REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Diverse Networks, Inc.
Houston, Texas
We have audited the accompanying balance sheets of Diverse Networks, Inc., as of
December 31, 2004 and 2003 and the related statements of operations,
stockholders' equity, and cash flows for each of the years then ended. These
financial statements are the responsibility of Diverse Networks, Inc. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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 financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Diverse Networks, Inc., as of
December 31, 2004 and 2003, and the results of its operations and its cash flows
for the periods described in conformity with accounting principles generally
accepted in the United States of America.
MALONE & BAILEY, PC
www.malone-bailey.com
Houston, Texas
February 1, 2006
Diverse Networks, Inc.
Balance Sheets
December 31, 2004 and 2003
Assets
------
2004 2003
---------- ----------
Current assets
Cash and cash equivalents $ 238,235 $ 542,858
Accounts receivable 480,477 632,555
Federal income taxes receivable 86,642 333
Prepaid expenses 18,644 11,493
---------- ----------
Total current assets 823,998 1,187,239
Property and equipment, net 351,025 477,364
Software, net 53,223 57,579
Deposits 14,375 14,375
---------- ----------
Total assets $1,242,621 $1,736,557
========== ==========
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities
Accounts payable $ 52,114 $ 37,127
Accrued expenses and other 496,137 706,784
Stockholder loan 300,000 300,000
Deferred tax liability 61,466 132,411
Capital lease - current portion 9,690 --
---------- ----------
Total current liabilities 919,407 1,176,322
Long-term liabilities
Capital lease - net of current portion 15,052 --
Stockholders' equity
Common stock - No par value; 40,000,000 shares authorized;
5,005,000 and 5,000,000 shares issued and outstanding 300,060 25,000
Retained earnings 8,102 535,235
---------- ----------
Total stockholders' equity 308,162 560,235
---------- ----------
Total liabilities and stockholders' equity $1,242,621 $1,736,557
========== ==========
See accompanying summary of accounting policies
and notes to the financial statements.
2
Diverse Networks, Inc.
Statements of Operations
For the Years Ended December 31, 2004 and 2003
2004 2003
----------- -----------
Revenues $ 6,589,736 $ 6,919,641
Cost of goods sold 4,632,597 4,024,696
----------- -----------
Gross profit 1,957,139 2,894,945
General and administrative expenses 2,329,207 2,477,496
Depreciation and amortization 189,311 179,297
----------- -----------
Total operating expenses 2,518,518 2,656,793
Net income (loss) from operations (561,379) 238,152
Other income (expense)
Interest income 4,750 3,527
Interest expense (30,410) (49,853)
Other income -- 620
----------- -----------
Total other income (expense) (25,660) (45,706)
----------- -----------
Net income (loss) before income taxes (587,039) 192,446
Income tax expense
Current (55,251) 99,618
Deferred (4,655) --
----------- -----------
(59,906) 99,618
----------- -----------
Net income (loss) $ (527,133) $ 92,828
=========== ===========
Earnings (loss) per share, basic and diluted $ (0.11) $ 0.02
=========== ===========
Weighted average number of shares outstanding (basic and diluted) 5,003,685 5,000,000
=========== ===========
See accompanying summary of accounting policies
and notes to the financial statements.
3
Diverse Networks, Inc.
Statements of Cash Flows
For the Years Ended December 31, 2004 and 2003
2004 2003
---------- ----------
Cash flows from operating activities
Net income (loss) $ (527,133) $ 92,828
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 155,760 151,106
Amortization 33,551 28,191
Modification of warrants 270,060 --
Deferred income tax (70,945) --
Changes in assets and liabilities
(Increase) decrease:
Accounts receivable 152,078 59,949
Prepaid expenses (7,151) (10,411)
Federal income tax receivable (86,309) 248,100
Other assets -- 76
Increase (decrease):
Accounts payable 14,987 37,127
Accrued expenses and other (210,647) 221,963
---------- ----------
Net cash provided by (used in) operating activities (275,749) 828,929
Cash flows from investing activities
Purchase of property, equipment and software (58,616) (211,391)
---------- ----------
Net cash used in investing activities (58,616) (211,391)
Cash flows from financing activities
Payments on shareholder loans -- (200,000)
Proceeds from capital lease obligation 29,888 --
Payments on capital lease obligations (5,146) --
Proceeds from exercise of stock options 5,000 --
---------- ----------
Net cash provided by (used in) financing activities 29,742 (200,000)
---------- ----------
Net increase (decrease) in cash and cash equivalents (304,623) 417,538
Cash and cash equivalents - beginning of year 542,858 125,320
---------- ----------
Cash and cash equivalents - end of year $ 238,235 $ 542,858
========== ==========
Supplemental disclosures of cash flow information
Income taxes paid $ -- $ 100,000
========== ==========
Interest paid $ 30,410 $ 49,853
========== ==========
See accompanying summary of accounting policies
and notes to the financial statements.
