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UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 OR [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition period from  to COMMISSION FILE NUMBER 0-28579 NOVO NETWORKS, INC.  Delaware
    
    75-2233445(State or Other Jurisdiction of Incorporation)
    
    (I.R.S. Employer Identification No.)
 2311 Cedar Springs Road, Suite 400
Dallas, Texas 75201
(Address of Principal Executive Offices) (214) 777-4100
(Registrants Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X] Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date: On May 17, 2004, 52,323,701 shares of the registrants common stock, $.00002
par value per share, were outstanding.




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NOVO NETWORKS, INC. QUARTERLY REPORT FORM 10-Q
INDEX PAGE NO.PART I:
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsConsolidated Balance Sheet as of March 31, 2004 and June 30, 2003
    
    
    3Consolidated
Statements of Operations for the Three and Nine Months Ended March 31, 2004, and March 31, 2003
    
    
    4Consolidated
Statements of Cash Flows for the Nine Months Ended March 31, 2004, and March 31, 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21PART II:
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    21Item 2.
    
    Changes in Securities and Use of Proceeds
    
    
    22Item 3.
    
    Defaults Upon Senior Securities
    
    
    22Item 4.
    
    Submission of Matters to Vote of Securities Holders
    
    
    22Item 5.
    
    Other Information
    
    
    22Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    22SIGNATURES
    
    
    
    
    
    
    24NonQualified Stojck Option Agreement-WissmanNonQualified Stock Option Agreement-RoblingNonQualified Stock Option Agreement-BeiersdorfCertification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906
  2




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NOVO NETWORKS, INC. 
 CONSOLIDATED BALANCE SHEETS
 March 31, 2004
    
    June 30, 2003(unaudited)ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    2,083,270
    
    
    $
    3,894,081Note receivable and other receivables,
net of allowance ($4,076,839 at March 31, 2004, and June 30, 2003)
    
    
    
    
    
    
    Prepaid expenses
    
    
    493,002
    
    
    
    441,9402,576,272
    
    
    
    4,336,021LONG-TERM ASSETSPrepaid expenses
    
    
    250,000
    
    
    
    26,736Deposits
    
    
    5,745
    
    
    
    5,745Property and equipment, net
    
    
    281,783
    
    
    
    379,783Equity investments
    
    
    1,250,000
    
    
    
    2,255,5231,787,528
    
    
    
    2,667,787$
    4,363,800
    
    
    $
    7,003,808LIABILITIES & STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    
    
    
    $
    5,935Accrued liabilities
    
    
    530,271
    
    
    
    496,443Customer deposits
    
    
    2,000
    
    
    
    2,000532,271
    
    
    
    504,378COMMITMENTS AND CONTINGENCIES
    
    
    
    
    
    
    STOCKHOLDERS EQUITYPreferred stock, $0.00002 par value, $1,000 liquidation preference per share,
authorized 25,000,000, 13,427 and 27,480 shares issued and outstanding
at March 31, 2004, and June 30, 2003, liquidation value  $13,427,000
and $27,480,000, respectively
    
    
    
    
    
    
    Common stock, $0.00002 par value, authorized 200,000,000,
issued and outstanding, 52,323,701
    
    
    1,050
    
    
    
    1,050Additional paid-in capital
    
    
    257,694,433
    
    
    
    257,165,054Accumulated deficit
    
    
    (253,863,954
    )
    
    
    (250,666,674
    )3,831,529
    
    
    
    6,499,430$
    4,363,800
    
    
    $
    7,003,808
 The accompanying notes are an integral part of these financial statements. 3




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NOVO NETWORKS, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 For the Three Months
    
    For the Nine MonthsEnded March 31,
    
    Ended March 31,2004
    
    2003
    
    2004
    
    2003(unaudited)
    
    (unaudited)Operating expenses:Selling, general and administrative expenses
    
    $
    453,999
    
    
    $
    982,172
    
    
    $
    1,576,416
    
    
    $
    2,387,926Impairment loss
    
    
    
    
    
    
    
    
    
    
    757,801
    
    
    
    Depreciation and amortization
    
    
    30,711
    
    
    
    36,555
    
    
    
    97,999
    
    
    
    113,012484,710
    
    
    
    1,018,727
    
    
    
    2,432,216
    
    
    
    2,500,938Loss from operations, before
other (income) expense
    
    
    (484,710
    )
    
    
    (1,018,727
    )
    
    
    (2,432,216
    )
    
    
    (2,500,938
    )Other (income) expense:Interest income
    
    
    (4,990
    )
    
    
    (55,145
    )
    
    
    (19,172
    )
    
    
    (96,926
    )Loss in equity investments
    
    
    
    
    
    
    131,506
    
    
    
    247,722
    
    
    
    396,257Net gain on liquidation of debtor subsidiaries
    
    
    
    
    
    
    (74,000
    )
    
    
    
    
    
    
    (288,000
    )Other
    
    
    22,254
    
    
    
    (62,515
    )
    
    
    7,135
    
    
    
    (99,620
    )17,264
    
    
    
    (60,154
    )
    
    
    235,685
    
    
    
    (88,289
    )Net loss
    
    
    (501,974
    )
    
    
    (958,573
    )
    
    
    (2,667,901
    )
    
    
    (2,412,649
    )Series D preferred dividends
    
    
    (179,994
    )
    
    
    (162,672
    )
    
    
    (529,379
    )
    
    
    (485,451
    )Net loss allocable to common shareholders
    
    $
    (681,968
    )
    
    $
    (1,121,245
    )
    
    $
    (3,197,280
    )
    
    $
    (2,898,100
    )BasicNet loss per share
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.06
    )
    
    $
    (0.06
    )Weighted average number of shares outstanding
    
    
    52,323,701
    
    
    
    52,323,701
    
    
    
    52,323,701
    
    
    
    52,323,701
 The accompanying notes are an integral part of these financial statements. 4




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NOVO NETWORKS, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months Ended March 31,2004
    
    2003(unaudited)CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (2,667,901
    )
    
    $
    (2,412,649
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    98,000
    
    
    
    113,012Other non-cash charges and credits:Stock-based compensation
    
    
    
    
    
    
    31,944Bad debt expense
    
    
    
    
    
    
    156,369Loss in equity investments
    
    
    247,722
    
    
    
    396,257Net gain on sale of fixed assets
    
    
    
    
    
    
    (1,661
    )Impairment loss
    
    
    757,801
    
    
    
    Net gain on liquidation of debtor subsidiaries
    
    
    
    
    
    
    (288,000
    )Change in operating assets and liabilities:Note receivable and other receivables
    
    
    
    
    
    
    (156,369
    )Prepaid expenses
    
    
    (274,326
    )
    
    
    (70,095
    )Accounts payable
    
    
    (5,935
    )
    
    
    (17,235
    )Accrued liabilities
    
    
    33,828
    
    
    
    60,720Net cash used in operating activities
    
    
    (1,810,811
    )
    
    
    (2,187,707
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment
    
    
    
    
    
    
    (11,633
    )Sale of property and equipment
    
    
    
    
    
    
    10,720Investments in equity investments
    
    
    
    
    
    
    (2,500,000
    )Net cash used in investing activities
    
    
    
    
    
    
    (2,500,913
    )NET CHANGE IN CASH AND CASH EQUIVALENTS
    
    
    (1,810,811
    )
    
    
    (4,688,620
    )CASH AND CASH EQUIVALENTS, beginning of year
    
    
    3,894,081
    
    
    
    9,871,305CASH AND CASH EQUIVALENTS, end of period
    
    $
    2,083,270
    
    
    $
    5,182,685
 The accompanying notes are an integral part of these financial statements. 5




