UNITED STATES SECURITIES AND EXCHANGE COMMISSION

  WASHINGTON, D.C 20549

 

FORM 10-QSB

 

x QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITES

EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED September 30, 2007

 

COMMISSION FILE NUMBER: 0-21419

 

NETFABRIC HOLDINGS, INC.

(Exact Name of Small Business Issuer as Specified in Its Charter)

Delaware	76-0307819
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S Employer Identification No.)

(Address of Principal Executive Offices)

299 Cherry Hill Road,

Parsippany, New Jersey 07054

 

(973)-537-0077

(Issuer's Telephone Number, Including Area Code)

(Former address, if changed since last report)

 

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 o

 

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of November 9, 2007, 96,0053,044 shares of common stock, $.001 par value per share, of the issuer were outstanding.

 

Transitional Small Business Disclosure Format (check one): Yes o  No x 

 

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NETFABRIC HOLDINGS, INC.

 

INDEX

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Operations	2
	Condensed Consolidated Statements of Cash Flows	3
	Notes to Interim Condensed Consolidated Financial Statements	4
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Controls and Procedures	19
PART II.	OTHER INFORMATION	19
Item 1.	Legal Proceedings	19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19
Item 3.	Defaults Upon Senior Securities	19
Item 4.	Submission of Matters to a Vote of Security Holders	20
Item 5.	Other Information	20
Item 6.	Exhibits	20
	Signatures	21

 

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NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

			SEPTEMBER 30,  2007			DECEMBER 31, 2006
ASSETS			(UNAUDITED)			(NOTE 1)
CURRENT ASSETS:
Cash		$	8,869		$	13,437
Trade accounts receivable, net			2,163,699			2,149,680
Prepaid expenses and other current assets			22,183			5,110
Total current assets			2,194,751			2,168,227
Property and equipment, net			217,958			197,215
Goodwill			10,585,000			13,982,451
Other intangibles, net			714,691			879,702
Other assets			22,924			55,028
TOTAL ASSETS		$	13,735,324		$	17,282,623
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Convertible debentures, net of unamortized discounts		$	150,000		$	685,168
Notes payable to officer, net of unamortized discounts						150,000
Short term borrowings			470,000
Accounts payable and accrued liabilities			4,100,338			3,747,809
Accrued compensation			382,936			338,283
Deferred revenues and customer advances			689,821			-
Revolving note, net of unamortized discount			973,556			1,014,249
Total current liabilities			6,766,651			5,935,509
Convertible note, net of unamortized discount			817,060			443,430
Total liabilities			7,583,711			6,378,939
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY :
Common Stock, $.001 par value, authorized shares 200,000,000, 96,053,044 and 75,023,883 shares issued and outstanding, respectively			96,053			75,024
Additional paid-in capital			37,797,055			36,201,479
Accumulated deficit			(31,741,495	)		(25,372,819	)
Total stockholders' equity			6,151,613			10,903,684
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	13,735,324		$	17,282,623
The accompanying notes should be read in conjunction with the condensed consolidated financial statements.

 

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NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

 