4
Diverse Networks, Inc.
Statements of Stockholders' Equity
For the Years Ended December 31, 2004 and 2003
Common Stock Retained
Shares Amount Earnings Totals
--------- --------- --------- ---------
Balances,
December 31, 2002 5,000,000 $ 25,000 $ 442,407 $ 467,407
Net income -- -- 92,828 92,828
--------- --------- --------- ---------
Balances,
December 31, 2003 5,000,000 25,000 535,235 560,235
Stock options exercised 5,000 5,000 -- 5,000
Modification of employee options 270,060 270,060
Net loss -- -- (527,133) (527,133)
--------- --------- --------- ---------
Balances,
December 31, 2004 5,005,000 $ 300,060 $ 8,102 $ 308,162
========= ========= ========= =========
See accompanying summary of accounting policies
and notes to the financial statements.
5
Diverse Networks, Inc.
Notes to the Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company Operations
Diverse Networks, Inc. (the Company) was incorporated in Texas on
September 18, 1998. The Company is based in Houston, Texas and provides
technical, operational, consulting and engineering services to various
companies with respect to wired and wireless communication networks. Such
services include design engineering, operational analysis, and outsourcing
of service management. The Company is particularly oriented to services
utilizing wireless technologies for data transport.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Accounting Method
The Company's financial statements are prepared using the accrual basis
under generally accepted accounting principles.
Cash and Cash Equivalents
Cash and cash equivalents consist primarily of cash on deposits and highly
liquid investments with original maturities of three months or less.
Accounts Receivable
The Company analyzes current accounts receivable for collectibility based
on historical bad debt, customer credit-worthiness, the current business
environment and historical experience with the customer. Based on this
analysis the Company has determined that no allowance for doubtful
accounts is required.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement
exists, services have been rendered, the sales price is fixed or
determinable, and collectibility is reasonably assured.
Concentrations of Credit Risk
The Company's cash and cash equivalents are temporarily invested in high
quality institutions. At times, such investments may be in excess of FDIC
insurance limits. Financial instruments that potentially subject the
Company to credit risk also include trade accounts receivable.
6
Property, Equipment, Improvements and Software
Property, equipment, improvements and software are stated at acquisition
cost and are depreciated using accelerated methods over useful lives as
follows:
Assets Life (Years)
------ ------------
Computer and Equipment 3
Furniture and Fixtures 5-7
Leasehold Improvements 10
Software 3
Property and equipment are summarized as follows: 2004 2003
--------- ---------
Furniture and fixtures $ 229,066 $ 239,739
Computer equipment 452,574 370,335
Leasehold improvements 259,385 301,530
------- -------
941,025 911,604
Less: Accumulated depreciation (590,000) (434,240)
--------- ---------
Total property and equipment and improvements $ 351,025 $ 477,364
========= =========
Depreciation expense for the year ended December 31, 2004 and 2003 was
$155,760 and $151,106, respectively.
The cost and accumulated depreciation and amortization of property,
equipment, improvements and software sold or otherwise disposed of are
removed from the accounts and the resulting gain or loss is included in
income in the period realized.
Income Taxes
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. Deferred tax assets, including tax loss and credit
carryforwards, 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 income in the period that includes the enactment date. Deferred income
tax expense represents the change during the period in the deferred tax
assets and deferred tax liabilities. The components of the deferred tax
assets and liabilities are individually classified as current and
non-current based on their characteristics. Deferred tax assets are
reduced by a valuation allowance when, in the opinion of management, it is
more likely than not that some portion or all of the deferred tax assets
will not be realized.
Basic and Diluted Income (Loss) Per Share
Basic and diluted income (loss) per share equals net income (loss) divided
by weighted average shares outstanding during the period. Diluted income
(loss) per share includes the impact of common stock equivalents using the
treasury stock method when the effect is dilutive. There were no common
stock equivalents during 2004 or 2003.
7
Stock Options
The Company accounts for employee stock options under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related
interpretations (APB 25). In accordance with APB 25, compensation cost for
stock options is recognized in income based on the excess, if any, of the
market price of the stock at the grant date of the award or other
measurement date over the amount an employee must pay to acquire the
stock. Generally, the exercise price for stock options granted to
employees equals or exceeds the fair market value of the Company's common
stock at the date of grant, thereby resulting in no recognition of
compensation expense by the Company.