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NOVO NETWORKS, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Business General Novo Networks, Inc. is a company that, through its operating subsidiaries,
previously engaged in the business of providing telecommunications services
over a facilities-based network until December of 2001. For further details
regarding our prior operations, see the section entitled (Business -
Bankruptcy Proceedings). References to Novo Networks, Company, we, us
or our refer to Novo Networks, Inc. and the registrant under the Securities
Exchange Act of 1934. Prior to September 22, 1999, we were a publicly held
company with no material operations. We were formerly known as eVentures Group,
Inc., and prior to that, as Adina, Inc., which was incorporated in Delaware on
June 24, 1987. During fiscal 2002, our principal telecommunications operating subsidiaries,
including AxisTel Communications, Inc. (AxisTel), e.Volve Technology Group,
Inc. (e.Volve) and Novo Networks Operating Corp. (NNOC) filed voluntary
petitions under Chapter 11 of Title 11 of the United States Code (the
Bankruptcy Code) as described more fully below. We will refer to the
subsidiaries that have filed for bankruptcy protection as our debtor
subsidiaries throughout this quarterly report (this Quarterly Report). In
December of 2002, we purchased an ownership interest in an Italian gelato
company, as described more fully below. Due to the ongoing liquidation of substantially all of our debtor subsidiaries
assets, we currently have no operations or revenues. We are not providing any
products or services of any kind (including telecommunications services) to any
customers. On December 19, 2002, we executed a purchase agreement (the Purchase
Agreement) with Ad Astra Holdings LP, a Texas limited partnership (Ad
Astra), Paciugo Management LLC, a Texas limited liability company and the sole
general partner of Ad Astra (PMLLC), and the collective equity owners of both
Ad Astra and PMLLC, being Ugo Ginatta, Cristiana Acerbi Ginatta and Vincent
Ginatta (collectively, the Equity Owners). Pursuant to the Purchase
Agreement, we acquired a 33% membership interest in PMLLC and a 32.67% limited
partnership interest in Ad Astra, which results in our holding an aggregate
interest, including the PMLLC general partnership interest, in Ad Astra equal
to 33% (the Initial Interest), for a purchase price of $2.5 million. In addition, we hold an option, exercisable for a period of two years from
December 19, 2002, to purchase a 17.3% membership interest in PMLLC and a
17.127% interest in Ad Astra (the Subsequent Interest) for $1.5 million.
Together, the Initial Interest and the Subsequent Interest would result in our
holding a 50.3% membership interest in PMLLC and a 49.797% limited partnership
interest in Ad Astra, for a total aggregate interest in Ad Astra, including the
PMLLC general partner interest, of 50.3%. Collectively, Ad Astra and PMLLC, through a number of wholly owned
subsidiaries, own and manage a gelato manufacturing, retailing and catering
business operating under the brand name Paciugo. Throughout this Quarterly
Report, we refer collectively to Ad Astra, PMLLC, and their subsidiaries as
Paciugo. Under the terms of the Purchase Agreement, we are to provide
services to support the business operations of Paciugo, including
administrative, accounting, financial, human resources, information technology,
legal, and marketing services (the Support Services). The Support Services
expressly exclude providing certain capital expenditures as well as services
that are customarily performed by third party professionals. In exchange for
our providing the Support Services, we are entitled to receive an annual amount
equal to the greater of $250,000 or 2% of the consolidated gross revenues
of Paciugo (excluding any gross revenues shared with third parties under
existing contractual arrangements). Effective January 1, 2003, we began
receiving monthly payments from Paciugo in the amount of $20,833, with positive
cumulative differences, if any, between 2% of such gross revenues and $20,833
per month to be paid within ten days of the end of such month. During the
current fiscal year, we recorded other income of $41,666 from the provision of
the Support Services to Paciugo for July and August of 2003 as agreed upon in
the Purchase Agreement. In August of 2003, certain disagreements arose between
us and Paciugo concerning the amount of the monthly payment for July of 2003,
as well as our performance of the Support Services. As a result, Paciugo has
failed to make these payments since August of 2003. 6




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Under the terms of the Purchase Agreement, we are entitled to such
representation on the governing board of PMLLC (the Board of Managers) as is
proportionate to our ownership interests therein. Effective as of December 19,
2002, PMLLCs Board of Managers was composed of Ugo Ginatta and Cristiana
Acerbi Ginatta, as the Equity Owners designees, and Barrett N. Wissman, as our
designee. PMLLC, as the sole general partner of Ad Astra, is empowered to make
all decisions associated with Ad Astra, except for those requiring the approval
of the limited partners, as set forth in the limited partnership agreement of
Ad Astra or under applicable law. We effectively maintain no ability to control the day-to-day affairs of Paciugo. On August 1, 2003, Susie C. Holliday resigned from her
positions as Senior Vice President and Chief Financial Officer of Paciugo in
connection with her resignation from similar positions with us. On August 15,
2003, Patrick G. Mackey was named Senior Vice President and Chief Financial
Officer of Paciugo. On August 25, 2003, Barrett N. Wissman resigned from the
position of President of Paciugo. In addition, during 2003, our Board of
Directors became increasingly concerned about Paciugos market position, the
industry in which Paciugo competes and Paciugos prospects for meaningful
success therein. Accordingly, during the fourth quarter of fiscal 2003, we
concluded that it was reasonably unlikely that we would exercise our option to acquire the Subsequent Interest. Therefore,
effective on October 1, 2003, Steven W. Caple and Patrick G. Mackey resigned
from their positions as Senior Vice President and General Counsel and Senior Vice
President and Chief Financial Officer, respectively, of Paciugo. During the quarter ended December 31, 2003, we engaged in discussions with
Paciugo that resulted in our entering into a sales agreement on January 13,
2004 (the Sales Agreement) with Ad Astra, PMLLC, and the Equity Owners,
whereby we agreed, subject to customary closing conditions, to (i) sell and
transfer to Ad Astra all of our right, title and interest in Ad Astra, (ii)
sell and transfer to PMLLC all of our right, title and interest in PMLLC, and
(iii) terminate our right to exercise the option to acquire the Subsequent
Interest, all in exchange for a total proposed Sales Price of $1.25 million
(the Sales Price), to be paid in cash at closing by Ad Astra and PMLLC. The
closing of the Sales Agreement was expected to take place on or about May 12,
2004, unless consummated earlier or later than such date, as provided for in
the Sales Agreement. Also, in connection with the execution of the Sales
Agreement with Paciugo, and for as long as it remains in
effect, we have given up any rights to receive any additional payments for the provision of Support
Services under the Purchase Agreement. As of the filing of this Quarterly
Report, Paciugo has entered into a letter of intent, subject to customary
closing conditions such as the negotiation of a definitive agreement and
completion of due diligence, which will allow the closing date to be pushed
back as far as July 11, 2004. Bankruptcy Proceedings On July 30, 2001, the debtor subsidiaries filed voluntary petitions for
protection under the Bankruptcy Code in the United States Bankruptcy Court for
the District of Delaware (the Delaware Bankruptcy Court) in order to
stabilize their operations and protect their assets while attempting to
reorganize their businesses. We have set forth below a table summarizing the current status of our wholly
owned subsidiaries. Subject toStatus as of May
    
    Bankruptcy PlanWholly Owned Subsidiary
    
    Date Acquired
    
    17, 2004(1)
    
    or Proceedings?Novo Networks Operating Corp.
    
    
    2/8/00
    (2)
    
    Inactive
    
    Yes, Chapter 11AxisTel Communications, Inc.
    
    
    9/22/99
    
    
    Inactive
    
    Yes, Chapter 11Novo Networks International Services, Inc.
    
    
    9/22/99
    
    
    Inactive
    
    Yes, Chapter 11Novo Networks Global Services, Inc.
    
    
    9/22/99
    
    
    Inactive
    
    Yes, Chapter 11Novo Networks Metro Services, Inc.
    
    
    9/22/99
    
    
    Inactive
    
    Yes, Chapter 11Novo Networks Metro Services (Virginia), Inc.
    
    
    9/22/99
    
    
    Inactive
    
    No
 7




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Subject toStatus as of May
    
    Bankruptcy PlanWholly Owned Subsidiary
    
    Date Acquired
    
    17, 2004(1)
    
    or Proceedings?Novo Networks Media Services, Inc.
    
    
    9/22/99
    
    
    Inactive
    
    Noe.Volve Technology Group, Inc.
    
    
    10/19/99
    
    
    Inactive
    
    Yes, Chapter 11Internet Global Services, Inc.
    
    
    3/10/00
    
    
    Inactive
    
    Yes, Chapter 7eVentures Holdings, LLC
    
    
    9/7/99
    (2)
    
    Active(3)
    
    No
   (1)
    
    Active status indicates current operations within the
respective entity. Inactive status indicates no current
operations, but may include certain activities associated with the
administration of an estate pursuant to a bankruptcy filing or plan.(2)
    
    Indicates the date of incorporation, if the entity was
organized by us.(3)
    
