Annual Report

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C., 20549

 

 

 

 

Form 10-KSB

 

 

 

 

 

Commission file number: 001-15385

 

 

Issuer’s telephone number: (713) 934-3855

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Common Stock, par value $0.0001 per share American Stock Exchange

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None

 

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act   o

 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  þ      NO  o

 

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.   o

 

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).  YES  o      NO  þ

 

Issuer’s revenue for fiscal year ended March 31, 2007:  $7,069,575

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the price of such common equity as of June 20, 2007 as reported on the American Stock Exchange is $18,313,421. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose.

 

Number of shares of Common Stock outstanding as of June 20,2007: 31,300,462.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Items 9 (as to directors, audit committee, audit committee financial expert and Section 16(a) Beneficial Ownership Reporting Compliance), 10, 11 (as to Beneficial Ownership), 12 and 14 of Part III of this Annual Report on Form 10-KSB incorporate by reference information from the registrant’s proxy statement to be filed with the Securities and Exchange Commission within 120 days of the end of the fiscal year ended March 31, 2007, in connection with the solicitation of proxies for the registrant’s 2007 Annual Meeting of Stockholders.

 

Transitional Small Business Disclosure Format:  Yes   o      No  þ

 

 

US DATAWORKS, INC.
TABLE OF CONTENTS

 

2007 FORM 10-KSB

 

 

When used in this Report, the words “expects,” “anticipates,” “believes,” “plans,” “will” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements regarding our critical accounting policies, our operating expenses, our strategic opportunities, adequacy of capital resources, our potential professional services contracts and the related benefits, demand for software and professional services, demand for our solutions, expectations regarding net losses, expectations regarding cash flow and sources of revenue, benefits of our relationship with an MSP and Hyundai, statements regarding our growth and profitability, investments in marketing and promotion, fluctuations in our operating results, our need for future financing, effects of accounting standards on our financial statements, our investment in strategic partnerships, development of customer base and our infrastructure, our dependence on establishing relationships with leading customers in the ATM market, our dependence on our strategic partners, our dependence on personnel, our disclosure controls and procedures, our ability to respond to rapid technological change, expansion of our technologies and products, benefits of our products, our competitive position, statements regarding future acquisitions or investments, our legal proceedings, our dividend policy and our transaction with Hyundai. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those discussed below, as well as risks related to our ability to develop and timely introduce products that address market demand, the impact of alternative technological advances and competitive products, market fluctuations, our ability to obtain future financing, our ability to close our transaction with Hyundai, performance under the Hyundai agreement, and the risks set forth below under “Factors That May Affect Our Results.” These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

All references to “US Dataworks,” “we,” “us,” or “our” means US Dataworks, Inc.

 

MICRworks ^tm , Clearingworks ^® , Returnworks ^tm , and Remitworks ^tm are trademarks of US Dataworks. Other trademarks referenced herein are the property of their respective owners.

 

General

 

US Dataworks is a developer of payment processing software, serving several of the top 25 banking institutions, top 10 credit card issuers, major retailers and the United States Government. We generate revenue from the licensing, system integration and maintenance of our core product, Clearingworks, and its component subsystems, ClearingworksACH, ClearingworksCHECK21, ClearingworksPAYMENTS and ClearingworksSECURE. Our software is designed to enable organizations to transition from traditional paper-based payment and billing processes to electronic payment solutions. Our products include check processing, point-of-purchase transactions and turnkey Automated Clearing House (ACH) payments. ACH payments are highly reliable and efficient electronic fund transfers among participating depository financial institutions including the Federal Reserve, the central bank of the United States. Our products are designed to provide organizations with an in-house solution that will complement and enhance such organizations’ existing technologies, systems and operational workflow. Our strategy is to identify, design and develop products that fill specific niches in the payment processing industry.

 

In the fourth quarter of 2007, through our strategic partnership with Hyundai Syscomm Corp., a California corporation, we entered the automated teller machine (ATM) market. Under our resale agreement with Hyundai Syscomm, we have exclusive rights to resell or lease Hyundai Syscomm’s ATMs/teller kiosks, enhanced by our proprietary Clearingworks software, in North America and India. We expect to generate revenue through the resale or lease of these ATMs and expand our revenue generation opportunities for Clearingworks.

Background

 

US Dataworks was incorporated in the state of Colorado as JLQ, Inc. in December 1994, and we changed our name to New World Publishing in October 1997. In May 1999, we acquired Communications Television, Inc., a California corporation, and changed our business to an Internet marketing and technology infrastructure company specializing in supporting cost effective business-to-business and business-to-consumer revenue based marketing initiatives. We changed our name to Sonicport.com, Inc. in October 1999 and in February 2000, changed our state of incorporation from Colorado to Nevada. In February 2001, we changed our name to Sonicport, Inc.

 

We acquired US Dataworks, Inc., a Delaware corporation, in April 2001. Following the acquisition, we focused our business on developing electronic check processing software. In March 2002, we changed our name to US Dataworks, Inc.

 

Products

 

Clearingworks is our transaction processing platform that provides a fully automated, end-to-end solution for electronic payment processing. Clearingworks technology includes state-of-the-art decision-making functionality that determines “best-fit clearing” and “least-cost routing” of payments. Clearingworks incorporates our industry-leading functionality in an easily configurable processing stream designed to give customers the scalability and flexibility needed to handle all of their payment transactions. We distribute our products and services by aligning ourselves with key strategic partners and by direct marketing by our in-house personnel.

 

ClearingworksACH:

 

ClearingworksACH is an integrated ACH payment management tool that handles all major National Automated Clearing House, or NACHA, Standard Entry Class codes. ClearingworksACH can receive data from several capture devises, such as point-of-sale, web, telephone or remittance processing systems, and can determine the best-fit clearing and least-cost routing. ClearingworksACH contains our industry-leading MICR parsing technology, which is designed to provide unsurpassed levels of accuracy and consistency for check conversion. It will support both centralized and distributed payment models and is integrated with most third party payment processing platforms such as PEP+, Wausau Financial Systems, J&B Software, BancTec and others.

 

ClearingworksCHECK21:

 

As part of the Clearingworks transaction processing platform, ClearingworksCHECK21 delivers an end-to-end solution for converting paper checks to substitute checks for banks and other payment processors. ClearingworksCHECK21 smart routing capability allows images to be routed to only those institutions that are equipped to receive image exchange transmissions. It provides an infrastructure through which these electronic transmissions will be received, downloaded, printed and delivered to the paying bank.

 

ClearingworksPAYMENTS:

 

ClearingworksPAYMENTS brings new innovation to problem solving in a traditional remittance environment. Conventional remittance processing requires an additional encoding pass to create a paper-based cash letter deposit. ClearingworksPAYMENTS, however, creates electronic cash letter deposits using ACH and Check 21 networks for a complete electronic solution. Express batching allows items to be processed independently from their physical capture batch, while a robust web architecture allows payments to be keyed in and processed from anywhere at any time.

 

ClearingworksSECURE:

 

ClearingworksSECURE is designed to provide broad protection to the customers’ data, including issues such as compliance, information assurance, privacy, business continuity, fraud, and disaster recovery.

Customers

 

US Dataworks’ customers include five of the top 25 banking institutions in the United States, four of the top 10 credit card issuers in the United States, major retailers and two United States Government agencies. Four of our customers, American Express, Federal Reserve Bank, Hyundai Syscomm and Citibank, accounted for 24%, 18%, 14%, and 11%, respectively, of our net revenue for the year ended March 31, 2007. Two of our customers, American Express and the Federal Reserve Bank, accounted for 51% and 20%, respectively, of our net revenue for the year ended March 31, 2006. Two of our strategic resellers, BancTec and Computer Sciences Corporation, accounted for an aggregate of 3% of our net revenue for the year ended March 31, 2007. BancTec and Computer Science Corp. accounted for an aggregate of 8% of our net revenue for the year ended March 31, 2006.

 

Strategic Business Relationships

 

We believe that, in addition to growth from organic sales, aligning ourselves with key strategic partners to sell and distribute our software products will accelerate our revenue growth and capture of market share. Further, we expect that these strategic business relationships, among other factors, will help us achieve positive cash flow in the near future. As of June 20, 2007, we have aligned ourselves with several strategic partners as a core component of our sales and distribution strategy, including Hyundai Syscomm.