The following table illustrates the effect on net loss and earnings per
share if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation," (SFAS 123) to stock-based compensation.
2004 2003
----------- -----------
Net income (loss) to common stockholders, as reported $ (527,133) $ 92,828
Deduct: Total stock-based employee/director
compensation expense under the fair value based
method for all awards, net of related tax effects (56,813) (72,276)
----------- -----------
Pro forma net income (loss) $ (583,926) $ 20,552
=========== ===========
Loss per share basic and diluted - as reported $ (0.11) $ 0.02
Loss per share basic and diluted - pro forma $ (0.12) $ 0.00
Shares used in basic and diluted loss per share 5,003,685 5,000,000
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 (Revised 2004),
Share-Based Payment, (SFAS 123R). This statement replaces SFAS 123,
supersedes APB 25, and amends SFAS95, Statement of Cash Flows. FAS-123R
requires companies to apply a fair-value-based measurement method in
accounting for shared-based payment transactions with employees and to
record compensation cost for all stock awards granted after the required
effective date and for awards modified, repurchased, or cancelled after
that date. The scope of SFAS 123R encompasses a wide range of share-based
compensation arrangements, including share options, restricted share
plans, performance-based awards, share appreciation rights, and employee
share purchase plans. FAS-123R is effective for the Company on January 1,
2006. The Company is currently evaluating the effect that SFAS 123R will
have on its financial position and results of operations.
8
2. STOCK OPTIONS
The Company has stock option plans, which provide for the granting of
qualified and nonqualified options to employees of the Company. A maximum
of 5,000,000 shares of common stock may be issued under the plans. The
option price, number of shares, vesting schedule, holding period or other
restrictions and grant dates are determined at the discretion of a
committee appointed by the Company's board of directors. Options granted
under the plans are exercisable for a period not to exceed ten years from
the option grant date.
A summary of option transactions during the year ended December 31, 2004
and 2003 is shown below:
2004 2003
------------------------------ ------------------------------
Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price
---------- ---------------- ---------- ----------------
Outstanding at January 1 4,174,457 0.3185 3,981,909 0.3111
Granted 14,000 1.0000 346,000 0.5043
Exercised (5,000) 0.5000 -- --
Canceled (297,905) 0.4547 (153,452) 0.4833
---------- ----------
Outstanding at December 31 3,885,552 4,174,457
========== ==========
Available for issuance at
December 31 1,114,448 748,906
========== ==========
A summary of options outstanding as of December 31, 2004 is shown below:
Weighted-Average
Exercise Number of Shares Remaining Contractual Life Number of Shares
Price Outstanding of Shares Outstanding Exercisable
--------- ---------------- -------------------------- ----------------
$ 0.01 2,091,011 4.4 years 2,091,011
$ 0.50 1,207,958 5.9 years 1,031,785
$ 1.00 586,583 6.3 years 492,955
---------------- ----------------
3,885,552 3,615,751
================ ================
The weighted-average estimated fair value of stock options granted during
2004 and 2003 was $0.20 and $0.20 per share, respectively. These amounts
were determined using the Black-Scholes option-pricing model, which values
options based on the stock price at the grant date, the expected life of
the option, the estimated volatility of the stock, the expected dividend
payments, and the risk-free interest rate over the expected life of the
option. The assumptions used in the Black-Scholes model were as follows
for stock options granted in 2004 and 2003:
Risk-free interest rate 1.66%-3.16%
Expected life (years) 10
Expected dividends None
Expected volatility 137%
The Black-Scholes option valuation model was developed for estimating the
fair value of traded options that have no vesting restrictions and are
fully transferable. Because option valuation models require the use of
subjective assumptions, changes in these assumptions can materially affect
the fair value of the options, and the Company's options do not have the
characteristics of traded options, the option valuation models do not
necessarily provide a reliable measure of the fair value of its options.
9
The terms of awards issued to employees state that awards are forfeited
upon termination of employment with the Company. In October 2004, the
Company modified the terms of certain awards issued to former employee in
connection with their termination, such that the awards continue after
termination of employment. The awards were fully vested at the time of
modification. As a result of this modification, the Company recorded
expense totaling $270,060 in fiscal 2004, representing the fair value of
the options on the date of modification.
3. LEASE COMMITMENTS
The Company leases office space under an operating lease that expires May
2010. Rent expense totaled $337,295 and $360,127 for the year ended
December 31, 2004 and 2003, respectively.