			THREE MONTHS ENDED			THREE MONTHS ENDED			NINE MONTHS ENDED			NINE MONTHS ENDED
			September 30, 2007			September 30, 2006			September 30, 2007			September 30, 2006
Revenues		$	3,636,721		$	4,553,403		$	12,016,185		$	12,951,807
OPERATING EXPENSES:
Direct employee compensation and
consultant expenses (includes share based compensation
of $11,396, $11,396, $34,188 and $11,396)			2,788,865			3,500,839			9,272,344			9,695,997
Selling, general and administrative expenses (includes
share based compensation of $83,237 and $190,778, $337,076 and $432,796 )			1,070,006			1,438,123			3,978,922			4,513,821
Non-cash charge for dispute settlements												9,492,070
Non-cash goodwill impairment			-						3,397,451
In process research and development						1,200,000						1,200,000
Depreciation and amortization			153,466			81,367			351,229			223,794
Total operating expenses			4,012,337			6,220,329			16,999,946			25,125,682
Loss from operations			(375,616	)		(1,666,926	)		(4,983,761	)		(12,173,875	)
OTHER INCOME / (EXPENSE):
Amortization of debt discounts and debt
issuance costs			(182,799	)		(364,144	)		(552,272	)		(2,600,572	)
Interest and bank charges			(78,359	)		(60,901	)		(240,202	)		(228,809	)
Gain/(charge) on derivative financial instruments												336,352
Debt extinguishment costs			(539,043	)		(27,104	)		(539,043	)		(1,773,181	)
Total other income / (expense)			(800,201	)		(452,149	)		(1,331,517	)		(4,266,210	)
Loss before provision for income taxes			(1,175,817	)		(2,119,075	)		(6,315,278	)		(16,440,085	)
Provision for income taxes			-			-			-			-
LOSS FROM CONTINUING OPERATIONS			(1,175,817	)		(2,119,075	)		(6,315,278	)		(16,440,085	)
DISCONTINUED OPERATIONS:
Loss from operations of discontinued operations									(53,398	)		(474,411	)
NET LOSS		$	(1,175,817	)	$	(2,119,075	)	$	(6,368,676	)	$	(16,914,496	)
Net loss from continuing operations
per common share, basic and diluted		$	(0.01	)	$	(0.03	)		(0.08	)	$	(0.25	)
Net loss from discontinued operations
per common share, basic and diluted			-			-			-		$	(0.01	)
Net loss per common share, basic and
diluted		$	(0.01	)	$	(0.03	)		(0.08	)	$	(0.26	)
Weighted average number of shares
outstanding, basic and diluted			91,148,533			70,601,600			80,763,179			65,749,547
The accompanying notes should be read in conjunction with the condensed consolidated financial statements.

 

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NETFABRIC HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED
STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES			NINE MONTHS  ENDED September 30, 2007			NINE MONTHS  ENDED September 30, 2006
Net loss			(6,368,676	)		(16,914,496	)
Loss from discontinued operations			53,398			474,411
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Non-cash charge for interest expense						22,500
Non-cash charge for settlement of disputes						9,492,070
Non-cash charge for reissuance of warrants in connection with
debt extinguishment						372,353
Common stock, options and warrants issued for services			77,600			105,503
Non-cash charge for employee share based compensation			293,664			338,689
Non-cash charge on debt extinguishment			539,043			1,152,104
Non-cash gain on derivative financial instrument						(336,352	)
Non-cash charge for in process research and development						1,200,000
Amortization of debt discounts			552,272			2,600,572
Non-cash goodwill impairment			3,397,451
Depreciation and amortization			351,229			223,794
Changes in operating assets and liabilities:
Trade accounts receivable			(14,019	)		(239,518	)
Prepaid expenses and other current assets			(17,073	)		(84,046	)
Other assets			31,502
Accounts payable and accrued liabilities			372,062			424,761
Accrued compensation			44,653			(8,353	)
Deferred revenues and advances			689,821			563,838
Net cash provided by continuing operations			2,927			(612,170	)
Net cash used in discontinued operations			(53,398	)		(454,344	)
Net cash used in operating activities			(50,471	)		(1,066,514	)
INVESTING ACTIVITIES
Net cash acquired in technology licensing transaction						450,000
Purchases of property and equipment			(95,010	)		(98,471	)
Net cash (used in) provided by investing activities			(95,010	)		351,529
FINANCING ACTIVITIES
Proceed from a private sale of common stock			450,000
Proceeds from sale of debentures			200,000
Repayment of debentures			(200,000	)
Short term borrowings			570,000
Repayment of short term borrowings			(100,000	)
Repayment of loans from officer and director						(170,000	)
Repayment of note to officer						(200,000	)
Proceeds of convertible debentures						650,000
Repayment of convertible debentures			(500,000	)		(100,000	)
Repayment of bridge loans						(500,000	)
Proceeds from issuance (repayment) of revolving note, net			(167,087	)		1,336,407
Proceeds from issuance of convertible note, net						1,430,500
Debt issuance costs			(112,000	)		(20,697	)
Repayment of convertible debenture						(1,658,160	)
Net cash (used in ) provided by financing activities			140,913			768,050
Net increase in cash			(4,568	)		53,065
Cash at beginning of period			13,437			9,540
Cash at end of period		$	8,869		$	62,605
Supplemental cash flow information:
Cash paid for interest expense		$	252,000		$	182,000
Cash paid for income taxes		$	-		$	-
The accompanying notes should be read in conjunction with the condensed consolidated financial statements.