 

We also have a key strategic alliance with Accuity, a unit of Thomson Corporation, to incorporate its EPICWare database into our products. We plan to continue pursuing additional strategic alliances to help increase market share.

 

Competition

 

Our competitors in the financial services market include E-Funds, Equifax, Wausau Financial Systems, J&B Software and Telecheck. The services offered by these competitors include electronic billing and payment, electronic funds transfer, payment solutions, reconciliation, checks by phone and recurring billing, as well as value-added services such as strategy consulting, marketing and technology infrastructure. The majority of these offerings are on an out-sourced basis, while our products offer an in-house solution. Our competitors in the ATM market include Diebold, NCR, Wincor Nixdorf GmbH & Co., Triton and Itautec. The services offered by these competitors include ATMs, cash dispensers and software solutions, and incorporate advanced features such as cash deposits, automated check cashing/deposit, web enablement, bill payment and the dispensing of non-cash items.

 

We believe that the principal competitive factors determining success in these markets include:

 

 

We believe we compete favorably with respect to these factors. However, the market for payment processing software and ATM equipment is highly competitive, rapidly evolving and subject to significant technological change. As these markets grow, we expect competition to increase. Increased competition may result in price reductions and reduced margins.

 

We may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully. If we fail to compete successfully, we may fail to gain market share or lose existing market share and our financial condition, operating results and business could be adversely affected.

Patents and Trademarks

 

US Dataworks has obtained trademarks on the names of our premier products and services, including Clearingworks, and a currently unlicensed developed product, ZeroPass. We also have applied for a patent on ImageKey, which is currently in development, and this application is pending. Our efforts to protect our intellectual property rights may not prevent the misappropriation of our intellectual property.

 

Government Regulation

 

As a processor of ACH payments, we must comply with federal laws governing the processing of electronic transactions. We are in compliance with all federal laws and work closely with NACHA to ensure our systems remain both compliant with the laws and regulations, as well as NACHA guidelines.

 

Employees

 

As of June 20, 2007, we have 47 employees, all of whom are full-time employees. We are not a party to any collective bargaining agreement with our employees. We believe our employee relations to be good.

 

Research and Development

 

For fiscal 2007 and 2006 we spent approximately $357,241 and $339,421, respectively, on research and development activities.

 

Our principal executive offices, currently consisting of 15,354 square feet of office space, are located at 5301 Hollister Road, Suite 250, Houston, Texas 77040, which is leased through July 2007. On June 25, 2007 we entered into a new lease for our principal executive offices consisting of 18,790 square feet of office space located at One Sugar Creek Center Blvd., Suite 500 Sugar Land, Texas 77478. This new lease is effective August 2007 and runs through July 2012.

 

From time to time, we are involved in various legal and other proceedings that are incidental to the conduct of our business. We believe that none of these proceedings, if adversely determined, would have a material effect on our financial condition, results of operations or cash flows.

 

None.

 

Executive Officers

 

As of June 20, 2007, the following persons were our executive officers:

 

 

Charles E. Ramey has served as a director since July 2001 and became our Chief Executive Officer in December 2001. Prior to joining US Dataworks, Mr. Ramey was a private investor from December 1998 through July 2001 and was President and co- founder of PaymentNet Inc., now Signio Inc., an outsourced e-commerce payment processing company, from April 1996 to December 1998.

 

Terry Stepanik has served as a director since September 2002 and our President and Chief Operating Officer since April 2001. Mr. Stepanik also served as our Interim Chief Financial Officer from September

2002 to March 2003. In November 1997, Mr. Stepanik co- founder of US Dataworks, Inc., a Delaware corporation, which we acquired in April 2001, and served as its President from November 1997 to April 2001. From April 1994 to November 1997, Mr. Stepanik was the Senior Project Manager for TeleCheck Services, Inc., a provider of paper and electronic check services.

 

John T. McLaughlin has served as our Chief Accounting Officer since March 2006, and as our Controller from February 2005 to March 2006. Prior to joining us, Mr. McLaughlin was self employed as a financial consultant to companies involved in wholesale and retail distribution. From 1995 through 2000, he served in various accounting and finance roles with companies involved in manufacturing and distribution of computer and office equipment. Mr. McLaughlin’s earlier experience included internal audit activities for a publicly traded oil and gas services company

 

John J. Figone has served as of Vice President of Business Operations and General Counsel since September 2003. Prior to joining us, Mr. Figone served as an attorney at the law firm of Pillsbury Winthrop Shaw Pittman LLP from 2000 to September 2003, as well as at the law firm of Ferrari, Olsen, Ottoboni & Bebb LLP from 1998 to 2000. Mr. Figone worked for the City and County of San Francisco where he was in charge of Special Projects from 1994 to 1998. In 1994, Mr. Figone became Senior Negotiator for the City and County of San Francisco.

 

Mario Villarreal has served as our Vice President and Chief Technology Officer since April 2001. In April 2004, he was named Senior Vice President. In November 1997, Mr. Villarreal co-founded US Dataworks, Inc., a Delaware corporation, and served as its Vice President from November 1997 to April 2001. From June 1991 to May 1997, Mr. Villarreal served as Manager of Systems Architecture Group at TeleCheck Services, Inc.

 

 

Holders

 

As of June 20, 2007, our common stock was held by 318 stockholders of record. Because many of the shares of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record.

 

Dividend Policy

 

We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to fund the development and growth of our business.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The information required by this Item is included under Item 11 of Part III of this Annual Report on Form 10-KSB.

 

The following discussion and analysis of our financial condition and results of operations should be read in conjuction with the consolidated financial statements and related notes included elsewhere in this Report.

 

Critical Accounting Policies

 

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

We believe that of the significant accounting policies used in the preparation of our financial statements (see Note 2 to the Financial Statements), the following are critical accounting policies, which may involve a higher degree of judgment, complexity and estimates.

 

Revenue Recognition

 

We recognize revenues associated with our software products in accordance with the provisions of the American Institute of Certified Public Accountants’ Statement of Position 97-2, “Software Revenue Recognition.” We license our software products under non-exclusive, non-transferable license agreements. These arrangements do not require significant production, modification or customization, therefore revenue is recognized when the license agreement has been signed, delivery of the software product has occurred, the related fee is fixed or determinable and collectibility is probable.

 

In certain instances, we license our software on a transactional fee basis in lieu of an up-front licensing fee. In these arrangements, the customer is charged a fee based upon the number of items processed by the software and we recognize revenue as these transactions occur. The transaction fee also includes the provision of standard maintenance and support services as well as product upgrades should such upgrades become available.

 

If professional services are provided in conjunction with the installation of the software licensed, revenue is recognized when those services have been provided.

 

For license agreements that include a separately identifiable fee for contracted maintenance services, such revenues are recognized on a straight-line basis over the life of the maintenance agreement noted in the license agreement, but following any installation period of the software.

 

We recognize revenues associated with the resale of ATMs in accordance with the provisions of the Statement of Financial Accounting Standards (SFAS) No. 48. Our sale price is fixed and determinable at the date of sale and we have no obligation to directly bring about the resale of the product. In addition, the buyer’s obligation to pay us is not contingent upon release of the product and our sale price is not adjusted if the product is lost or damaged. The buyer has economic substance apart from us and we can reasonably estimate the amount of returns at the time of sale. Therefore revenue is recognized at the time of sale.

 

Concentrations of Credit Risk

 

We extend credit to our customers and perform ongoing credit evaluations of our customers. We do not obtain collateral from our customers to secure our accounts receivables. We evaluate our accounts receivable on a regular basis for collectibility and provide for an allowance for potential credit losses as deemed necessary.

 

Four of our customers, American Express, Federal Reserve Bank, Hyundai Syscomm and Citibank, accounted for 24%, 18%, 14%, and 11%, respectively, of our net revenue for the year ended March 31, 2007. Two of our customers, American Express and the Federal Reserve Bank, accounted for 51% and 20%, respectively, of our net revenue for the year ended March 31, 2006. Two of our strategic resellers, BancTec and Computer Sciences Corporation, accounted for an aggregate of 3% of our net revenue for the year ended March 31, 2007. BancTec and Computer Science Corp. accounted for an aggregate of 8% of our net revenue for the year ended March 31, 2006.