The Company leases certain equipment under capital leases. The following
is a schedule by years of future minimum lease payments as of December 31,
2004.
Years ending December 31,
2005 $ 10,911
2006 10,911
2007 4,845
--------
Total minimum lease payments 26,667
Less amount representing interest 1,925
--------
24,742
Less current installments of obligations
under capital leases 9,690
--------
Long-term obligation under capital leases,
with interest rate of 9.7% $ 15,052
========
Obligations under capital leases are collateralized by leased equipment.
Future minimum payments under capital and operating leases as of December
31, 2004 are as follows:
2005 $ 153,132
2006 262,512
2007 262,512
2008 262,512
2009 262,512
2010 109,338
-----------
$ 1,312,518
===========
4. EMPLOYEE RETIREMENT PLAN
The Company maintains a plan under which eligible employees may elect to
defer a portion of their annual compensation, up to a maximum of 50%, not
to exceed $16,000 for the year 2004 or later years as adjusted for cost of
living increases, pursuant to Section 401(k) of the Internal Revenue Code.
Substantially all employees are eligible to participate. The Company
matches contributions on a discretionary basis as determined by the board
of directors. Employees are 100% vested in their portion of the Company's
contributions, if any. The Company contribution and expenses to the plan
for the year ended December 31, 2004 was $129,246 and for the year ended
December 31, 2003 was $125,758.
10
5. SHAREHOLDER LOAN
Shareholder loans are uncollateralized, $300,000, including interest at
10%, due in December, 2005.
6. MAJOR CUSTOMER
For the year ended December 31, 2004, the Company had four major
customers, sales to which represent approximately 86% of the Company's
revenues. For the year ended December 31, 2003, the Company had 4 major
customers, sales to which represent approximately 95% of the Company's
revenues.
7. INCOME TAXES
The following table presents the principal reasons for the difference
between the Company's effective tax rates and the United States federal
statutory income tax rate of 35% for 2004 and 2003:
2004 2003
--------- ---------
Federal income tax expense (benefit) at statutory rate $(205,464) $ 67,356
Non-deductible expense 96,839 3,028
Adjustments 48,719 29,234
--------- ---------
Income tax expense (benefit) $ (59,906) $ 99,618
========= =========
Effective income tax rate 0% 39%
========= =========
8. SUBSEQUENT EVENT
On December 2, 2005, the Company was acquired by the Jackson Rivers
Company, a Florida corporation (JRC), through its wholly-owned subsidiary,
JKRC Sub, Inc., a Texas corporation (JKRC), pursuant to merger agreement.
Pursuant to the merger agreement, the Company merged with and into JKRC as
the surviving corporation, and each share of the Company's common stock
outstanding at the effective time of the merger was converted into the
right to receive either (i) $0.21 in the form of a one-year 8% promissory
note, or (ii) one share of a JRC Series B Preferred Stock, at the election
of the Company's stockholder.
11
Diverse Networks, Inc.
Balance Sheets
September 30, 2005
(Unaudited)
Assets
------
September 30, December 31,
2005 2004
------------- -------------
Current assets
Cash and cash equivalents $ 131,923 $ 238,235
Accounts receivable 290,952 480,477
Federal income taxes receivable 333 86,642
Prepaid expenses 20,160 18,644
------------- -------------
Total current assets 443,368 823,998
Property and equipment, net 251,437 351,025
Software, net 42,104 53,223
Deposits 14,375 14,375
------------- -------------
Total assets $ 751,284 $ 1,242,621
============= =============
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities
Accounts payable $ 58,028 $ 52,114
Accrued expenses and other 117,881 496,137
Deferred tax liability 123,075 61,466
Stockholder loan 233,182 300,000
Capital lease - current portion 8,088 9,690
------------- -------------
Total current liabilities 540,254 919,407
Long-term liabilities
Capital lease - net of current portion 9,875 15,052
Stockholders' equity
Common stock - No par value; 40,000,000 shares authorized;
5,005,000 shares issued and outstanding 300,060 300,060
Retained earnings (deficit) (98,905) 8,102
------------- -------------
Total stockholders' equity 201,155 308,162
------------- -------------
Total liabilities and stockholders' equity $ 751,284 $ 1,242,621
============= =============
12
Diverse Networks, Inc.