    This entity has no operations other than to hold certain
equity interests. As originally contemplated, the goal of the reorganization effort relating to
our debtor subsidiaries that filed voluntary petitions under Chapter 11 of the
Bankruptcy Code was to preserve the going concern value of our debtor
subsidiaries core assets and to provide distributions to their creditors.
However, based largely on the fact that our debtor subsidiaries ceased
receiving traffic from their sole remaining customer, a determination was made
that the continued viability of the debtor subsidiaries was not realistic.
Accordingly, the bankruptcy plan was amended. The amended plan and disclosure
statement were filed with the Delaware Bankruptcy Court on December 31, 2001.
The amended plan provides for a liquidation of substantially all of the assets
of our debtor subsidiaries, pursuant to Chapter 11 of the Bankruptcy Code,
instead of a reorganization, as previously planned. On January 14, 2002, the Delaware Bankruptcy Court approved the amended
disclosure statement, with certain minor modifications, and on March 1, 2002,
the Delaware Bankruptcy Court confirmed the amended plan, again with minor
modifications. On April 3, 2002, the amended plan became effective and a
liquidating trust was formed, with funding provided by us in the
amount of $200,000. Assets to be liquidated of $700,000 were transferred to the
liquidating trust during the fourth quarter of fiscal 2002. The purpose of the
liquidating trust is to collect, liquidate and distribute the remaining assets
of the debtor subsidiaries and prosecute certain causes of action against
various third parties, including, without limitation, Qwest Communications
Corporation (Qwest). No assurance can be given that the liquidating trust
will be successful in liquidating substantially all of the debtor subsidiaries
assets pursuant to the amended plan. Also, it is not possible to predict the
outcome of the prosecution of causes of action against third parties,
including, without limitation, Qwest, as described in the amended plan and
disclosure statement. We have previously guaranteed certain indebtedness of one
or more of the debtor subsidiaries and, depending upon the treatment of and
distribution to the holders of such indebtedness under the amended plans, we
may be liable for some or all of this indebtedness. In connection with the bankruptcy proceedings, we initially provided our debtor
subsidiaries with approximately $1.9 million in secured debtor-in-possession
financing to fund their reorganization efforts. The credit facility made funds
available to permit the debtor subsidiaries to pay employees, vendors,
suppliers, customers and professionals consistent with the requirements of the
Bankruptcy Code. In connection with the amended plan being confirmed by the
Delaware Bankruptcy Court and becoming effective on April 3, 2002, the credit
facility was converted into a new secured note. During fiscal 2003, we provided
additional funding of $500,000 to the liquidating trust. The current
balance on the new secured note is approximately $3.3 million, which has been
fully reserved due to the uncertainty surrounding the collection of this note.
For further details regarding the funding provided to the debtor subsidiaries,
see Item 2 entitled Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital Resources. Claims Against Qwest On June 17, 2002, we, along with the liquidating trust, filed a lawsuit seeking
damages resulting from numerous disputes over business dealings and agreements
with Qwest, a former customer and vendor, and John L. Higgins, a former
employee and consultant. No assurances can be given that any recoveries will
result from the prosecution of 8




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such causes of action against Qwest and Mr. Higgins. Furthermore, if there are
any recoveries, they may or may not inure to our benefit. Qwest filed a motion
to stay the litigation and compel arbitration on August 14, 2002. On March 13,
2003, a hearing was held to determine the proper forum for the various claims.
After listening to oral arguments, the district judge granted Qwests motion.
On April 2, 2003, we, along with the liquidating trust, filed a petition with
the Supreme Court of Nevada, asking it to direct the district judge to
reconsider her order. On August 13, 2003, our petition was denied. Accordingly,
an arbitrator was appointed on December 30, 2003. He presided over a
preliminary hearing on February 4, 2004, and originally set the matter for a
final hearing on July 7, 2004. On April 22, 2004, the arbitrator granted
Qwests motion to continue the final hearing until September 27, 2004. For
further details regarding this matter, see Note 7 entitled Legal
Proceedings. 2. General The accompanying consolidated financial statements as of March 31, 2004, and
for the three and nine month periods ended March 31, 2004, and March 31, 2003,
respectively, have been prepared by us, without audit, pursuant to the interim
financial statements rules and regulations of the United States Securities and
Exchange Commission (SEC). In our opinion, the accompanying consolidated
financial statements include all adjustments necessary to present fairly the
results of our operations and cash flows at the dates and for the periods
indicated. The results of operations for the interim periods are not
necessarily indicative of the results for the full fiscal year. The
accompanying consolidated financial statements should be read in conjunction
with the audited consolidated financial statements included in our Annual
Report on Form 10-K for the fiscal year ended June 30, 2003. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures 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.
The consolidated financial statements include our accounts and those of our
wholly owned subsidiaries not currently involved in the bankruptcy plan
administration process. As of June 30, 2002, the assets and liabilities of the debtor subsidiaries were
deconsolidated, as the liquidating trust controls their assets. For further
details regarding the bankruptcy proceedings, see Note 1 entitled Business -
Bankruptcy Proceedings. We have recorded an accrual of
approximately $313,000 in the accompanying financial statements for the estimated costs of
liquidating substantially all of the assets and liabilities of the debtor
subsidiaries. The estimated realizable values and settlement amounts may be
different from the proceeds ultimately received or payments ultimately made. Certain fiscal 2003 balances have been reclassified for comparative purposes to
be consistent with the fiscal 2004 presentation. Such reclassifications have no
impact on the reported net loss. All significant intercompany accounts have
been eliminated. 3. Basis of Presentation The accompanying consolidated financial statements for the three and nine
months ended March 31, 2004, and 2003, respectively, include us and our
subsidiaries that are not involved in the bankruptcy proceedings. The debtor
subsidiaries assets and liabilities were deconsolidated effective June 30,
2002. For us and
our remaining subsidiaries, which are not involved in the bankruptcy plan
administration process (such subsidiaries have nominal operations), the
financial statements, consisting primarily of cash, investments and office
equipment, have been prepared in accordance with accounting principles
generally accepted in the United States of America. The estimated realizable
values and settlement amounts may be different from the proceeds ultimately
received or payments ultimately made. Revenues.For the three and nine months ended March 31, 2004, and 2003,
respectively, no revenues were generated. We currently do not anticipate that
we will have revenue from telecommunications or any other services. Selling, General and Administrative Expenses. These expenses include general
corporate expenses, management salaries, professional fees, travel expenses,
benefits, rent and administrative expenses. Currently, we maintain our 9




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corporate headquarters in Dallas, Texas. We provided administrative services to
our debtor subsidiaries pursuant to an administrative services agreement
approved by the Delaware Bankruptcy Court. Initially, the agreement dictated
that our debtor subsidiaries pay us $30,000 per week for legal, accounting,
human resources and other services. The original agreement expired on April 2,
2002, and an interim agreement was reached whereby, the liquidating trust, as
successor-in-interest to our debtor subsidiaries, paid us $40,000 per month for
some of the same services. The interim agreement expired on August 15, 2002.
During the fourth quarter of fiscal 2003, we negotiated an on-going agreement
with the liquidating trust, whereby we provide administrative services to the
debtor subsidiaries on a per hour basis. Pursuant to the terms of this
arrangement, the debtor subsidiaries owed us $653,000 as of March 31,
2004. Due to the uncertainty surrounding the collection of this receivable, it
has not been recorded in our financial statements. Under the terms of the
administrative services agreement, any payments to us are deferred until such
time that the trustee receives funds in excess of the outstanding claims, which
most likely will depend on a positive outcome in the Qwest arbitration. Impairment Loss. Impairment loss results from an assessment as to whether the
net book value of the assets can be recovered through projected undiscounted
future cash flows. Due to the execution of the Sales Agreement with Paciugo, we
recorded an impairment loss of $758,000 during the three months ended
December 31, 2003, reducing the net book value of the investment to the
proposed Sales Price. Depreciation and Amortization. Depreciation and amortization represents the
depreciation of property and equipment. We do not expect these costs to
increase in the near term. Loss in equity investments. Loss in equity investments results from our
minority ownership interests in various subsidiaries that are accounted for
under the equity method of accounting. Under the equity method, our
proportionate share of each subsidiarys operating loss is included in equity
in loss of investments. In December of 2002, we purchased the Initial Interest
in Paciugo. For further details regarding Paciugo, see Note 1 entitled
Business  General, above. The value of our outstanding equity interests,
other than Paciugo, have been reduced to zero either by recording our
proportionate share of prior period losses incurred by each subsidiary to the
cost of that interest or from impairment losses. As mentioned previously, our
minority holdings, other than Paciugo, are either winding up their
affairs or liquidating. We do not expect to record future charges related to
those losses, as the interests have no carrying value. We expect Paciugo to
continue in the near future to incur operating losses, but we do not intend to
record our portion of those losses since the book value of our interest in
Paciugo reflects the proposed Sales Price in the Sales Agreement. Other Income. Other income results from the Support Services we provided to
Paciugo. For further details regarding the Support Services to Paciugo, see
Note 1 entitled Business  General, above. During the current fiscal year, we
recorded other income of $41,666 from the provision of the Support Services to
Paciugo for July and August of 2003 as agreed upon in the Purchase Agreement.
In August of 2003, certain disagreements arose between us and Paciugo
concerning the amount of the monthly payment for July of 2003, as well as our
performance of the Support Services. As a result, Paciugo has failed to make
these payments since August of 2003. In connection with the execution of the
Sales Agreement with Paciugo, and for as long as it remains
in effect, we have given up any rights to receive any additional payments for the provision of Support
Services under the Purchase Agreement in exchange for the proposed Sales Price.
The administrative services agreement with our debtor subsidiaries initially
dictated that our debtor subsidiaries pay us $30,000 per week for legal,
accounting, human resources and other services. The original agreement expired
on April 2, 2002, and an interim agreement was reached whereby the liquidating
trust, as successor-in-interest to our debtor subsidiaries, paid us $40,000 per
month for some of the same services. During the fourth quarter of fiscal 2003,
we negotiated an on-going agreement with the liquidating trust, whereby we
provide administrative services to the debtor subsidiaries on a per hour basis.
As of March 31,2004, we had an outstanding receivable from the debtor
subsidiaries relating to the provision of such administrative services of
approximately $653,000. Under the terms of the administrative services
agreement, any payments to us are deferred until such time that the trustee
receives funds in excess of the outstanding claims, which most likely will
depend on a positive outcome in the Qwest arbitration. Due to the uncertainty
surrounding the collection of the receivable, it has been fully reserved. 4. Loss Per Share We calculate earnings (loss) per share in accordance with SFAS No. 128,
Earnings Per Share (EPS). SFAS No. 128 requires dual presentation of basic
EPS and diluted EPS on the face of the income statement for all entities with
complex capital structures. Basic EPS is computed as net income (loss) less
preferred dividends divided by the 10