 

At March 31, 2007, amounts due from three customers, accounted for 41%, 31%, and 9% of accounts receivable.

 

At March 31, 2006, amounts due from three customers, accounted for 66%, 18% and 7% of accounts receivable.

 

 

Revenues increased by 1.4% in fiscal 2007, as compared to fiscal 2006. Transactional revenue and professional services revenues increased 64.7% and 16.7%, respectively, in fiscal 2007, as compared to fiscal 2006. The increase in transactional revenue was primarily attributable to new customers added during the year and a steady growth of transactions processed by our existing customers. Professional services revenue increased in large part due to additional service revenues recorded in connection with our consulting agreement with American Express, which we signed in June 2005. In connection with this consulting agreement, we received a purchase order for $1,521,250 in professional services in September 2006, of which we recorded $1,193,581 in fiscal 2007. In addition, under our agreement with Online Resources Corporation, which we signed in June 2006, we recorded $355,969 in fiscal 2007. In the fourth quarter of fiscal 2007, we began generating revenue under our resale agreement with Hyundai Syscomm, which accounted for our ATM equipment revenues.

 

These increases were partially offset by a decrease in our licensing revenues by 74.3% in fiscal 2007, as compared to fiscal 2006. This decrease was primarily due to $1,532,000 of revenue recorded on a percentage of completion, in the prior year associated with amending our licensing agreement with American Express, a significant customer, in August 2005. During fiscal 2007, we recorded $119,000 of license revenue under this agreement. As of March 31, 2007, no license revenues remained to be recorded under this agreement.

 

Cost of Sales

 

Cost of sales principally include the costs of our personnel who perform the services associated with our software maintenance, support, training and installation activities, the cost of third party software sold in conjunction with licenses of our software to convert electronic data into acceptable formats utilized by the Nation’s banking system, and equipment costs associated with the sale of ATM equipment. Total cost of sales increased by $1,303,287, or 84%, from $1,555,776 in fiscal 2006 to $2,859,063 in fiscal 2007. Cost of sales as a percentage of combined maintenance and services revenues for the current year was 74%, as compared to 46% in the prior year. The increase in the dollar amount of cost of sales is principally the result of an increase in personnel expenses associated with the installation activities in support of the integrated license maintenance and service agreement with one of the country’s largest credit card and financial service companies and approximately $740,000 associated with ATM equipment costs.

 

Operating Expenses

 

Total operating expenses increased by $1,346,572, or 23%, from $5,828,766 in fiscal 2006 to $7,175,338 in fiscal 2007. The increase in operating expenses was principally attributable to an increase of $304,000 in legal expenses primarily related to our investigation of potential acquisition targets, $449,000 in outside consultants and recruitment fees to supplement and increase key software developmental personnel, and $647,000 in stock based compensation expense, partially offset by a reduction of $268,000 in salary expense.

We anticipate that our operating expenses will continue to increase going forward as we expect to continue to add to staff, engage outside consulting services when needed and pursue any strategic opportunities as they become available.

 

Other Expenses

 

Total other expenses, including interest expense and financing costs, decreased $67,609, or 17%, from $408,792 in fiscal 2006 to $341,183 in fiscal 2007. The decrease is principally due to a decrease of financing costs of $113,800, a decrease of interest expense of $115,600, a decrease of $206,000 related to the loss on extinguishment of debt, which occurred in the prior year and a decrease of $445,200 related to the reversal of a contingent loss liability from the prior year. The decrease in these costs and expenses was partially offset by a $769,161 increase or loss on derivatives associated with the debt feature of the convertible promissory note of June 16, 2005, a $22,000 increase in interest expense related to Mr. Ramey’s note payable, and a $22,000 decrease in other income.

 

Net Loss

 

Net loss increased by $2,487,852, or 304%, from a net loss of $818,157 in fiscal 2006 to a net loss of $3,306,009 in fiscal 2007.

 

Financing activities provided cash of $1,310,450 in fiscal 2006, and included $600,000 in proceeds from stock sales, $25,000 from the exercise of warrants and options and $700,000 from proceeds from issue of convertible promissory notes.

 

As a result of our recent capital raising transactions, our increased level of transactional revenues achieved in fiscal 2007, and the expected increase in revenues to be received from recently received and contemplated contracts, we believe we currently have adequate capital resources to fund our anticipated cash needs through March 31, 2008 and beyond. However, an adverse business or legal development could require us to raise additional financing sooner than anticipated. We recognize that we may be required to raise such additional capital, at times and in amounts, which are uncertain, especially under the current capital market conditions. If we are unable to acquire additional capital or are required to raise it on terms that are less satisfactory than we desire, it may have a material adverse effect on our financial condition. In the event we raise additional equity, these financings may result in dilution to existing shareholders.

 

Our contractual obligations, which are described elsewhere in our financial statements, have been summarized in the table below:

 

 

Recently Issued Accounting Pronouncements

 

In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement replaces Accounting Principle Bulletin (APB) Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This Statement is effective for fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to have a material impact on our financial position or results of operations.

 

In February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.” SFAS 155 resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The requirements in SFAS 155 are effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of this pronouncement is not expected to have an impact on our consolidated financial position, results of operations, or cash flows.

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires an entity to recognize the impact of a tax position in its financial statements if that position is more likely than not to be sustained on audit based on the technical merits of the position. The provisions of FIN 48 are effective for us as of the beginning of fiscal 2008, with earlier application encouraged. Any cumulative effect of the change in accounting principle will be recorded as an adjustment to the opening accumulated deficit balance. The adoption of this pronouncement is not expected to have an impact on our consolidated financial position, results of operations, or cash flows.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the U.S., and expands disclosures about fair value measurements. SFAS 157 is effective for the Company as of the beginning of fiscal 2009, with earlier application encouraged. Any cumulative effect will be recorded as an adjustment to the opening accumulated deficit balance, or other appropriate component of equity. The adoption of this pronouncement is not expected to have an impact on the Company’s consolidated financial position, results of operations, or cash flows.

Factors That May Affect Our Results

 

We have a general history of losses and may not operate profitably in the future.

 

We have incurred losses for the last three fiscal years. Our net losses and negative cash flow may continue for the foreseeable future. As of March 31, 2007, our accumulated deficit was $50,416,347. We believe that our planned growth and profitability will depend in large part on our ability to promote our brand name and gain clients and expand our relationships with clients for whom we would provide licensing agreements and system integration. Accordingly, we intend to invest heavily in marketing, strategic partnership, development of our client base and development of our marketing technology and operating infrastructure. If we are not successful in promoting our brand name and expanding our client base, it will have a material adverse effect on our financial condition and our ability to continue to operate our business.

 

Our ability to continue as a going concern may be contingent upon our ability to secure capital from prospective investors or lenders.

 

The accompanying consolidated financial statements have been prepared assuming we will continue on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We believe we currently have adequate cash to fund anticipated cash needs through March 31, 2008. However, we may need to raise additional capital in the future. Any equity financing may be dilutive to shareholders, and debt financing, if available, will increase expenses and may involve restrictive covenants. We may be required to raise additional capital, at times and in amounts that are uncertain, especially under the current capital market conditions. These factors raise substantial doubt about our ability to continue as a going concern. Under these circumstances, if we are unable to obtain additional capital or are required to raise it on undesirable terms, it may have a material adverse effect on our financial condition, which could require us to:

 

 

Our financial statements do not include any adjustments relating to the recoverability and classification of recorded assets or liabilities that might be necessary should we be unable to continue as a going concern.

 

Our operating results are subject to fluctuations caused by many factors that could cause us to fail to achieve our revenue or profitability expectations, which in turn could cause our stock price to decline.