 

 

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NETFABRIC HOLDINGS INC. AND SUBSIDIARIES

 

NOTE 3. IMPAIRMENT OF GOODWILL

Goodwill represents the Company’s allocation of the cost to acquire UCA Services in excess of the fair value of net assets acquired. The purchase price and its allocation, to reflect the fair values of identifiable assets acquired and liabilities assumed, have been based on management’s evaluation and an independent valuation.

Pursuant to SFAS No. 142 “Goodwill and Other Intangibles Assets,” (“SFAS No. 142”), the Company performed its annual testing of goodwill impairment in the second quarter of 2007. As a part of goodwill impairment testing, management reviewed various factors, such as the market price of the Company’s common stock, discounted cash flows from projected earnings and values of comparable companies to determine whether impairment exists. Based on this evaluation it was determined that the goodwill was impaired.   The impairment was due to a continued decline in the Company’s market capitalization during the past year, and due to lower future cash flows expected to be generated by the business due to working capital constraints. The implied value of the goodwill was $10,585,000 compared to a carrying value of $13,982,451, indicating an impairment of $3,397,451. The impairment loss was charged to operations during the nine months ended September 30, 2007.

 

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NETFABRIC HOLDINGS INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4. DEBT FINANCINGS

  Debt Financings consist of the following as of September 30, 2007 and December 31, 2006:  

 

			2007
						Unamortized
						debt
			Principal			Discount			Net
2006 Convertible Debenture, due in December 2007		$	150,000					$	150,000
Short term borrowing, due at various dates between October 2007 and December 2007			470,000						470,000
Laurus Revolving Note Due in February 2009			1,320,265			(346,709	)		973,556
Laurus Convertible Note Due in February 2009			1,500,000			(682,940	)		817,060
		$	3,440,265			($1,029,649	)	$	2,410,616

 

			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

 

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 holders of the Convertible Debentures agreed to extend the term of two of 2006 Convertible Debentures in the face amount of $200,000 to April 30, 2007. In April 2007, the Company and the holders of the Convertible Debentures agreed to extend the term of two of 2006 Convertible Debentures in the face amount of $200,000 to August 31, 2007. In August 2007, the Company and the officer who is the holder of the 2006 Convertible Debentures in the amount of $150,000 agreed to extend the term to December 2007 and $50,000 of the 2006 Convertible Debentures was converted as fully explained later in this note .

In April 2007, the Company sold Debentures (the "Debentures") in the face amount of $200,000 to an individual. The Debentures bear interest at 8% and is due on July 12, 2007. In connection with the sale, the Company issued warrants to acquire an aggregate of 500,000 shares of its common stock with a nominal exercise price. The warrants expire in three years from the date of issuance. The Company allocated the $200,000 of proceeds received based on the computed relative fair value of debt and warrants. The warrants were valued using a Black-Scholes option-pricing model, which resulted in a fair value of $46,026 and a relative fair value of $37,415. The relative fair value of the warrants of $37,415 was recorded to additional paid in capital and the resulting debt discount was amortized over the term of the Debentures. The Company paid financing costs of $20,000 to third parties and this amount was included as debt issuance costs in other assets and amortized over the term of the Debentures. In July 2007, the Company repaid the Debentures.