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##### Table of Contents



weighted average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur from common shares
issuable through stock options, warrants and convertible debentures. For the
three and nine months ended March 31, 2004, and 2003, respectively, diluted EPS
are not presented, as the assumed conversion would be antidilutive. Had the
effect not been antidilutive, an additional 14,688,876 and 16,105,699 shares of
common stock would have been included in the diluted earnings per share
calculation for the three months and nine months ended March 31, 2004, and
2003, respectively. 5. Equity Investments Subsidiaries whose results are not consolidated, but over whom we exercise
significant influence, are generally accounted for under the equity method of
accounting. Whether we exercise significant influence with respect to a
subsidiary depends on an evaluation of several factors, including, without
limitation, representation on the subsidiarys governing board and ownership
level, which is generally a 20% to 50% interest in the voting securities of the
subsidiary, including voting rights associated with our holdings in common
stock, preferred stock and other convertible instruments in the subsidiary.
Under the equity method of accounting, the subsidiarys accounts will not be
reflected in our consolidated financial statements. Our proportionate share of
a subsidiarys operating earnings and losses will be included in the caption
Loss in equity investments in our consolidated statements of operations. Currently, we have minority equity interests in Paciugo, an ongoing gelato
manufacturing, retailing and catering business, and certain development stage
Internet and communications companies, which are currently either winding up
their affairs or liquidating. During the second quarter of fiscal 2003, we
purchased the Initial Interest in Paciugo. For further details regarding this
transaction, see Note 1 entitled Business  General. The Initial Interest is
accounted for under the equity method. For the nine-month period ended March 31, 2004, our proportionate share of
equity losses totaled approximately $248,000. The value of our
outstanding equity interests, other than Paciugo, have been reduced to zero
either by recording our proportionate share of losses incurred by the
subsidiary up to the cost of that interest or from impairment losses. Based on
the negotiation and execution of the Sales Agreement, we recorded an impairment
loss in the second quarter of fiscal 2004 on our interest in Paciugo so that
our carrying value equaled the proposed Sales Price. For further detail
regarding the Sales Agreement and the proposed Sales Price, see Note 1 entitled
Business  General. For those equity interests that were completely impaired
in previous quarters, we ceased recording our share of losses incurred by the
subsidiary. Our equity interests consist of the following at March 31, 2004: % Ownership *
    
    Accounting
    
    CarryingCompany Name
    
    Common
    
    Preferred
    
    Method
    
    ValuePaciugo
    
    
    33.0
    %
    
    
    33.0
    %
    
    Equity
    
    $
    1,250,000Gemini Voice Solutions (f/k/a PhoneFree)**
    
    
    17.2
    %
    
    
    31.7
    %
    
    Equity
    
    
    ORB Communications & Marketing, Inc. ***
    
    
    19.0
    %
    
    
    100.0
    %
    
    Equity
    
    
    FonBox,
Inc.
    
    
    14.0
    %
    
    
    50.0
    %
    
    Equity
    
    
    Launch Center 39 (LC39)
    
    
    0.0
    %
    
    
    2.1
    %
    
    Cost
    
    
    Spydre Labs
    
    
    5.0
    %
    
    
    0.0
    %
    
    Cost
    
    
    $
    1,250,000
 *
    
    Reflects our ownership percentage at March 31, 2004.**
    
    Gemini Voice began the process of winding up its affairs in August of 2003.***
    
    ORB filed a voluntary petition under Chapter 7 of the Bankruptcy Code in February of 2003.
 Paciugo meets the criteria for a significant subsidiary as set forth in Rule
1.02(w) of Regulation S-X under the Exchange Act. Summarized unaudited
financial information for Paciugo as of March 31, 2004, and for the three and
nine months ended March 31, 2004, is as follows: 11




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Financial position information:Current assets
    
    $
    569,075Non-current assets
    
    
    1,551,496Current liabilities
    
    
    216,812Non-current liabilities
    
    
    697,365Net assets
    
    
    1,206,395Income statement information:For three months
    
    For the nine monthsended
    
    endedMarch 31, 2004
    
    March 31, 2004Revenues
    
    $
    455,044
    
    
    $
    1,459,699Gross profit
    
    
    318,549
    
    
    
    1,010,285Net loss
    
    
    (191,498
    )
    
    
    (959,759
    )Our equity in Paciugos net loss  recorded
    
    $
    
    
    
    $
    (247,722
    )
 6. Stock Options As of March 31, 2004, we sponsor two stock option plans: (i) the 1999 Omnibus
Securities Plan (the 1999 Plan) and (ii) the 2001 Equity Incentive Plan (the
2001 Plan). We have elected to account for those plans under Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees. We have adopted the disclosure-only provision of SFAS 123, Accounting for
Stock Based Compensation and SFAS 148, Accounting for Stock-Based
Compensation-Transition and Disclosure an Amendment to SFAS 123. Pro forma
information is presented as if we have accounted for the stock options granted
during the fiscal periods presented using the fair value method. We granted
stock options to each of our three directors on February 27, 2004, with an
exercise price based upon the thirty-day average of the closing price prior to
the date of grant, pursuant to the resolution of the Board of Directors on
January 24, 2003, which approved annual grants of 25,000 options to each of our
directors in recognition of the services that they render to us. For purposes of pro forma disclosure, the estimated fair market values of the
options are amortized to expense over the options vesting period. Our pro
forma information relative to the 2001 Plan and 1999 Plan is as follows: For the three months ended
    
    For the nine months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003(unaudited)
    
    (unaudited)
    
    (unaudited)
    
    (unaudited)Pro Forma Net LossNet loss allocable to common shareholders as reported
    
    $
    (681,968
    )
    
    $
    (1,121,245
    )
    
    $
    (3,197,280
    )
    
    $
    (2,898,100
    )Compensation recorded
    
    
    
    
    
    
    31,944

    
    
    
    
    
    
    
    31,944Additional compensation expense under SFAS 123
    
    
    (4,000
    )
    
    
    (618,000
    )
    
    
    (9,000
    )
    
    
    (2,270,006
    )Net loss allocable to common shareholders, pro forma
    
    $
    (685,968
    )
    
    $
    (1,707,301
    )
    
    $
    (3,206,280
    )
    
    $
    (5,136,162
    )Net loss per share, pro forma
    
    $
    (0.01
    )
    
    $
    (0.03
    )
    
    $
    (0.06
    )
    
    $
    (0.10
    )Net loss per share, basic and diluted, as reported
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.06
    )
    
    $
    (0.06
    )
 7. Legal Proceedings As previously reported, Eos Partners, LP, Eos Partners SBIC, LP, Eos Partners
(Offshore), LP, Kuwait Fund for Arab Economic Development and TBV Holdings Ltd.
(collectively, the Plaintiffs) filed a lawsuit against us, Fred Vierra,
Barrett N. Wissman, Clark K. Hunt, Mark R. Graham, Olaf Guerrand-Hermes, Stuart
Subotnick, Jan Robert Horsfall, Stuart Chasanoff, John Stevens Robling, Jr.,
Samuel Litwin, Mitchell Arthur, BDO Seidman, LLP, Hunt 12