 

Our operating results can vary significantly depending upon a number of factors, many of which are outside our control. Factors that may affect our quarterly operating results include:

 

 

 

In addition, each quarter we derive a significant portion of our revenue from agreements signed at the end of the quarter. Our operating results could suffer if the timing of these agreements is delayed. Depending on the type of agreements we enter into, we may not be able to recognize revenue under these agreements in the quarter in which they are signed. Some of all of these factors could negatively affect demand for our products and services, and our future operating results.

 

Most of our operating expenses are relatively fixed in the short-term. We may be unable to adjust spending rapidly to compensate for any unexpected sales shortfall, which could harm our quarterly operating results. Because of the emerging nature of the markets in which we compete, we do not have the ability to predict future operating results with any certainty. Because of the above factors, you should not rely on period-to-period comparisons of results of operation as an indication of future performances.

 

We are entering into a new market that is highly competitive with well established competitors.

 

As a result of our recent strategic partnership with Hyundai Syscomm, we are entering into a new market and we may need to invest a significant amount of resources to compete successfully. This new market is highly competitive and has put increased pressure on companies to develop new products and services. For example, well-established ATM equipment companies, include Diebold, NCR, Wincor Nixdorf GmbH & Co., Triton and Itautec. As a new entrant into this market, we believe that our success depends on our ability to establish relationships with leading customers and our ability to introduce and market new services for ATM’s which utilize our proprietary software products. Our failure to do so could harm our ability to successfully compete in this new market and could adversely affect our operating results.

 

We may not be able to maintain our relationships with strategic partners, which may cause our cash flow to decline.

 

We may not be able to maintain our relationships with strategic partners, such as BancTec and Computer Sciences Corporation. These strategic relationships are a core component of our sales and distribution strategy. The loss of a strategic partner could harm our financial results.

 

Because a small number of customers have historically accounted for and may in future periods account for substantial portions of our revenue, our revenue could decline because of delays of customer orders or the failure to retain customers.

 

We have a small number of customers that account for a significant portion of our revenue. Our revenue could decline because of a delay in signing agreements with a single customer or the failure to retain an existing customer. We may not obtain additional customers. The failure to obtain additional customers and the failure to retain existing customers will harm our operating results.

 

If general economic and business conditions do not improve, we may experience decreased revenue or lower growth rates.

 

The revenue growth and profitability of our business depends on the overall demand for computer software and services in the product segments in which we compete. Because our sales are primarily to major banking and government customers, our business also depends on general economic and business conditions. A softening of demand caused by a weakening of the economy may result in decreased revenue or lower growth rates. As a result, we may not be able to effectively promote future license revenue growth in our application business.

 

We may not be able to attract, retain or integrate key personnel, which may prevent us from successfully operating our business.

 

We may not be able to retain our key personnel or attract other qualified personnel in the future. Our success will depend upon the continued service of key management personnel. The loss of services of any of the key members of our management team or our failure to attract and retain other key personnel could disrupt operations and have a negative effect on employee productivity and morale and harm our financial results.

We operate in markets that are intensely and increasingly competitive, and if we are unable to compete successfully, our revenue could decline and we may be unable to gain market share.

 

The markets for financial services software and ATM equipment are highly competitive. Our future success will depend on our ability to adapt to rapidly changing technologies, evolving industry standards, product offerings and evolving demands of the marketplace.

 

Some of our competitors have:

 

 

Our competitors may also be better positioned to address technological and market developments or may react more favorably to technological changes. We compete on the basis of a number of factors, including:

 

 

Competitors may develop or offer strategic services that provide significant technological, creative, performance, price or other advantages over the services we offer. If we fail to gain market share or lose existing market share, our financial condition, operating results and business could be adversely affected and the value of the investment in us could be reduced significantly. We may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully.

 

We may be responsible for maintaining the confidentiality of our client’s sensitive information, and any unauthorized use or disclosure could result in substantial damages and harm our reputation.

 

The services we provide for our clients may grant us access to confidential or proprietary client information. Any unauthorized disclosure or use could result in a claim against us for substantial damages and could harm our reputation. Our contractual provisions attempting to limit these damages may not be enforceable in all instances or may otherwise fail to adequately protect us from liability for damages.

 

If we do not adequately protect our intellectual property, our business may suffer, we may lose revenue or we may be required to spend significant time and resources to defend our intellectual property rights.

 

We rely on a combination of patent, trademark, trade secrets, confidentiality procedures and contractual procedures to protect our intellectual property rights. If we are unable to adequately protect our intellectual property, our business may suffer from the piracy of our technology and the associated loss in revenue. Any patents that we may hold may not sufficiently protect our intellectual property and may be challenged by third parties. Our efforts to protect our intellectual property rights, may not prevent the misappropriation of our intellectual property. These infringement claims or any future claims could cause us to spend significant time and money to defend our intellectual property rights, redesign our products or develop or license a substitute technology. We may be unsuccessful in acquiring or developing substitute technology and any required license may be unavailable on commercially reasonable terms, if at all. In the event of litigation to determine the validity of any third party claims or claims by us against such third party, such litigation, whether or not determined in our favor, could result in significant expense and divert the efforts of our technical and management personnel, regardless of the outcome of such litigation. Furthermore, other parties may also independently develop similar or competing products that do not infringe upon our intellectual property rights.

 

We may be unable to consummate future potential acquisitions or investments or successfully integrate acquired businesses or investments or foreign operations with our business, which may disrupt our

business, divert management’s attention and slow our ability to expand the range of our technologies and products.

 

We intend to continue to expand the range of our technologies and products, and we may acquire or make investments in additional complementary businesses, technologies or products, if appropriate opportunities arise. We may be unable to identify suitable acquisition or investment candidates at reasonable prices or on reasonable terms, or consummate future acquisitions or investments, each of which could slow our growth strategy. We have no prior history or experience in investing in or acquiring and integrating complementary businesses and therefore may have difficulties completing such transactions or realizing the benefits of such transactions, or they may have a negative effect on our business. Such investments or acquisitions could require us to devote a substantial amount of time and resources and could place a significant strain on our management and personnel. To finance any acquisitions, we may choose to issue shares of our common stock, which would dilute your interest in us. Any future acquisitions by us also could result in significant write-offs or the incurrence of debt and contingent liabilities, any of which could harm our operating results.

 

US DATAWORKS, INC.

 

TABLE OF CONTENTS

 

 

Board of Directors and Stockholders

US Dataworks, Inc.

 

We have audited the accompanying balance sheet of US Dataworks, Inc. as of March 31, 2007, and the related statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended March 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 US Dataworks, Inc. as of March 31, 2007, and the results of its operations and its cash flows for each of the two years in the period ended March 31, 2007 in conformity with U.S. generally accepted accounting principles.

 

 

Houston, Texas

 

June 28, 2007

US DATAWORKS, INC.

 

 

BALANCE SHEET
March 31, 2007

 

 

The accompanying notes are an integral part of these financial statements.

US DATAWORKS, INC.

 

 

STATEMENTS OF OPERATIONS
for the years ended March 31, 2007 and 2006

 

 

The accompanying notes are an integral part of these financial statements.

US DATAWORKS, INC.

 

STATEMENTS OF STOCKHOLDERS’ EQUITY
for the years ended March 31, 2007 and 2006

 

 

The accompanying notes are an integral part of these financial statements.

US DATAWORKS, INC.

 

STATEMENTS OF STOCKHOLDERS’ EQUITY
for the years ended March 31, 2007 and 2006

 

 

The accompanying notes are an integral part of these financial statements.

US DATAWORKS, INC.

 

STATEMENTS OF CASH FLOWS
for the years ended March 31, 2007 and 2006

 

 

The accompanying notes are an integral part of these financial statements.

US DATAWORKS, INC.

NOTES TO FINANCIAL STATEMENTS

 

 

General

 

US Dataworks, Inc. (the “Company”), a Nevada corporation, develops, markets, and supports payment processing software for the financial services industry. Its customer base includes many of the largest financial institutions as well as credit card companies, government institutions, and high-volume merchants in the United States. The Company was formerly known as Sonicport, Inc.

