thatham
cc: Via Facsimile
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Fahad Syed
NetFabric Holdings, Inc.
Facsimile: (973) 384-9061
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