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##### Table of Contents



Asset Management, LLC, HW Partners, LP, HW Finance, LLC, HW Capital, LP and HW Group, LLC
(collectively, the Defendants) in the 190th Judicial District Court of Harris
County, Texas, on December 19, 2002. The lawsuit alleged breach of contract,
fraud and conspiracy in connection with the Plaintiffs purchase of certain of
our Series C Convertible Preferred Stock in December of 1999 and January of
2000. The Defendants denied the allegations and vigorously defended against the
Plaintiffs claims and sought all other appropriate relief. The Plaintiffs
claimed actual damages of approximately $17.4 million and requested additional
exemplary damages, costs of court and attorneys fees. The Defendants submitted
the claims to their insurance carriers. The district judge denied the
Plaintiffs motion to transfer the case to Dallas County and ruled that it
should instead proceed in Harris County. However, it was reassigned to the
280th Judicial District Court. The Plaintiffs and the Defendants mediated the
case on February 9, 2004, and the claims were settled at that time on terms in
which we did not expend any cash or assets. As part of the settlement, we
received all of the outstanding Series C Convertible Preferred Stock from the
holders thereof, including the Plaintiffs, without any additional
consideration, and the shares were subsequently retired. As previously reported, we, along with the liquidating trust, filed a lawsuit
on June 17, 2002, against Qwest, a former customer and vendor, and John L.
Higgins, a former employee and consultant, in the Eighth Judicial District
Court of Clark County, Nevada. The amended plan called for certain causes of
action to be pursued by the liquidating trust against various third parties,
including Qwest, in an attempt to marshal sufficient assets to make
distributions to creditors. We were a co-proponent of the amended plan and
suffered independent damages as a result of Qwests actions. Accordingly, we
and the liquidating trust asserted, among other things, the following claims
against Qwest: (i) breach of contract, (ii) conversion, (iii) misappropriation
of trade secrets, (iv) breach of a confidential relationship, (v) fraud, (vi)
breach of the covenant of good faith and fair dealing, (vii) tortious
interference with existing and prospective business relations, (viii) aiding
and abetting Mr. Higginss misconduct, (ix) civil conspiracy, and (x) unjust
enrichment. The following claims also have been asserted against Mr. Higgins:
(i) breach of contract, (ii) breach of fiduciary duties, (iii) breach of a
confidential relationship, (iv) fraud, (v) aiding and abetting Qwests
misconduct, (vi) civil conspiracy, and (vii) unjust enrichment. In addition to
an award of attorneys fees, we and the liquidating trust are seeking such
actual, consequential and punitive damages as may be awarded by a jury or other
trier of fact. Qwest filed a motion to stay the litigation and compel
arbitration on August 14, 2002. On March 13, 2003, a hearing was held to
determine the proper forum for the various claims. After listening to oral
arguments, the district judge granted Qwests motion. On April 2, 2003, we,
along with the liquidating trust, filed a petition with the Supreme Court of
Nevada, asking it to direct the district judge to reconsider her order. On
August 13, 2003, our petition was denied. Accordingly, an arbitrator was
appointed on December 30, 2003. He presided over a preliminary hearing on
February 4, 2004, and he originally set the matter for a final hearing on July
7, 2004. On April 22, 2004, the arbitrator granted Qwests motion to continue
the final hearing until September 27, 2004. We have previously disclosed in other reports filed with the SEC certain other
legal proceedings pending against us and our subsidiaries. Consistent with the
rules promulgated by the SEC, descriptions of these matters have not been
included in this Quarterly Report because they have neither been terminated nor
has there been any material developments during the nine months ended March 31,
2004. Readers are encouraged to refer to our prior reports for further
information concerning other legal proceedings affecting us and our
subsidiaries. We and our subsidiaries are involved in other legal proceedings from time to
time, none of which we believe, if decided adversely to us or our subsidiaries,
would have a material adverse effect on our business, financial condition or
results of operations. 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Operations Summary As of March 31, 2004, we effectively had no operations, no sources of revenue
and no profits, and we do not anticipate being in a position to resume
operations until such time, if any, as we identify an appropriate opportunity
and consummate a transaction that would result in the adoption of a new
business plan. During fiscal 2003, we purchased the Initial Interest in
Paciugo. During the eight months ended August 31, 2003, we received $166,667
from Paciugo for the provision of Support Services. In connection with the
execution of the Sales Agreement with Paciugo, and for as
long as it remains in effect, we have given up any rights to receive any additional payments for the
provision of Support Services under the Purchase Agreement in exchange for
receipt of the proposed Sales Price. We cannot predict when or if we will
receive the proposed Sales Price or when or if we will be successful in a
business venture or other potential business opportunities that we may
consider, if any. For further details regarding the Support Services,
see Note 1 entitled Business  General, above. 13




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##### Table of Contents



During the nine months ended March 31, 2004, no revenues from operations were
generated based on (i) the termination of operations of our debtor
subsidiaries, which have historically provided all significant revenues for us
and (ii) the uncertainties surrounding other potential business opportunities
that we may consider, if any. In August of 2003, certain disagreements arose
between us and Paciugo concerning the amount of the monthly payment for July of
2003, as well as our performance of the Support Services. As a result, Paciugo
has failed to make the monthly payment since August of 2003. In connection with
the execution of the Sales Agreement with Paciugo, and for
as long as it remains in effect, we have given up any rights to receive any additional payments for the
provision of Support Services under the Purchase Agreement For further details
regarding the Support Services, see Note 1 entitled Business 
General, above. 14




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##### Table of Contents



Summary of Operating Results The table below summarizes our operating results. For the Three Months
    
    For the Nine MonthsEnded March 31,
    
    Ended March 31,2004
    
    2003
    
    2004
    
    2003(unaudited)
    
    (unaudited)Operating expenses:Selling, general and administrative expenses
    
    $
    453,999
    
    
    $
    982,172
    
    
    $
    1,576,416
    
    
    $
    2,387,926Impairment loss
    
    
    
    
    
    
    
    
    
    
    757,801
    
    
    
    Depreciation and amortization
    
    
    30,711
    
    
    
    36,555
    
    
    
    97,999
    
    
    
    113,012484,710
    
    
    
    1,018,727
    
    
    
    2,432,216
    
    
    
    2,500,938Loss from operations, before
other (income) expense
    
    
    (484,710
    )
    
    
    (1,018,727
    )
    
    
    (2,432,216
    )
    
    
    (2,500,938
    )Other (income) expense:Interest income
    
    
    (4,990
    )
    
    
    (55,145
    )
    
    
    (19,172
    )
    
    
    (96,926
    )Loss in equity investments
    
    
    
    
    
    
    131,506
    
    
    
    247,722
    
    
    
    396,257Net gain on liquidation of debtor subsidiaries
    
    
    
    
    
    
    (74,000
    )
    
    
    
    
    
    
    (288,000
    )Other
    
    
    22,254
    
    
    
    (62,515
    )
    
    
    7,135
    
    
    
    (99,620
    )17,264
    
    
    
    (60,154
    )
    
    
    235,685
    
    
    
    (88,289
    )Net loss
    
    
    (501,974
    )
    
    
    (958,573
    )
    
    
    (2,667,901
    )
    
    
    (2,412,649
    )Series D preferred dividends
    
    
    (179,994
    )
    
    
    (162,672
    )
    
    
    (529,379
    )
    
    
    (485,451
    )Net loss allocable to common shareholders
    
    $
    (681,968
    )
    
    $
    (1,121,245
    )
    
    $
    (3,197,280
    )
    
    $
    (2,898,100
    )BasicNet loss per share
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.06
    )
    
    $
    (0.06
    )Weighted average number of shares outstanding
    
    
    52,323,701
    
    
    
    52,323,701
    
    
    
    52,323,701
    
    
    
    52,323,701
 Three Months Ended
March 31, 2004, Compared to Three Months Ended March 31, 2003 Revenues.No revenues were generated during either period presented. No
revenues were generated based on (i) the termination of all operations of our
debtor subsidiaries by December of 2001, which have historically provided all
of our significant revenues and (ii) the uncertainty surrounding our plans to
explore other opportunities. Direct costs.No direct costs were incurred during the three months and nine
months ended March 31, 2004, and 2003, respectively. Selling, General and Administrative.Selling, general and administrative
expenses decreased approximately $528,000 during the three months ended March
31, 2004, from approximately $982,000 during the three months ended March 31,
2003, a decrease of 54%. The drop in selling, general and administrative
expenses is primarily due to (i) the downsizing of the workforce, (ii) the
reduction in professional fees relating to the bankruptcy plan administrative
process, (iii) reduction in legal fees and (iv) an overall reduction of
overhead related to office expenses. Selling, general and administrative expenses for the three months ended March
31, 2004, consisted primarily of approximately (i) $127,000 of salaries and
benefits, (ii) $36,000 of consulting and professional fees, (iii) $59,000 of
legal fees, (iv) $143,000 of business insurance and (v) $89,000 of other
operating expenses. Selling, general and 15