 

 

Revenue Recognition

 

The Company recognizes revenues associated with our software services in accordance with the provisions of the American Institute of Certified Public Accountants’ Statement of Position 97-2, “Software Revenue Recognition” (“SOP 97-2”). The Company licenses its software products under nonexclusive, nontransferable license agreements. These arrangements do not require significant production, modification, or customization. Therefore, revenue is recognized when such a license agreement has been signed, delivery of the software product has occurred, the related fee is fixed or determinable, and collectibility is probable.

 

In certain instances, the Company licenses its software on a transactional fee basis in lieu of an up-front licensing fee. In these arrangements, the customer is charged a fee based upon the number of items processed by the software and the Company recognizes revenue as these transactions occur. The transaction fee also includes the provision of standard maintenance and support services as well as product upgrades should such upgrades become available.

 

If professional services were provided in conjunction with the installation of the software licensed, revenue is recognized when these services have been provided.

 

For license agreements that include a separately identifiable fee for contracted maintenance services, such maintenance revenues are recognized on a straight-line basis over the life of the maintenance agreement noted in the agreement, but following any installation period of the software.

 

The Company recognizes revenues associated with the resale of ATMs in accordance with the provisions of the Statement of Financial Accounting Standards (“SFAS”) No. 48. The Company’s sale price is fixed and determinable at the date of sale and it has no obligation to directly bring about the resale of the product. In addition, the buyer’s obligation to pay the Company is not contingent upon release of the product and its sale price is not adjusted if the product is lost or damaged. The buyer has economic substance apart from the Company and it can reasonably estimate the amount of returns at the time of sale. Therefore revenue is recognized at the time of sale.

 

Cash and Cash Equivalents

 

For the purpose of the statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

 

 

Maintenance and minor replacements are charged to expense as incurred. Gains and losses on disposals are included in the results of operations.

 

Impairment of Long-Lived Assets

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash flows expected to be generated by the assets. If the assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets.

 

Goodwill

 

Effective January 1, 2002, the Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets,” which establishes new accounting and reporting requirements for goodwill and other intangible assets. Under SFAS No. 142, all goodwill amortization ceased effective January 1, 2002.

 

The goodwill recorded on the Company’s books is from the acquisition of US Dataworks, Inc. in fiscal year 2001 which remains the Company’s single reporting unit. SFAS 142 requires goodwill for each reporting unit of an entity be tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value is determined using a combination of the discounted cash flow, market multiple and market capitalization valuation approaches. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples for each reportable unit. On an ongoing basis, absent any impairment indicators, the Company performs impairment tests annually during the fourth quarter.

 

SFAS 142 requires goodwill to be tested annually and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of the reportable unit below its carrying amount. The Company did not have an impairment of goodwill to record for the years ended March 31, 2007 or March 31, 2006.

 

Fair Value of Financial Instruments

 

The Company measures its financial assets and liabilities in accordance with generally accepted accounting principles. For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, and accrued expenses, the carrying amounts approximate fair value due to their short maturities. The amounts shown for convertible promissory note payable and notes payable — related parties also approximate fair value because current interest rates offered to the Company for debt of similar maturities are substantially the same or the difference is immaterial.

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

Convertible Debt Financing — Derivative Liabilities

 

The Company reviews the terms of convertible debt and equity instruments issued to determine whether there are embedded derivative instruments, including embedded conversion options, that are required to be bifurcated and accounted for separately as a derivative financial instrument. In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated , the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. Also, in connection with the sale of convertible debt and equity instruments, the Company may issue freestanding options or warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity.

 

In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended, the convertible debt holder’s conversion right provision, interest rate adjustment provision, interest rate adjustment provision, liquidated damages clause, cash premium option, and the redemption option (collectively, the debt features) contained in the terms governing the convertible notes are not clearly and closely related to the characteristics of the notes. Accordingly, the features qualify as embedded derivative instruments at issuance and, because they do not qualify for any scope exception within SFAS 133, they are required by SFAS 133 to be accounted for separately from the debt instrument and recorded as derivative instrument liabilities.

 

Stock Options

 

Effective April 1, 2006, the Company adopted the SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which require the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values. The Company adopted SFAS 123R using the modified prospective transition method, which requires the application of the accounting standard as of April 1, 2006, the first day of the Company’s fiscal year 2007. The Company’s financial statements as of and for the year ended March 31, 2007 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, the Company’s financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. Stock-based compensation expense recognized under SFAS 123R for the year ended March 31, 2007 was $647,387, which consists of stock-based compensation expense related to employee and director stock options and restricted stock issuances.

 

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s statement of operations. Prior to the adoption of SFAS 123R, the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Prinicles Bulletin Opinion No. 25, “Accounting for Stock Issued to Employees,” as allowed under SFAS No. 123, Accounting for Stock-Based Compensation,. Under the intrinsic value method, no share-based compensation expense had been recognized in the Company’s Statement of Operations prior to April 1, 2006 because the exercise price of the Company’s stock options granted to employees and directors was equal to or greater than the fair market value of the underlying stock at the date of grant.

 

 

The fair value of these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the years ended March 31, 2007 and 2006: dividend yields of 0% and 0%, respectively; expected volatility of 79% and 89%, respectively; risk-free interest rates of 4.85% and 4.01%, respectively; and expected lives of 3.0 and 3.0 years, respectively. The per-share weighted average fair values of stock options granted during the years ended March 31, 2007 and 2006 were $0.58 and $0.58, respectively.

 

Advertising Expense

 

Advertising costs are charged to expense as incurred. For the years ended March 31, 2007 and 2006, the Company recorded advertising expense of $55,861 and $23,342 respectively.

 

Income Taxes

 

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes, if applicable, represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

 

Loss per Share

 

The Company calculates loss per share in accordance with SFAS No. 128, “Earnings per Share.” Basic loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common stock equivalents had been issued and if the additional common shares were dilutive.

 

The following potential common stock equivalents have been excluded from the computation of diluted net loss per share for the periods presented because the effect would have been anti-dilutive (Options and

 

 

 

 

Reclassifications

 

Certain amounts included in the prior year financial statements have been reclassified to conform with the current year presentation. Such reclassification did not have any effect on reported net loss.

 

Estimates

 

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Concentrations of Credit Risk

 

The Company sells its products throughout the United States and extends credit to its customers. It also performs ongoing credit evaluations of such customers. The Company does not obtain collateral to secure its accounts receivable. The Company evaluates its accounts receivable on a regular basis for collectibility and provides for an allowance for potential credit losses as deemed necessary.

 

Four of our customers, American Express, Federal Reserve Bank, Hyundai Syscomm, and Citibank, accounted for 24%, 18%, 14%, and 11% respectively of our net revenue for the year ended March 31, 2007. Two of our customers, American Express and the Federal Reserve Bank , accounted for 51% and 20% respectively of our net revenue for the year ended March 31, 2006. Two of our strategic resellers, BancTec and Computer Sciences Corporation, accounted for an aggregate of 3% of our net revenue for the year ended March 31, 2007. BancTec and Computer Science Corp. accounted for an aggregate of 8% of our net revenue for the year ended March 31, 2006.

 

At March 31, 2007, amounts due from three customers , accounted for 41%, 31%, and 9% of accounts receivable.

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

At March 31, 2006, amounts due from three customers, accounted for 66%, 18% and 7% of accounts receivable.

 

Recently Issued Accounting Pronouncements

 

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This Statement is effective for fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations.

 

In February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140”. SFAS 155 resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The requirements in SFAS 155 are effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of this pronouncement is not expected to have an impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires an entity to recognize the impact of a tax position in its financial statements if that position is more likely than not to be sustained on audit based on the technical merits of the position. The provisions of FIN 48 are effective for the Company as of the beginning of fiscal 2008, with earlier application encouraged. Any cumulative effect of the change in accounting principle will be recorded as an adjustment to the opening accumulated deficit balance. The adoption of this pronouncement is not expected to have an impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the U.S., and expands disclosures about fair value measurements. SFAS 157 is effective for the Company as of the beginning of fiscal 2009, with earlier application encouraged. Any cumulative effect will be recorded as an adjustment to the opening accumulated deficit balance, or other appropriate component of equity. The adoption of this pronouncement is not expected to have an impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

 

Depreciation and amortization expense for the years ended March 31, 2007 and 2006 was $144,116 and $362,031, respectively.