In August 2007, the Company entered into an Agreement to Convert (the “Agreement”) with Fred Nazem, a stockholder. Pursuant to this Agreement, the stockholder agreed to convert $218,882 due to him in outstanding convertible debentures and accrued interest of $18,882 into 5,472,050 shares of common stock, which includes 4,900,394 shares as an inducement for conversion. The fair value of the inducement to convert approximated $539,000 and was charged to operations in the three months ended September 30, 2007 as debt extinguishment costs.

 

During the nine months ended September 30, 2007, the Company borrowed an aggregate o f $570,000 from three individuals and repaid $100,000 of that prior to September 30, 2007. The amount outstanding as of September 30, 2007 is $470,000 and is due at various dates between October 2007 and December 2007. In October 2007, the Company repaid $200,000. The borrowings are unsecured and bear nominal interest. The Company paid financing costs of $92,000 to third parties and this amount is being amortized over the term of the borrowings.

NOTE 5. STOCKHOLDERS' EQUITY

COMMON STOCK

 

During the nine months ended September 30, 2007, the Company entered into a placement agency agreement with an unaffiliated entity and a consulting agreement with an unaffiliated individual. Pursuant to the agreements, the Company issued an aggregate of 640,000 shares of its common stock. The fair value of the shares was $77,600 and was charged to operations as a consulting expense during the nine months ended September 30, 2007.

 

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. ("IDTI"). 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 in 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 payments from 2009 onwards.

 

On September 30, 2006, the Company determined the purchase price at $1,200,000 based on the estimated fair value of common stock issued of $1,650,00, net of cash acquired was allocated to the license agreement . Subsequently at December 31, 2006, the Company revised the purchase price. 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.

 

NOTE 9. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES 

 

			For the Nine Months
			ended September 30,
			2007			2006
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 April 2006 Convertible debentures related to common stock					$	251,379
Discount on April 2006 Convertible Debentures related to beneficial conversion feature					$	322,755
Discount on April 2006 Convertible Debentures related to warrants					$	206,647
Discount on April 2007 Debenture related to warrants		$	37,519
Amortization of debt discounts		$	552,272		$	2,600,572
Settlement on bridge loan with common stock					$	500,000
Common stock issued for technology licensing acquisition					$	1,650,000
Conversion on Convertible debenture issued to stockholder with common stock		$	200,000		$	130,000

NOTE 10. SUBSEQUENT EVENTS

 

In October 2007, the Company sold Debentures (the "Debentures") in the face amount of $200,000 to an individual. The Debentures bear interest at 8% and is due on January 18, 2008. In connection with the sale, the Company issued warrants to acquire an aggregate of 300,000 shares of its common stock with a nominal exercise price. The warrants expire in three years from the date of issuance.

 

The Company’s agreement with Laurus Master Fund, Ltd. (“Laurus”) had an over advance feature for $1,000,000 that expired on July 31, 2007. On October the Company and Laurus entered into an extensions agreement (the “Extension Agreement’). The Extension Agreement provides for the extension of the over advance feature until February 2009 .However, the over advance amount will reduce by $5,000 each month from November 2007 to February 2008 and by $50,000 each month from March of 2008. 

 

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ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes and the other financial information appearing elsewhere in this report and reports included herein by reference. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

 

Our independent registered public accounting firm has indicated in their report, dated April 13, 2007, on our December 31, 2006 financial statements since we have experienced net losses since inception and have a working capital deficiency their report indicates that these matters raise substantial doubt about our ability to continue as a going concern. Our plan with regard to this matter is discussed elsewhere in this document. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

CORPORATE HISTORY

 

We were formerly known as Houston Operating Company and were incorporated in Delaware on August 31, 1989. On December 9, 2004, we entered into an Acquisition Agreement with all of the stockholders of NetFabric Corp., a Delaware corporation. NetFabric Corp. was incorporated in Delaware on December 17, 2002 and began operations in July 2003. At the closing, which occurred simultaneously with the execution of the Acquisition Agreement, we acquired all of the issued and outstanding capital stock of NetFabric Corp. from the stockholders in exchange for an aggregate of 32,137,032 newly-issued shares of our common stock. The acquisition was accounted for as a reverse merger whereby NetFabric Corp. was treated as the acquirer. On April 19, 2005, our name was changed from Houston Operating Company to NetFabric Holdings, Inc. and our stock symbol was changed from "HOOC" to "NFBH."