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administrative expenses for the three months ended March 31, 2003, consisted primarily of approximately (i) $223,000
of salaries and benefits, (ii) $150,000 of bad debt expense, (iii) $293,000 of
legal fees, (iv) $54,000 of consulting and professional fees, (v) $158,000 of
business insurance and (vi) $104,000 of other operating expenses. We anticipate
that selling, general and administrative expenses will remain relatively constant as (i) we currently have no operations, (ii) we completed personnel
reductions and (iii) we continue to work toward the conclusion of the various
bankruptcy proceedings. We expect our selling, general and administrative
expense to be approximately $125,000 per month until such time, if any, as we
are able to develop an alternative business strategy. Impairment Loss. Due to the execution of the Sales Agreement with Paciugo, we
recorded an impairment loss of $758,000 during the three months ended
December 31, 2003 reducing the net book value of the investment to the proposed
Sales Price. Depreciation and Amortization.Depreciation recorded on fixed assets during
the three months ended March 31, 2004, totaled approximately $31,000, as
compared to approximately $37,000 for the three months ended March 31, 2003. We
expect our depreciation expense to remain relatively constant until such time,
if any, as we are able to develop an alternative business strategy. Interest Income.We recorded interest income from cash investments of
approximately $5,000 for the three months ended March 31, 2004, as compared to
approximately $55,000 for the three months ended March 31, 2003. The decrease
in interest income during the current quarter is a result of lower amounts of
cash available to be invested. Loss in Equity Investments.Loss in equity investments resulted from our
minority ownership in certain non-impaired interests that are accounted for
under the equity method of accounting. Under the equity method, our
proportionate share of each of our subsidiarys operating loss is included in
equity in loss of investments. During the three months ended March 31, 2004, we
did not record our portion of Paciugos losses since our interest in Paciugo
reflects the proposed Sales Price in the Sales Agreement as compared to a loss
of approximately $131,000 during the three months ended March 31, 2003.
For further details regarding Paciugo, see Note 1 entitled Business  General, above. The value of our outstanding equity interests,
other than Paciugo, have been reduced to zero either by recording our
proportionate share of prior period losses incurred by each subsidiary up to
the cost of that interest or from impairment losses. We anticipate that those
interests will continue to incur operating losses. However, we do not expect to
record future charges related to them since they are completely impaired. As
mentioned previously, our minority holdings, other than Paciugo,
are either winding up their affairs or liquidating. We do not expect
to record future charges related to those losses, as the interests have no
carrying value. We expect Paciugo to continue in the near future to incur
operating losses, but we do not intend to record our portion of those losses
since our interest reflects the proposed Sales Price in the Sales Agreement. Other.We recorded
estimated franchise taxes of $22,200 during the three months ended
March 31, 2004, as compared to $300 in the three months ended March
31, 2003. On May 14, 2004,we were notified by our registered agent
that the Delaware Department of States office (the DDOS)
had initiated an effort to void our charter, effective as of March 1,
2004, as a result of an ongoing dispute over the calculation of our
2002 franchise taxes. The DDOS bases its franchise taxes on the
assets shown on its resident companies federal income tax
returns. On our 2002 federal income tax return, we included the
amounts that we had invested in our debtor subsidiaries. Accordingly,
the DDOS took the position that we should be taxed on those assets,
even though the debtor subsidiaries were liquidating as part of the
bankruptcy plan administration process, and the DDOS thereafter
advised us that we had not paid the correct amount of 2002 franchise
taxes. The amount in dispute is $51,262, and it has been fully
reserved. We are in the process of preparing an amended 2002 federal
income tax return that will eliminate the amounts that we had
invested in our debtor subsidiaries, and therefore, it will support
our position that we originally paid the correct amount of 2002
franchise taxes. We are also in the process of filing appropriate
paperwork with the DDOS to restore, renew and revive our charter. Nine Months Ended
March 31, 2004, Compared to Nine Months Ended March 31, 2003 Revenues.No revenues were generated during either period presented. No
revenues were generated based on (i) the termination of all operations of our
debtor subsidiaries by December of 2001, which historically provided all of our
significant revenues and (ii) the uncertainty surrounding our plans to explore
other opportunities. Direct costs.No direct costs were incurred during the nine months ended March
31, 2004, and 2003, respectively. Selling, General and Administrative.Selling, general and administrative
expenses decreased approximately $812,000 during the nine months ended March
31, 2004, from approximately $2.39 million during the nine months ended March 31,
2003, a decrease of 34%. The drop in selling, general and administrative
expenses is primarily due to (i) the downsizing of the workforce, (ii) the
reduction in professional fees relating to the bankruptcy plan administrative
process, (iii) reduction in legal fees and (iv) an overall reduction of
overhead related to office expenses. Selling, general and administrative expenses for the nine months ended March
31, 2004, consisted primarily of approximately (i) $402,000 of salaries and
benefits, (ii) $284,000 of legal fees, (iii) $163,000 of consulting and
professional fees, (iv) $446,000 of business insurance, (v) $116,000 of office
rent and expenses and (vi) $165,000 of other operating expenses. Selling,
general and administrative expenses for the nine months ended March 31, 2003,
consisted primarily of approximately (i) $788,000 of salaries and benefits,
(ii) $269,000 of bad debt expense (iii) $497,000 of legal fees, (iv) $97,000 of
consulting and professional fees, (v) $432,000 of business insurance, (vi)
$160,000 of office rent and expenses and (vii) $145,000 of other operating
expenses. We anticipate that selling, 16




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general and administrative expenses will remain relatively constant as (i) we currently have no operations, (ii) we
completed personnel reductions and (iii) we continue to work toward the
conclusion of the various bankruptcy proceedings. We expect our selling,
general and administrative expense to be approximately $125,000 per month until
such time, if any, as we are able to develop an alternative business strategy. Impairment Loss. Due to the execution of the Sales Agreement with Paciugo, we
recorded an impairment loss of $758,000 during the nine months ended
March 31, 2004, reducing the net book value of the investment to the proposed
Sales Price. Depreciation and Amortization.Depreciation recorded on fixed assets during
nine months ended March 31, 2004, totaled approximately $98,000, as compared to
approximately $113,000 for the nine months ended March 31, 2003. We expect our
depreciation expense to remain relatively constant until such time, if any, as
we are able to develop an alternative business strategy. Interest Income.We recorded interest income from cash investments of
approximately $19,000 for the nine months ended March 31, 2004, as compared to
approximately $97,000 for nine months ended March 31, 2003. The decrease in
interest income during the current period is a result of lower amounts of cash
available to be invested. Loss in Equity Investments.Loss in equity investments resulted from our
minority ownership in certain non-impaired interests that are accounted for
under the equity method of accounting. Under the equity method, our
proportionate share of each of our subsidiarys operating loss is included in
equity in loss of investments. During the nine months ended March 31, 2004, we
recorded a loss of approximately $248,000 as compared to a loss of
approximately $396,000 during the nine months ended March 31, 2003. As
previously discussed, we did not record any loss from our interest in Paciugo
during the three months ended March 31, 2004. The current nine-month loss
resulted from our 33% Initial Interest in Paciugo. For further details
regarding Paciugo, see Note 1 entitled Business  General,
above. The value of our outstanding equity interests, other than Paciugo, have
been reduced to zero either by recording our proportionate share of prior
period losses incurred by each subsidiary up to the cost of that investment or
from impairment losses. As mentioned previously, our minority interests, other than Paciugo,
are either winding up their affairs or liquidating. We do
not expect to record future charges related to them since they are completely
impaired. We expect Paciugo to continue in the near future to incur operating
losses, but we do not intend to record our portion of those losses due the
impairment of asset to the proposed Sales Price in the Sales Agreement. Other.We recorded other income of $41,666
from the provision
of the Support Services to Paciugo as agreed upon in the Purchase
Agreement during the nine months ended March 31, 2004, as
compared to $62,500 during the nine months ended March 31, 2003. In
August of 2003, certain disagreements arose between us and Paciugo concerning
the amount of the monthly payment for July of 2003, as well as our performance
of the Support Services. As a result, Paciugo has failed to make these payments
since August of 2003. Upon the closing of the Sales Agreement
with Paciugo, we will permanently relinquish any rights to receive any additional payments for
the provision of Support Services under the Purchase Agreement in exchange for
the receipt of the proposed Sales Price. We recorded estimated
franchise taxes of $50,300 during the nine months ended
March 31, 2004, as compared to a credit of $37,800 in the nine
months ended March 31, 2003. As noted above, on
May 14, 2004, we were notified by our registered agent that the
DDOS had initiated an effort to void our charter, effective as of
March 1, 2004, as a result of an ongoing dispute over the
calculation of our 2002 franchise taxes. The DDOS bases its franchise
taxes on the assets shown on its resident companies federal income
tax returns. On our 2002 federal income tax return, we included the
amounts that we had invested in our debtor subsidiaries. Accordingly,
the DDOS took the position that we should be taxed on those assets,
even though the debtor subsidiaries were liquidating as part of the
bankruptcy plan administration process, and the DDOS thereafter
advised us that we had not paid the correct amount of 2002 franchise
taxes. The amount in dispute is $51,262, and it has been fully
reserved. We are in the process of preparing an amended 2002 federal
income tax return that will eliminate the amounts that we had
invested in our debtor subsidiaries, and therefore, it will support
our position that we originally paid the correct amount of 2002
franchise taxes. We are also in the process of filing appropriate
paperwork with the DDOS to restore, renew and revive our charter. Liquidity and Capital Resources At March 31, 2004, we had consolidated current assets of $2.6 million,
including cash and cash equivalents of approximately $2.1 million and net
working capital of $2.0 million. Principal uses of cash have been to fund (i)
operating losses, (ii) acquisitions and strategic business opportunities, (iii)
working capital requirements, (iv) expenses related to the bankruptcy plan
administration process and (v) the Qwest arbitration. Due to our financial
performance, the lack of stability in the capital markets and the economys
downturn, our only current source of funding is expected to be cash on hand. Effectively, our only ability to satisfy our current obligations is our cash on
hand. Our current obligations include (i) funding working capital, (ii) funding
the liquidating trust, and (iii) funding the Qwest arbitration. We estimate
that it will take approximately $1.5 million of our remaining cash to satisfy
these obligations for the next nine months. This would leave us with
approximately $600,000 of cash available for use in any potential
transaction for the redeployment of our remaining cash assets (a Business
Opportunity) at the end of that nine-month period. In the event we expend all
of our $600,000 on a Business Opportunity and achieve no return or cash
flow from that transaction before December 31, 2004, or if we incur other
unanticipated expenses for operations, we would likely be required to cease
operations altogether and pursue other alternatives, such as liquidating or
filing a voluntary petition for relief under the Bankruptcy Code.
We believe that under any liquidation scenario, our 17