 

 

On September 26, 2006, the Company entered into a note payable with its Chief Executive Officer for $500,000. The note bears an 8.75% per annum interest rate, is unsecured and is due September 25, 2007. As of March 31, 2007 the outstanding balance on the note payable is $500,000.

 

 

Convertible promissory notes at March 31, 2007 consisted of the following:

 

 

Convertible promissory note with interest at 10% per annum

 

This note is an amendment and restatement of a note in the same principal amount originally dated September 15, 2004. The original note was issued effective September 15, 2004 in connection with the November 2004 settlement of a lawsuit brought by an investor in December 2003. The amended note is convertible at any time, at the holder’s election, into shares of the Company’s common stock at a per share conversion price of $1.10, subject to standard anti dilution provisions.

 

The amended note is effective September 15, 2005 and extended the principal payment of $256,066 originally due September 15, 2005 for one year. The final principal payment of $256,066 is due on September 15, 2007. In consideration of this amendment, the Company issued the holder a common stock purchase warrant to purchase up to 650,000 shares of the Company’s common stock at an exercise price of $0.59 per share. The warrant will expire on September 15, 2008.

 

The changes to this debt caused the accounting treatment to be an extinguishment of the old debt and issuance of new debt instead of being treated as modification of debt. Therefore, the excess of the fair value of the note and warrants over the carrying amount of the debt is $206,000 and has been recorded as a loss on extinguishment for the year ended March 31, 2006.

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

In connection with the November 2004 settlement, the Company also issued a warrant to purchase 160,000 shares of the Company’s common stock at a purchase price of $0.75 per share, which warrant will expire on November 10, 2006.

 

Using the Black-Scholes pricing model the Company has determined the value of the warrants issued in connection with the settlement to be $126,000. This amount, together with the value of the convertible promissory note, the value of the plaintiff’s legal expense reimbursement and the Company’s legal costs incurred in connection with the settlement totaled $924,200 and has been recorded as Investor litigation settlement expense for the year ended March 31, 2005.

 

Convertible promissory note issued June 16, 2005 with $70,000 Original Issue Discount

 

On June 16, 2005, the Company entered into a Securities Purchase Agreement with an institutional investor (the “Debenture Agreement”) for the sale of a convertible debenture with a principal amount of $770,000 and an original issue discount of $70,000 for gross proceeds of $700,000. The debenture is convertible at anytime at the discretion of the holder at a price per share of $0.572 into 1,346,154 shares of the Company’s common stock. The convertible debenture is to be repaid in 15 monthly installments of $51,333.33 beginning April 15, 2006. The Company may also elect, upon proper notice, to pay any monthly installment in shares of the Company’s common stock based on a conversion price equal to the lesser of (i) the then applicable conversion price, or (ii) 90% of the volume weighted average price of the Company’s common stock for the 10 trading days immediately preceding the payment; provided, that, such conversion price must be at least equal to the conversion floor of $0.23, or such monthly installment must be paid in cash. This convertible debenture was amended on March 9, 2006, pursuant to which the Company must, within 25 calendar days prior to each monthly payment, deliver 89,744 shares of its common stock to the holders, which represents the monthly installment amount divided by the then conversion price with the first monthly payment becoming due on April 17, 2006. In connection with the Debenture Agreement, the Company issued two groups of warrants, Short Term Warrants and Long Term Warrants to the institutional investor. The Short Term Warrants allow the institutional investor to purchase an aggregate of 407,926 shares of the Company’s common stock with an exercise price of $0.572 per share exercisable for a period of 180 days at any time after the later of (i) the effective date of the registration statement (as described below) or (ii) December 16, 2005. The Long Term Warrants allow the institutional investor to purchase an aggregate of 471,154 shares of the Company’s common stock with an exercise price of $0.572 per share exercisable at anytime from December 16, 2005 through December 16, 2008; provided, however, the institutional investor will not be permitted to exercise a warrant to the extent that the number of shares of the Company’s common stock beneficially owned by such institutional investor taken together with the number of shares to be issued upon exercise of the warrant equals or exceeds 4.999% of the Company’s then issued and outstanding shares of common stock. The warrants also contain trading market restrictions that preclude the Company from issuing shares of common stock upon exercise thereof if such issuance, when aggregated with other issuances of the Company’s common stock pursuant to the warrants, would exceed 19.999% of the Company’s then issued and outstanding shares of common stock, unless the Company has previously obtained the required shareholder approval. Pursuant to a Registration Rights Agreement dated June 16, 2005 between the Company and the institutional investor, the Company agreed to file a registration statement for the resale of the shares of the Company’s common stock that may be issued to the institutional investor upon the conversion of the convertible debenture and the exercise of the Short Term Warrants and the Long Term Warrants. The registration statement covering these securities was effective on September 1, 2005.

 

In accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”, the debt features contained in the terms governing the notes are not clearly and closely related to the characteristics of the notes. Accordingly, the debt features qualify as embedded derivative instruments at issuance and, because they did not qualify for any scope exception within SFAS 133, they were required to be accounted for separately from the debt instrument and recorded as derivative financial instruments.

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

At the date of issuance, the embedded debt feature had an estimated initial fair value of $449,089, which was recorded as a discount to the convertible notes and derivative liability on our balance sheet. In subsequent periods, if the price of the security changes, the embedded derivative financial instrument related to the debt features will be adjusted to the fair value with the corresponding charge or credit to other income/(expense). The estimated fair value of the debt features was determined using the probability weighted averaged expected cash flows / Lattice Model with a closing price of $0.65, a conversion price as defined in the respective note agreement and a period of two years. Concerning the debt features, the model uses several assumptions including: historical stock price volatility, approximate risk-free interest rate (3.5%), remaining term to maturity, and the closing price of the company’s common stock to determine the estimated fair value of the derivative liability. For the year ended March 31, 2007, due in part to a fluctuations in the market value of the Company’s common stock , the Company recorded an other income item on the statement of operations for the change in fair value of the embedded debt feature of approximately $118,416.

 

As per the terms of the convertible note, the Company at any time, with 30 day prior notice may pay off the note subject to an early payment penalty of 30% on any outstanding balance. Accordingly, the Company elected to pay off the remaining balance of $154,000 and incurred an additional $46,200 in prepayment penalties both of which were paid on March 21, 2007. As of March 21, 2007 the company no longer had any obligation related to this convertible note.

 

The recorded value of the embedded debt feature related to this debt can fluctuate significantly based on fluctuations in the fair value of the Company’s common stock.

 

The warrants included with this note for purchase of the Company’s common stock had an initial value of $271,940. This amount has been classified as a derivative financial instrument and recorded as a liability on our consolidated balance sheet in accordance with SFAS 133. The estimated fair value of the warrants at the date of issuance was determined using the Black-Scholes option-pricing model with a closing price of $1.14, the respective exercise price of the warrants, a 2 year term, and a 90% volatility factor relative to the date of issuance. The model uses several assumptions including: historical stock price volatility, approximate risk-free interest rate (3.50%), remaining term to maturity, and the closing price of the company’s common stock to determine the estimated fair value of the derivative liability. In accordance with the provisions of SFAS 133, the Company is required to adjust the carrying value of the instrument to its fair value at each balance sheet date and recognize any change since the prior balance sheet date as a component of other income/ (expense) on its statement of operations. The warrant derivative liability at March 31, 2007, increased to a fair value of $75,255, due in part to a increase in the market value of the company’s common stock, which resulted in an other income item of $37,575.

 

The recorded value of the warrants can fluctuate significantly based on fluctuations in the market value of the underlying securities of the issuer of the warrants, as well as in the volatility of the stock price during the term used for observation and the term remaining for the warrants.

 

Due to changes in value upon the conversion of this debt when shares were issued for required principal payments, additional losses were incurred amounting to $435,369. This loss is the result of differences in the settlement method and the assumptions that were used in the original derivative valuation.