 

UCA SERVICES, INC. ACQUISITION

 

On May 20, 2005, we entered into and closed on a share exchange agreement, whereby we purchased all of the issued and outstanding shares of UCA Services, Inc., a New Jersey company (“UCA Services”) from its shareholders in exchange for the issuance of 24,096,154 shares of our common stock. UCA Services is an IT services and solutions company that serves the information needs of a wide range of Fortune 500 clients in the financial markets industry and the pharmaceutical, health care and hospitality sectors. UCA Services delivers a broad range of IT services in managed services, professional services, infrastructure building and maintenance, application development and maintenance areas. The acquisition was accounted for using the purchase method of accounting with UCA Service’s results of operations included in our consolidated financial statements from the date of acquisition.

 

DISCONTINUED OPERATIONS

 

Prior to acquiring NetFabric Corp., Houston Operating Company did not have any operations, and we were a shell company whose primary business objective was to merge and become public.

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NetFabric Corp. was a provider of hardware and services to small to mid-sized businesses ("SMBs") that utilized the Internet for telephone communications or Voice over Internet Protocol ("VoIP"). It developed and marketed appliances or Customer Premises Equipment ("CPE") that simplified the integration of standard telephone systems with an IP infrastructure. In addition, NetFabric Corp resold transport services of a third party VoIP transport provider.

 

Our operations, prior to the UCA Services acquisition, consisted of developing VoIP appliances, including research and product development activities. We also hired additional personnel for sales and marketing and developed our sales and marketing programs.

 

With minimal revenues from VoIP operations, we concluded that we could not implement our original business plan for VoIP operations within our resources or with the additional capital we could raise in the near term. On May 5, 2006, our Board of Directors decided that the Company should exit the hardware-based VoIP communications product line (including resale of transport services) that is targeted to SMBs. In accordance with Statement of Financial Accounting Standards (‘SFAS’) No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets", ("SFAS No. 144"), the results of operations from the VoIP business segment has been reclassified as discontinued operations for all periods presented. After the discontinuation of VoIP operations, our only operations are that of UCA Services.

 

OVERVIEW OF UCA SERVICES BUSINESS

 

UCA Services derives revenues primarily from managed IT services, professional services, application development services and business process management services. Service arrangements with customers are generally on a time and material basis or fixed-price, fixed-timeframe revenue basis. UCA Services principal operating expenses are direct employee costs, consultant expenses and selling, general and administrative expenses. The principal components of selling, general and administrative expenses are salaries of sales and support personnel, and office rent. Direct employee costs and consultant expenses are comprised primarily of the costs of consultant labor, including employees, subcontractors and independent contractors, and related employee benefits. Approximately 50% of our consultants are employees and the remainder are subcontractors and independent contractors.

 

We compensate most of our consultants only for the hours that we bill to our clients for projects undertaken, which allows us to better match our labor costs with our revenue generation. With respect to our consultant employees, we are responsible for employment-related taxes, medical and health care costs and workers' compensation. Labor costs are sensitive to shifts in the supply and demand of IT professionals, as well as increases in the costs of benefits and taxes.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

As of September 30, 2007, our working capital deficiency was $4,571,900, compared to a working capital deficiency of $3,767,282 on December 31, 2006. The increase in the working capital deficiency was principally due to operating losses. During the nine months ended September 30, 2007, our operating activities from continuing operations provided approximately $3,000 of cash, compared to approximately $612,000 used during the nine months ended September 30, 2006.

 

During the nine months ended September 30, 2007, our operating losses, after adjusting for non-cash items, utilized approximately $1,104,000 of cash, and working capital items provided approximately $1,107,000 of cash. The principal component of these working capital changes was an increase in our deferred revenues and accounts payable. During the nine months ended September 30, 2006, our operating losses, after adjusting for non-cash items, utilized approximately $1,269,000 of cash, and working capital items provided approximately $657,000 of cash.