Statements of Operations
For the Nine Months Ended September 30, 2005 and 2004
(Unaudited)
2005 2004
----------- -----------
Revenues $ 1,731,387 $ 5,408,692
Costs of goods sold 1,055,706 3,788,448
----------- -----------
Gross profit 675,681 1,620,244
General and administrative expenses 611,992 1,642,684
Depreciation and amortization 110,400 131,944
----------- -----------
Total operating expenses 722,392 1,774,628
Net loss from operations (46,711) (154,384)
Other income (expense)
Interest income 259 4,129
Interest expense (26,184) (23,286)
Gain on sale of fixed asset 500 --
Other income 29,262 --
----------- -----------
3,837 (19,157)
----------- -----------
Net loss before income taxes (42,874) (173,541)
Income tax expense
Current -- --
Deferred 64,133 --
----------- -----------
64,133 --
----------- -----------
Net loss $ (107,007) $ (173,541)
=========== ===========
Earnings (loss) per share, basic and diluted $ (0.02) $ (0.03)
=========== ===========
Weighted average number of shares outstanding (basic and diluted) 5,005,000 5,003,242
=========== ===========
13
Diverse Networks, Inc.
Statements of Cash Flows
For the Nine Months Ended September 30, 2005 and 2004
(Unaudited)
2005 2004
--------- ---------
Cash flows from operating activities
Net loss $(107,007) $(173,541)
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 98,983 119,115
Amortization 11,417 12,829
Changes in assets and liabilities (Increase) decrease:
Accounts receivable 189,525 102,756
Prepaid expenses (1,516) (188,880)
Increase (decrease):
Accounts payable 5,914 (37,127)
Accrued expenses and other (296,581) (66,961)
--------- ---------
Net cash used in operating activities (99,265) (231,809)
Cash flows from investing activities
Purchase of property, equipment and software (298) (35,294)
--------- ---------
Net cash provided by (used in) investing activities (298) (35,294)
Cash flows from financing activities
Proceeds from short-term debt -- 18,643
Proceeds from capital lease obligation -- 29,888
Payments on capital lease obligations (6,779) (2,813)
Sale of common stock -- 5,000
--------- ---------
Net cash provided (used) by financing activities (6,779) 50,718
--------- ---------
Net decrease in cash and cash equivalents (106,342) (216,385)
Cash and cash equivalents - beginning of year 238,235 542,858
--------- ---------
Cash and cash equivalents - end of period $ 131,893 $ 326,473
========= =========
Supplemental disclosures of cash flow information
Income taxes paid $ -- $ --
========= =========
Interest paid $ 26,184 $ 23,286
========= =========
14
Diverse Networks, Inc.
Notes to the Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States of America for interim financial information. Accordingly, they do
not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Accordingly, the results from operations for the nine-month
period ended September 30, 2005, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2005. The
unaudited financial statements should be read in conjunction with the
December 31, 2004 financial statements and footnotes thereto included in
Form 8-K filed with the SEC.
2. STOCK OPTIONS
The Company accounts for employee stock options under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related
interpretations (APB 25). In accordance with APB 25, compensation cost for
stock options is recognized in income based on the excess, if any, of the
market price of the stock at the grant date of the award or other
measurement date over the amount an employee must pay to acquire the
stock. Generally, the exercise price for stock options granted to
employees equals or exceeds the fair market value of the Company's common
stock at the date of grant, thereby resulting in no recognition of
compensation expense by the Company.
The following table illustrates the effect on net loss and earnings per
share if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation," (SFAS 123) to stock-based compensation.
2004 2003
----------- -----------
Net income (loss) to common stockholders, as reported $ (107,007) $ (173,541)
Deduct: Total stock-based employee/director
compensation expense under the fair value based
method for all awards, net of related tax effects (42,610) (54,207)
----------- -----------
Pro forma net income (loss) $ (149,617) $ (227,748)
=========== ===========
Loss per share basic and diluted - as reported $ (0.02) $ (0.03)
Loss per share basic and diluted - pro forma $ (0.03) $ (0.05)
Shares used in basic and diluted loss per share 5,005,000 5,003,242
3. SUBSEQUENT EVENT
On December 2, 2005, the Company was acquired by the Jackson Rivers
Company, a Florida corporation (JRC), through its wholly-owned subsidiary,
JKRC Sub, Inc., a Texas corporation (JKRC), pursuant to merger agreement.
Pursuant to the merger agreement, the Company merged with and into JKRC as
the surviving corporation, and each share of the Company's common stock
outstanding at the effective time of the merger was converted into the
right to receive either (i) $0.21 in the form of a one-year 8% promissory
note, or (ii) one share of a JRC Series B Preferred Stock, at the election
of the Company's stockholder.
16