 

 

On September 27, 2006, the Company entered into a Purchase and Sale Agreement with Catalyst Finance, L.P. (“Catalyst”) for sale of certain of its accounts receivables. The Company’s borrowing costs under this Agreement range from 1.25% to 20% of the gross amount of the receivables sold to Catalyst based on the timing of collection. The maximum funds available under the agreement are all available accounts receivables as agreed to by Catalyst and the Company. The agreement allows for Catalyst to request repurchase of an account receivable under certain conditions. For the year ended March 31, 2007, Catalyst has not requested

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

repurchase of an account receivable. To date, the Company has sold $444,150 in receivables under the agreement, which yielded a loss on the sale of these receivables of $8,353. The Agreement will continue in effect until terminated by either party.

 

 

 

Subsequent to March 31, 2007 the Company entered into a new lease. Future minimum lease payments related to that lease were as follows:

 

 

Employment Agreements

 

On April 3, 2006, the Company entered into an employment agreement with each of its President, Payment Products Division and Vice Chairman, Sr. Vice President and Chief Technology Officer, and Vice President of Business Development and General Counsel, for a term of three years with automatic renewal for successive one-year terms unless either party gives timely notice of non-renewal.

 

Annual base salary for the President, Payment Products Division and Vice Chairman of the Company is $190,000 and pursuant to the terms of the agreement he is entitled to receive an option to purchase 550,000 shares of the Company’s common stock. This option vests over a 3 year period with 150,000 shares vesting on April 3, 2006 and 200,000 shares vesting on each of April 3, 2007 and 2008. In addition the President, Payment Products Division and Vice Chairman is entitled to receive a bonus of $48,125 for year end 2006.

 

Annual base salary for the Senior Vice President and Chief Technology Officer of the Company is $185,000 and pursuant to the terms of the agreement he is entitled to receive 200,000 shares of restricted common stock. The restricted shares vest over a 3 year period with 25,000 shares vesting on April 3, 2006 and 87,500 shares vesting on each of April 3, 2007 and 2008. The Senior Vice President and Chief Technology Officer is also eligible to receive a quarterly bonus of equal to 3.5% of the increase in the Company’s revenue from fiscal year quarter to fiscal year quarter and to receive a bonus of $78,750 for fiscal year 2006.

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

Annual base salary for the Vice President of Business Development and General Counsel of the Company is $175,000, and pursuant to the terms of the agreement he is entitled to receive an option to purchase 700,000 shares of the Company’s common stock. This option vests over a 3 year period with 300,000 shares vesting on April 3, 2006 and 200,000 shares vesting on each of April 3, 2007 and 2008. The Vice President of Business Development and General Counsel is also eligible to receive a quarterly bonus based upon the Company’s future acquisitions or mergers.

 

On May 23, 2006, the Company entered into an employment agreement with its Chairman of the Board and Chief Executive Officer. The agreement has a 2 year term with automatic renewal for successive one year terms unless either party gives timely notice of non-renewal. His annual base salary is $220,000 and he is entitled to receive 100,000 shares of restricted common stock that vest immediately and is entitled to receive an option to purchase 600,000 shares of the Company’s common stock. This option vests as to 300,000 shares on each of May 22, 2007 and 2008.

 

Litigation

 

In June 2005, two of our former employees initiated arbitration against the company alleging wrongful termination and sought severance pay. Arbitration was held on March 28, 2006 and on June 19, 2006, the arbitration ruled that each employee was entitled to $90,000 in severance pay, as well as costs and interest. These amounts were included in accrued liabilities at March 31, 2006. On August 25, 2006 all severance pay, as well as costs and interest due each employee was paid. These amounts were removed from accrued liabilities at September 30, 2006. .

 

 

Preferred Stock

 

The Company has 10,000,000 authorized shares of $0.0001 par value preferred stock. The preferred stock may be issued in series, from time to time, with such designations, rights, preferences, and limitations as the Board of Directors may determine by resolution.

 

Convertible Series B Preferred Stock

 

The Company has 700,000 authorized shares of $0.0001 par value convertible Series B preferred stock.

 

In August and October 2000, the Company issued 101,867 and 26,733 units respectively, in a private placement for gross proceeds of $382,000 and $100,250, respectively. Each unit consisted of one share of its voting convertible Series B preferred stock (the “Series B”) and a warrant to purchase one share of the Company’s common stock. The Series B has a liquidation preference of $3.75 per share and carries a 10% cumulative dividend payable on each March 1 and September 1. The Company has the right to redeem the Series B at any time after issuance at a redemption price of $4.15 per share, plus any accrued but unpaid dividends. The Series B is convertible upon issuance into common stock at $3.75 per share. The warrant entitles the holder to purchase one share of the Company’s common stock at $6.25 per share, which represents 115% of the market value of the Company’s stock at the closing date.

 

In May 2001, an investor in the Company’s convertible Series B preferred stock rescinded its acquisition and returned 2,667 shares and warrants for the purchase of 533 shares of common stock to the Company in exchange for the return of its investment of $10,000.

 

In August 2004, an investor in the Series B elected to convert his 16,000 shares and accordingly was issued 3,200 shares of the Company’s common stock.

 

At March 31, 2007, there were accumulated, undeclared dividends in arrears of $252,238 or $0.46 per share.

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

Common Stock and Warrants

 

During the year ended March 31, 2006, the Company completed the following:

 

Non-Cash Financing

 

In the quarter ended June 30, 2006, the Company issued 303,116 shares of common stock with a value of $154,000 to pay down debt associated with the convertible promissory note issued June 16, 2005.

 

In the quarter ended September 30, 2006, the Company issued 287,173 shares of common stock with a value of $154,000 to pay down debt associated with the convertible promissory note issued June 16, 2005.

 

In the quarter ended December 31, 2006, the Company issued 314,253 shares of common stock with a value of $154,000 to pay down debt associated with the convertible promissory note issued June 16, 2005.

 

In the quarter ended March 31, 2007, the Company issued 261,159 shares of common stock with a value of $154,000 to pay down debt associated with the convertible promissory note issued June 16, 2005.

 

Sale of Common Stock and Warrants

 

On December 29, 2006, the Company entered into a stock purchase agreement (the “Purchase Agreement”), with Hyundai Syscomm Corp., a California corporation (“Hyundai”), pursuant to which the Company agreed to issue to Hyundai an aggregate of 6,100,000 shares of the Company’s common stock, $0.0001 par value (the “Common Stock”), for an aggregate purchase price of $1,500,000 (“Purchase Shares”). In connection with the Purchase Agreement, and subject to shareholder approval, the Company also agreed to issue to Hyundai a warrant (the “Warrant”) to purchase up to an aggregate of 14,300,000 shares of Common Stock (the “Warrant Shares”); provided, however, in no event shall the aggregate of Hyundai’s Warrant Shares and Purchased Shares exceed 39.9% of the Company’s total outstanding shares. Under no condition will Warrant Shares become issuable hereunder unless and until the Company secures the necessary vote from its shareholders in favor of the issuance of this Warrant. The Warrant will vest as to one million shares of Common Stock for each $1 million in gross profits allocated to Hyundai under the Resale Agreement. At Hyundai’s option, it may elect to apply its allocation of gross profits to the payment of the exercise price of the exercise of any of the Warrant Shares. The exercise price will be $0.01 per share and it will have term of 10 years. The fair value of the shares and the warrant will be recorded on the Company’s books at the time all of the conditions of the Stock Purchase Agreement as amended have been met. The warrants will be valued at fair value and going forward will be valued mark to market in accordance with the requirements of FASB 133. The Purchase Shares and Warrant are being held in escrow pending the Closing.

 

On February 13, 2007, the Company and Hyundai amended the Purchase Agreement and related escrow agreement, pursuant to which the parties agreed to postpone the closing until March 2007, at which time the Company would issue the Purchased Shares and the Warrant, subject to shareholder approval.

 

On March 22, 2007, the Company and Hyundai further amended the Purchase Agreement, pursuant to which the parties agreed that the Company will retain all of the Gross Profits, as defined in the Purchase Agreement, until an aggregate amount of $1,500,000 is received, which will constitute payment in full for the Purchased Shares. Following receipt of the $1,500,000 the Purchased Shares and Warrant, subject to shareholder approval, will be issued to Hyundai.