 

In February 2006, we repaid $70,000 owed to Fred Nazem, a stockholder of the Company, and $200,000 owed to Fahad Syed, an officer and director of the Company. Additionally, we repaid $100,000 plus accrued interest to Faisal Syed, a stockholder of the Company, in full satisfaction of a promissory note issued to him by UCA Services, prior to our acquisition of UCA Services. The promissory note bore interest at the rate of 6% and was due, together with accrued but unpaid interest in June 2005.

 

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In February 2006, we along with our subsidiaries, entered into a Security Agreement, dated February 10, 2006 ( the "Security Agreement") with Laurus Master Fund, Ltd., a Cayman Islands company ("Laurus"). Under the Security Agreement, Laurus purchased a Secured Convertible Note (the "Laurus Convertible Note"), from the Company with a maturity date of February 10, 2009, in the aggregate principal amount of $1,500,000, and a Secured Non-Convertible Revolving Note (the "Laurus Revolving Note") in the aggregate principal amount of $1,500,000. The Laurus Convertible Note and Laurus Revolving Note are collectively referred to as the "Laurus Notes". Availability under the Laurus Notes is based on an advance rate equal to 90% of eligible accounts receivable, and Laurus has agreed to provide us an over advance for a specified period. The Laurus Convertible Note has a three-year term, and bears interest at 1% above the prime rate, with a minimum interest rate of 8%. Laurus has the option, but not the obligation, at any time until the maturity date, to convert all or any portion of the Laurus Convertible Note and accrued interest thereon into shares of our common stock at an exercise price of $0.91 per share. If converted in full, we would be obligated to issue an aggregate of 1,648,352 shares of our common stock to Laurus. We have the option to prepay the Laurus Convertible Note by paying Laurus the applicable redemption premium. The Laurus Revolving Note has a three-year term, and bears interest at 1% above the prime rate, with a minimum interest rate of 8%.

 

In connection with the borrowing, we issued a common stock purchase option (the "Option") to Laurus to purchase up to 4,256,550 shares of our common stock for nominal consideration. Additionally, we entered into a registration rights agreement with Laurus (the "Registration Rights Agreement"), covering the registration of common stock underlying the Laurus Convertible Note and the Option. Our obligations under the Laurus Notes are secured by first liens on all of our assets, and Laurus may accelerate all obligations under the Laurus Notes upon an event of default.

The Company’s agreement with Laurus had an over advance feature for $1,000,000 that expired on July 31, 2007. On October the Company and Laurus entered into an extensions agreement (the “Extension Agreement’). The Extension Agreement provides for the extension of the over advance feature until February 2009 .However, the over advance amount will reduce by $5,000 each month from November 2007 to February 2008 and by $50,000 each month from March of 2008. 

 

Our initial borrowing was approximately $2,300,000 and we utilized approximately $1,900,000 of the initial borrowing to repay all amounts owed to Cornell pursuant to the October Convertible Debenture, including a redemption premium. At September 30, 2007, our availability and borrowing with Laurus was approximately $2,821,000 (face amount).

 

At various dates between April and December of 2006, we sold seven Convertible Debentures in the aggregate face amount of $700,000. In January and February of 2007, we repaid five out of the seven 2006 Convertible Debentures in the aggregate face amount of $500,000. In December 2006, the Company, and the officer director and the stockholder agreed to extend the term of two of the 2006 Convertible Debentures in the face amount of $200,000 to April 30, 2007. In April the term was extended to August 31, 2007. In August 2007, we entered into an agreement with the stockholder to convert an aggregate amount of $200,000 in Convertible Debentures and accrued interest into shares of our common stock. See Note 4 to the unadudited condensed consolidated financials statements. In August the officer and director with $150,000 face amount of Convertible Debentures entered into an agreement with us to extend the maturity to December 2007.