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stockholders would not receive any recovery on or value for their holdings. We currently anticipate that we will not generate any revenue from operations
in the near term based on (i) the termination of the operations of our debtor
subsidiaries, which have historically provided all of our significant revenues
on a consolidated basis and (ii) the uncertainties surrounding other potential
Business Opportunities that we may consider, if any. As noted above, we do not believe that any of the traditional funding sources
will be available to us and that our only option will likely be cash on hand.
Consequently, our failure to identify potential Business Opportunities, if any,
will jeopardize our ability to continue as a going concern. Due to these
factors, we are unable to determine whether current available financing will be
sufficient to meet the funding requirements of (i) our debtor subsidiaries
bankruptcy plan administration process, (ii) the Qwest arbitration and (iii)
our ongoing general and administrative expenses. No assurances can be given
that adequate levels of financing will be available to us on acceptable terms,
if at all. The net cash provided by or used in operating, investing and financing
activities for the nine months ended March 31, 2004, and 2003, respectively, is
summarized below: Cash used in operating activities in nine months ended March 31, 2004, totaled
approximately $1.8 million as compared to approximately $2.2 million in the
nine months ended March 31, 2003. During the nine months ended March 31, 2004,
cash flow used by operating activities primarily resulted from operating
losses, net of non-cash charges, totaling approximately $1.6 million, and an
increase in prepaid expenses of approximately $275,000. During the nine
months ended March 31, 2003, cash flow used by operating activities primarily
resulted from operating losses, net of non-cash charges, totaling $2.0 million,
an increase in prepaid expenses of $70,000, an increase in note and other
receivables of $160,000 and a net decrease in accounts payable and accrued
liabilities of $40,000. During the nine months ended March 31, 2003, we
invested $2.5 million in Paciugo. Ability to Continue as a Going Concern The accompanying consolidated financial statements have been prepared assuming
that we will continue as a going concern. They do not include any adjustments
that might result should we be unable to continue as a going concern and no
assurances can be given that we will continue as a going concern. In fact, it
is unlikely that we will be able to continue as a going concern past December 31, 2004, unless we receive the Sales
Price from Paciugo or successfully realize a cash settlement or obtain an award
in connection with the Qwest arbitration. Our independent accountants have previously included an explanatory paragraph
in their report on our financial statements for the year ended June 30, 2003,
contained in our most recent Annual Report on Form 10-K, which states that
although our financial statements have been prepared assuming that we will
continue as a going concern, substantial doubt exists as to our ability to do
so. Plan of Operation Prior Plan of Operation. We have continued to expend considerable time
and resources pursuing a plan of operation focused on locating, negotiating
and, if possible, consummating a Business Opportunity. Unfortunately, our
efforts, with the exception of Paciugo, have not resulted in such an outcome,
with negotiations ceasing prior to the consummation of any of the various
transactions that we have pursued to date. Considering our current cash on hand
and the funding needed to satisfy our obligations for the next nine months, it
has become increasingly clear that the consummation of a Business Opportunity with
our remaining free cash assets and current capital structure appears highly
unlikely, particularly when such a transaction must be capable of producing
positive cash flow for us in the immediate future. During the three months
ended March 31, 2004, we contemplated a possible plan of recapitalization that
would have resulted in all of the holders of our preferred stock electing to convert
their shares into common stock, at a negotiated and substantially reduced
conversion price (a Recapitalization Event). Our belief is that we would be
in a better position to consummate a Business Opportunity or a Strategic
Combination (as defined below) if we were able to achieve such a
Recapitalization Event. Despite significant efforts, we cannot report that we
have a reasonable likelihood of completing a Business Opportunity or a
Recapitalization Event as of the date of this Quarterly Report. 18




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Revised Plan of Operation. In light of our current liquidity position, the
lack of a viable Business Opportunity, and our belief that under any
liquidation scenario our stockholders would not receive any recovery on or
value for their holdings, we have shifted our focus and are pursuing a revised
Plan of Operations as of the date of this Quarterly Report. Given our current
situation, we believe that the most beneficial transaction for our stockholders
would involve the exchange a certain amount of our common stock for the equity
of a privately held company that values our assets and our status as a reporting company under
the Securities Exchange Act of 1934, as amended (a Strategic Combination). In
pursuing the best Strategic Combination possible, we believe that it will be
necessary to effect a Recapitalization Event beforehand. It should be noted,
however, that the pursuit of a Strategic Combination is not guaranteed to
benefit us or any specific holder of our equity securities. With our limited
cash, the most likely form of Strategic Combination would involve a substantial
portion of the consideration being paid in the form of common stock.
Furthermore, any Strategic Combination would likely require the approval of the
holders of our common stock and perhaps our outstanding preferred stock. We can
offer no assurances that we could obtain such stockholder approval even if we
were able to locate a suitable Strategic Combination. Even if we entered into a Strategic Combination, the consummation of such
a transaction would likely cause significant dilution in the holdings of our
existing common and possibly our preferred stockholders. If accomplishing a
Recapitalization Event is a condition to the completion of a Strategic
Combination, then the holders of our existing common stock would likely
experience significant material dilution of their holdings both at the time of
such a Recapitalization Event as well as upon the consummation of the Strategic
Combination. Similarly, our preferred stockholders, if converted as part of a
Recapitalization Event, would also experience significant material dilution of
their holdings as a result of the Strategic Combination. We can offer no assurances that we will be able to effect a
Recapitalization Event or a Strategic Combination on terms that would be
acceptable to us or that would provide a benefit to our stockholders. In the
event that we cannot achieve those objectives on or before December 31, 2004,
we would likely be required to cease operations altogether and pursue other
alternatives, such as liquidating or filing a voluntary petition for relief
under the United States Bankruptcy Code. ForwardLooking Statements Forward-looking statements appear in the following Managements Discussion
and Analysis of Financial Condition and Results of Operations as well as
elsewhere in this Quarterly Report. We have based these forward-looking
statements on our current expectations and projections about future events. Forward-looking statements include, without limitation, the following:  Statements concerning our financial condition and strategic
direction:  
    
    statements regarding our future capital requirements and our ability to satisfy our capital needs;
    
    statements regarding our ability to continue as a going concern;
    
    statements regarding our exposure, if any, arising from
litigation matters currently pending against us;
    
    statements regarding our ability to collect amounts owed
by Qwest and other third parties and to successfully pursue causes
of action against Qwest and other third parties;
    
    statements regarding the ability of our debtor
subsidiaries to successfully liquidate and distribute
substantially all of their assets, pursuant to the amended plan,
without causing a material adverse impact on us;
    
    statements regarding the consummation of the Sales
Agreement and realization of the proposed Sales Price;
    
    statements regarding the redeployment of our remaining
cash assets, if any, in furtherance of a potential Business
Opportunity;
    
    statements regarding the potential generation of revenue
resulting from the redeployment of our cash assets;
    
    statements regarding the possibility of accomplishing a
Recapitalization Event or a Strategic Combination and the
potential effects on us and on our stockholders, including,
without limitation, the possibility of significant stockholder
dilution; and 19