 

During the year ended March 31, 2006, the Company completed the following:

 

Sale of Common Stock and Warrants

 

Effective June 16, 2005, the Company entered into definitive agreements with nine accredited investors for the sale of 1,258,654 shares of the Company’s common stock for gross proceeds of $600,000. The

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

agreements also provide that the Company will issue warrants, exercisable over a three year period, to purchase up to 314,664 shares of the Company’s common stock at an exercise price of $0.715 per share and an additional 314,664 shares of the Company’s common stock at an exercise price of $0.812 per share. In July 2005, upon receipt of approval of the American Stock Exchange for issuance of the shares of the Company’s common stock, the agreements were completed and the investors were issued the shares of the Company’s common stock and warrants.

 

Amendment of Convertible Promissory Note and Issuance of Warrant

 

On October 13, 2005, the Company amended and restated its 10% convertible debenture effective September 15, 2005 in the principal amount of $768,199.24, issued by the Company for the benefit of an accredited individual investor. This convertible debenture, originally dated September 15, 2004, was amended to extend the payment of the principal due and payable on September 15, 2005 until September 15, 2006. In consideration of this amendment, the Company issued to the individual investor a common stock purchase warrant to purchase up to 650,000 shares of its common stock at an exercise price of $0.59 per share. The warrant will expire on September 15, 2008.

 

Sale of Warrants

 

Additionally in June 2005, the Company sold to an institutional investor a convertible debenture with a principal amount of $770,000 and an original issue discount of $70,000 for gross proceeds of $700,000. The debenture is convertible at anytime at the discretion of the holder at a price per share of $0.572 into 1,346,154 shares of the Company’s common stock. The convertible debenture is to be repaid in 15 monthly installments of $51,333.33 beginning April 15, 2006. In connection with the sale of the debenture, the Company issued the investor two groups of warrants, Short Term and Long Term warrants. The Short Term warrants allow the purchase of up to 407,926 shares of the Company’s common stock with an exercise price of $0.572 per share that may be exercised for a period of 180 days at any time after the later of (i) the effective date of the registration statement covering the conversion and warrant shares or (ii) December 16, 2005. The Long Term warrants allow the purchase of up to 471,154 shares of the Company’s common stock with an exercise price of $0.572 per share that may be exercised at anytime from December 16, 2005 through December 16, 2008.

 

On November 22, 2005, the Company entered into an agreement with the institutional investor owning the $770,000 convertible debenture issued June 16, 2005 whereby the investor agreed to (i) pay the Company $25,000 and (ii) waive all rights the institutional investor may have related to the Company’s September 15, 2005 amended note agreement with an individual investor (see Note 5) in exchange for a common stock purchase warrant to purchase up to 650,000 shares of the Company’s common stock at an exercise price of $0.59 per share, which warrant will expire on November 22, 2008. Using the Black-Scholes pricing model the Company has determined the value of the warrants issued in connection with this November 22, 2005 agreement to be $185,000. This amount, less the $25,000 proceeds received, has been recorded as Financing costs expense for the year ended March 31, 2006.

 

Stock Options

 

In August 1999, the Company implemented its 1999 Stock Option Plan (the “1999 Plan”). In August 2000, the Company’s Board of Directors approved the 2000 Stock Option Plan (the “2000 Plan”), which amends and restates the 1999 Plan. In September 2006, shareholders approved an amendment to the 2000 Plan to increase the maximum aggregate number of shares available for issuance thereunder from 6,000,000 to 7,500,000. Under the 2000 Plan, the exercise price must not be less than the fair market value on the date of grant of the option. The options vest in varying increments over varying periods and expire 10 years from the date of vesting. In the case of incentive stock options granted to any 10% owners of the Company, the exercise

 

US DATAWORKS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

price must not be less than 100% of the fair market value on the date of grant. Such incentive stock options vest in varying increments and expire five years from the date of vesting.

 

During the years ended March 31, 2007 and 2006, the Company granted 3,219,500 and 1,174,400 stock options, respectively, to certain employees that may be exercised at prices ranging between $0.82 and $0.45, and between $.65 and $0. 44, respectively.

 

The following table summarizes certain information relative to stock options:

 

 

The weighted-average remaining life and the weighted-average exercise price of all of the options outstanding at March 31, 2007 were 7.93 years and $0.78, respectively. The exercise prices for the options outstanding at March 31, 2007 ranged from $0.43 to $6.25, and information relating to these options is as follows:

 

 

 

The valuation allowance increased by $609,103 during the year ended March 31, 2007 and increased by $159,194 during the year ended March 31, 2006. At March 31, 2007, the Company had approximately $27,200,000 of federal net operating loss carryforwards attributable to losses incurred since the Company’s inception that may be offset against future taxable income through 2026. Because United States tax laws and the tax laws of most states limit the time during which NOL carryforwards may be applied against future taxable income, the Company may be unable to take full advantage of its NOL for federal income tax purposes should the Company generate taxable income. Based on such limitations, the Company has significant NOL carryforwards for which realization of tax benefits is uncertain. Further, the benefit from utilization of NOL carryforwards could be subject to limitations if material ownership changes occur in the Company. For the years ended March 31, 2007 and 2006, the Company recognized revisions to deferred tax assets with offsetting revisions to the valuation allowance that resulted in an insignificant net change in the aggregate of total deferred tax assets less the valuation allowance.

 

Income tax expense differs from the amounts computed by applying the United States federal income tax rate of 34% to loss before income taxes as follows:

 

 

Subsequent to the fiscal year end 2007 the Company entered into a lease agreement with Parkway Properties LP. The Company will move its executive offices to One Sugar Creek Center Blvd. Suite 500 Sugar Land, Texas, 77478. The Company will lease 18,790 square feet of office space starting in August 2007 and running through July 2012.

 

None.

 

(a)  Evaluation of disclosure controls and procedures .  We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-KSB, our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, have concluded that, as of that date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

(b)  Changes in internal control over financial reporting .  There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with management’s evaluation during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 8B.   Other Information

 

None.

PART III

 

The information required by this Item 9 regarding our directors is incorporated by reference to the information contained in the section captioned “Election of Directors” in the Company’s definitive proxy statement for its 2007 annual meeting of stockholders that will be filed within 120 days of its year ended March 31, 2007, or the Proxy Statement.

The information required by this Item 9 regarding executive officers is incorporated by reference from the information contained in the section captioned “Executive Officers” included in Part I of this Annual Report on Form 10-KSB.

 

The information required by this Item 9 regarding our audit committee and audit committee financial expert is incorporated by reference from the information contained in the Proxy Statement.

 

The information required by this Item 9 regarding Section 16(a) Beneficial Ownership Reporting Compliance is incorporated by reference from the information contained in the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement.

 

Code of Ethics

 

In April 2003, our Board of Directors adopted a Code of Business Conduct and Ethics governing all our officers, directors and employees. Our Code of Business Conduct and Ethics is available on our corporate website at http://www.usdataworks.com on the “Investor Relations” page under “Code of Business Conduct and Ethics.” We intend to disclose on our website any waivers or amendments to our Code of Business Conduct and Ethics within five business days of such action.

 

The information required by this Item 10 is incorporated by reference from the sections captioned “Executive Compensation” in the Proxy Statement. The information required by this Item 10 regarding compensation of directors is incorporated by reference from the information contained in the section captioned “Director Compensation” in the Proxy Statement.

 

The information required by this Item 11 is incorporated by reference from the information contained in the section captioned “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement.

 

 

The Amended and Restated 2000 Stock Option Plan is our only equity compensation plan that has been approved by the stockholders. We have also granted non-statutory stock options to purchase shares of our common stock pursuant to stock option agreements. These grants were made outside of our 2000 Stock Option Plan. The exercise prices of these options were equal to the fair market value of our common stock on the

date of grant. These options vest over periods up to three years from the date of grant and have a duration of ten years (1,160,000). The exercise price may be paid in cash or by a net issuance.

 

The information required by this Item 12 is incorporated by reference from the information contained in the sections captioned “Certain Relationships and Related Transactions” and “Election of Directors” in the Proxy Statement.

 

The exhibits listed below are required by Item 601 of Regulation S-B. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-KSB has been identified.