In April 2007, we sold Debentures (the "Debentures") in the face amount of $200,000 to an individual. The Debentures bear interest at 8% and is due on July 12, 2007. In connection with the sale, the Company issued warrants to acquire an aggregate of 500,000 shares of its common stock at a nominal exercise price. The warrants expire in three years from the date of issuance. We repaid the Debenture in July 2007.

In order to meet our working capital requirements, we borrowed an aggregate of $570,000 from three individuals during the nine months ended September 30, 2007. We repaid $100,000 of the borrowing prior to September 30, 2007. The balance amounts are due at various dates between October and December 2007. In October 2007, we repaid $200,000 of the borrowings.

 

In order to execute our business plan and achieve our objectives for the near future, management believes it will require approximately $2,000,000 over the next 12 months for working capital. A significant amount of this will be used to satisfy our obligations, both from borrowing and vendor accounts payable, as they become due. Our ability to continue as a going concern and our future success are dependent upon our ability to raise capital in the near term to satisfy our current obligations. Management's plans in this regard include, but are not limited to, current discussions and negotiations with a number of additional financing alternatives, one or more of which management believes will be able to successfully close to provide the necessary working capital. There is no assurance that we will be successful in completing the financing. The accompanying condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

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To fund our operations for fiscal year 2007, we need to raise additional financing and generate cash flows from our operations. Should additional cash flows not be available, we believe that we will have the ability to restructure our operations, and if necessary, initiate significant expense reductions. In addition, we will have to negotiate with our lenders to extend the repayment dates of our indebtedness. There can be no assurance, however, that we will be able to successfully restructure our operations or debt obligations in the event we fail to obtain additional financing.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The discussion and analysis and plan of operation is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable and long-lived assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the current circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect the judgment and estimates used in preparation of our condensed consolidated financial statements:

 

Income Taxes and Uncertain Income Tax Positions

 

We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in results of operations in the period that the tax change occurs.

 

Effective January 1, 2007, we adopted FIN No. 48 (“FIN 48”), A ccounting for Uncertainty in Income Taxes. FIN No. 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures.

 

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ITEM 3. CONTROLS AND PROCEDURES

 

A. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES:

 

Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and reported, within the time period specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed under the Exchange Act are accumulated and communicated to management, including the Chief Executive Officer ("CEO"") and Chief Financial Officer ("CFO") , as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon and as of the date of that evaluation, the CEO and CFO concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act are recorded, processed, summarized and reported as and when required.

 

B. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:

 

There were no changes in our internal controls over financial reporting during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II. OTHER INFORMATION 

ITEM 1. LEGAL PROCEEDINGS

 

The Company from time to time is involved in routine legal matters incidental to business. In the opinion of management, the ultimate resolution of such matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

During the three months ended September 30, 2007:

The Company issued 11,250,000 shares of common stock to three individuals and a company in private sale of common stock, including 2,500,000 shares to Fred Nazem, a stockholder.

The Company issued 5,472,050 shares of common stock to Fred Nazem, a stockholder, upon conversion of convertible debentures and accrued interest.

The Company issued 3,667,111 shares of the Company’s common stock upon exercise of warrants to Laurus.

The foregoing shares were issued pursuant to exemptions from registration under Sections 3(a)(9) and 4(2) of the Securities Act of 1933.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None

 

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None

ITEM 5. OTHER INFORMATION

 

None

ITEM 6. EXHIBITS

 

(a) Exhibits:

 

31.1 Rule 13a-14(a)/15d-14(a) Certification (CEO)   31.2 Rule 13a-14(a)/15d-14(a) Certification (CFO)   32.1 Section 1350 Certification (CEO)   32.2 Section 1350 Certification (CFO)

 

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SIGNATURES

 

In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act , the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 19, 2007	By:	/s/ Fahad Syed
		Name: Fahad Syed Title: Chairman and Chief Executive Officer

	By:	/s/ Vasan Thatham
		Name: Vasan Thatham Title: Principal Financial Officer and Vice President

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