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
    
    statements regarding the potential liquidation of our
assets, whether in a voluntary wind down or a bankruptcy
proceeding.  Statements concerning our debtor subsidiaries:  
    
    statements regarding the estimated liquidation value of
assets and settlement amounts of liabilities; and
    
    statements regarding the impact of the bankruptcy proceedings on our financial condition.  Statements concerning our interest in Paciugo:  
    
    statements regarding our ability to realize any benefit from the Paciugo Sales Agreement;
    
    statements regarding Paciugos operations; and
    
    statements regarding our relationship with the Equity Owners.  Other statements:  
    
    statements that contain words like believe,
anticipate, expect and similar expressions are also used to
identify forward-looking statements. You should be aware that all of our forward-looking statements are subject
to a number of risks, assumptions and uncertainties, such as (and in no
particular order):  
    
    risks inherent in our ability to redeploy our remaining assets, including remaining cash assets;
    
    risks associated with competition in the sector or industry that we may enter;
    
    risks associated with our ability to successfully
prosecute claims against Qwest and other third parties;
    
    risks associated with our ability to close the Sales
Agreement and the realization of the proposed Sales Price;
    
    risks associated with Paciugos market position, the
industry in which Paciugo competes, Paciugos prospects for
meaningful success, Paciugos operations and our relationship
with the Equity Owners;
    
    risks associated with having no current operations or
revenue;
    
    risks that we will be unable to redeploy our remaining
cash assets, or if so deployed, risks that we will not be able to
generate positive cash flow or revenue after consummating such a
transaction sufficient to satisfy our current obligations;
    
    risks that we will be unable to obtain the approval of
our stockholders if we were to propose a Recapitalization Event or
a Strategic Combination;
    
    risks that we might not be able to locate a suitable
entity with which to engage in a Strategic Combination;
    
    risks that we might not be able to effect a
Recapitalization Event or a Strategic Combination on terms that
were acceptable to us or would benefit our stockholders;
    
    risks that a Recapitalization Event may be entered into
upon terms and conditions that would result in significant and
material dilution of our common and preferred stockholders;
    
    risks that a Strategic Combination may be entered into
upon terms and conditions that would result in significant and
material dilution of our common and preferred stockholders;
    
    risks that any Strategic Combination would result in us
pursuing a new and unknown business model that
may or may not benefit our stockholders;
    
    risks that any wind down or liquidation would not
result in our stockholders receiving any recovery on or value for
their stock holdings; 20




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
    
    risks associated with preserving the net operating loss
carryforwards of our debtor subsidiaries;
    
    risks associated with uncertainties in the
implementation of the amended plan concerning the liquidation of
substantially all of the remaining assets of our debtor
subsidiaries and any resulting impact on us; and
    
    risks associated with changes in the laws and
regulations that govern us. This list is only an example of the risks that may affect the forward-looking
statements. If any of these risks or uncertainties materialize (or if they fail
to materialize), or if the underlying assumptions are incorrect, then actual
results may differ materially from those projected in the forward-looking
statements. Additional factors that could cause actual results to differ materially from
those reflected in the forward-looking statements include those discussed in
this section, elsewhere in this report, in our Quarterly Reports on Form 10-Q
for our fiscal quarters ended September 30, 2003, and December 31, 2003, and
the risks discussed in the Business Considerations section included in our
Annual Report on Form 10-K for our fiscal year ended June 30, 2003, as filed
with the SEC. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect the Companys analysis, judgment,
belief or expectation only as of the date of this Quarterly Report. We
undertake no obligation to publicly revise these forward-looking statements to
reflect events or circumstances that arise after the date of this report. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to the impact of interest rate and other risks. We had
investments in money market funds of approximately $2.1 million as of March 31,
2004. Due to the short-term nature of our investments, we believe that the
effects of changes in interest rates are limited and would not materially
affect profitability. 
 Item 4. Controls and Procedures Within the 90 days prior to the filing date of this Quarterly Report, we
carried out an evaluation, under the supervision and with the participation of
our Principal Executive Officer and Principal Accounting Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as defined in Rule 13a-14 of the Securities Exchange Act of 1934. Based upon that evaluation, the Principal
Executive Officer and the Principal Financial and Accounting Officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to us (including our consolidated
subsidiaries) required to be included in this Quarterly Report. There have been
no significant changes in our internal controls over financial reporting or in
other factors, which could significantly affect such internal controls,
subsequent to the date we carried out our evaluation. 
 PART II: OTHER INFORMATION 
 Item 1. Legal Proceedings As previously reported, Eos Partners, LP, Eos Partners SBIC, LP, Eos Partners
(Offshore), LP, Kuwait Fund for Arab Economic Development and TBV Holdings Ltd.
(collectively, the Plaintiffs) filed a lawsuit against us, Fred Vierra,
Barrett N. Wissman, Clark K. Hunt, Mark R. Graham, Olaf Guerrand-Hermes, Stuart
Subotnick, Jan Robert Horsfall, Stuart Chasanoff, John Stevens Robling, Jr.,
Samuel Litwin, Mitchell Arthur, BDO Seidman, LLP, Hunt Asset Management, LLC,
HW Partners, LP, HW Finance, LLC, HW Capital, LP and HW Group, LLC
(collectively, the Defendants) in the 190th Judicial District Court of Harris
County, Texas, on December 19, 2002. The lawsuit alleged breach of contract,
fraud and conspiracy in connection with the Plaintiffs purchase of certain of
our Series C Convertible Preferred Stock in December of 1999 and January of
2000. The Defendants denied the allegations and vigorously defended against the
Plaintiffs claims and sought all other appropriate relief. The Plaintiffs
claimed actual damages of approximately $17.4 million and requested additional
exemplary damages, costs of court and attorneys fees. The Defendants submitted
the claims to their insurance carriers. The district judge denied the
Plaintiffs motion to transfer the case to Dallas County and ruled that it
should instead proceed in Harris County. However, it was reassigned to the
280th Judicial District Court. The Plaintiffs and the Defendants mediated the
case on February 9, 2004, and the claims were settled at that time on terms in
which we did not expend any cash or assets. As part of the
settlement, we received all of the outstanding Series C Convertible Preferred Stock from the 21




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holders thereof, including the Plaintiffs, without any additional
consideration, and the shares were subsequently retired. As previously reported, we, along with the liquidating trust, filed a lawsuit
on June 17, 2002, against Qwest, a former customer and vendor, and John L.
Higgins, a former employee and consultant, in the Eighth Judicial District
Court of Clark County, Nevada. The amended plan called for certain causes of
action to be pursued by the liquidating trust against various third parties,
including Qwest, in an attempt to marshal sufficient assets to make
distributions to creditors. We were a co-proponent of the amended plan and
suffered independent damages as a result of Qwests actions. Accordingly, we
and the liquidating trust asserted, among other things, the following claims
against Qwest: (i) breach of contract, (ii) conversion, (iii) misappropriation
of trade secrets, (iv) breach of a confidential relationship, (v) fraud, (vi)
breach of the covenant of good faith and fair dealing, (vii) tortious
interference with existing and prospective business relations, (viii) aiding
and abetting Mr. Higginss misconduct, (ix) civil conspiracy, and (x) unjust
enrichment. The following claims also have been asserted against Mr. Higgins:
(i) breach of contract, (ii) breach of fiduciary duties, (iii) breach of a
confidential relationship, (iv) fraud, (v) aiding and abetting Qwests
misconduct, (vi) civil conspiracy, and (vii) unjust enrichment. In addition to
an award of attorneys fees, we and the liquidating trust are seeking such
actual, consequential and punitive damages as may be awarded by a jury or other
trier of fact. Qwest filed a motion to stay the litigation and compel
arbitration on August 14, 2002. On March 13, 2003, a hearing was held to
determine the proper forum for the various claims. After listening to oral
arguments, the district judge granted Qwests motion. On April 2, 2003, we,
along with the liquidating trust, filed a petition with the Supreme Court of
Nevada, asking it to direct the district judge to reconsider her order. On
August 13, 2003, our petition was denied. Accordingly, an arbitrator was
appointed on December 30, 2003. He presided over a preliminary hearing on
February 4, 2004, and he originally set the matter for a final hearing on July
7, 2004. On April 22, 2004, the arbitrator granted Qwests motion to continue
the final hearing until September 27, 2004. We have previously disclosed in other reports filed with the SEC certain other
legal proceedings pending against us and our subsidiaries. Consistent with the
rules promulgated by the SEC, descriptions of these matters have not been
included in this Quarterly Report because they have neither been terminated nor
has there been any material developments during the nine months ended March 31,
2004. Readers are encouraged to refer to our prior reports for further
information concerning other legal proceedings affecting us and our
subsidiaries. We and our subsidiaries are involved in other legal proceedings from time to
time, none of which we believe, if decided adversely to us or our subsidiaries,
would have a material adverse effect on our business, financial condition or
results of operations. 
 Item 2. Changes in Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other Information Effective May 11, 2004, Russell W. Beiersdorf resigned as a director. 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits 10.1
    
    NonQualified Stock Option Agreement
between the Registrant and Barrett N. Wissman.10.2
    
    NonQualified Stock Option
Agreement between the Registrant and John Stevens Robling.10.3
    
    NonQualified Stock Option Agreement
between the Registrant and Russell W. Beiersdorf.31.1
    
    Certification of the Principal Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley
    Act of 2002.31.2
    
    Certification of the Principal Financial and Accounting
Officer pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.32.1
    
    Certification pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
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| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------



| |  |  | On January 15, 2004, we filed a Report on Form 8-K, disclosing the
execution of a Sales Agreement to sell our interests in Paciugo.
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, Novo
Networks, Inc. has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. NOVO NETWORKS, INC.Date: May 17, 2004
    
    By:
    
    /s/ Steven W. CapleSteven W. CaplePresident(Principal Executive Officer)Date: May 17,2004
    
    By:
    
    /s/ Patrick G. MackeyPatrick G. MackeySenior Vice President(Principal Financial and Accounting Officer)
 24