DDS Technologies USA (DDSU) 10QSB 2006 Q3 Quarterly report (small business)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-QSB

x Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2006

¨ Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from            to            

Commission File No. 000-30498

DDS Technologies USA, Inc.

(Exact name of small business issuer as specified in its charter)

Nevada	13-4253546
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

150 East Palmetto Park Road

Suite 510

Boca Raton, Florida 33432

(Address of Principal Executive Offices)

(561) 750-4450

(Issuer’s telephone number)

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 issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

State the number of shares outstanding of each of the issuer’s classes of common equity, as of October 31, 2006: 21,353,169 shares of common stock outstanding, $0.0001 par value per share.

Transitional Small Business Disclosure Format.    Yes  ¨    No  x

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONTENTS

PAGE	1	PART I – FINANCIAL INFORMATION, ITEM 1 – FINANCIAL STATEMENTS
PAGE	1	CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2006 (UNAUDITED) AND DECEMBER 31, 2005.
PAGE	2	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 AND FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006 (UNAUDITED).
PAGES	3-7	CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY) FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006 (UNAUDITED).
PAGE	8	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 AND FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006 (UNAUDITED).
PAGES	9-22	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2006 (UNAUDITED).
PAGES	23-27	ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
PAGE	27-28	ITEM 3 - CONTROLS AND PROCEDURES
PAGES	28	PART II OTHER INFORMATION
PAGE	28	ITEM 1 – LEGAL PROCEEDINGS
PAGE	28	ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
PAGE	29	ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
PAGES	30	SIGNATURES

PART I – FINANCIAL INFORMATION

ITEM 1. – FINANCIAL STATEMENTS

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30, 2006 (Unaudited)			December 31, 2005
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	1,354,277		$	1,365,798
Inventories, net		124,972			361,083
Prepaid expenses		85,224			410,003
Total Current Assets		1,564,473			2,136,884
FIXED ASSETS, NET		40,137			16,388
PATENT		4,935,000			4,935,000
OTHER ASSETS		16,527			10,327
TOTAL ASSETS	$	6,556,137		$	7,098,599
LIABILITIES AND STOCKHOLDERS’ (DEFICIENCY) EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	617,620		$	538,954
Accrued professional fees		60,000			77,000
Notes payable – related parties		81,569			77,500
Preferred stock to be issued		—			1,567,500
Embedded derivatives at fair value		3,723,075			3,075,026
Total Current Liabilities		4,482,264			5,335,980
COMMITMENTS AND CONTINGENCIES
6% CONVERTIBLE PREFERRED STOCK, net of discount of $521,353 and $1,404,686, respectively (Series A)		1,403,647			770,314
6% CONVERTIBLE PREFERRED STOCK, net of discount of $1,629,062 at September 30, 2006 (Series A1)		375,938			—
7% CONVERTIBLE PREFERRED STOCK, net of discount of $948,436 at September 30, 2006 (Series B)		569,064			—
STOCKHOLDERS’ (DEFICIENCY) EQUITY
Preferred stock, $.0001 par value, 1,000,000 shares authorized, 3,492.5 shares issued and outstanding		—			—
Common stock, $.0001 par value, 50,000,000 shares authorized, 21,353,169 and 19,864,202 shares issued and outstanding, respectively		2,135			1,986
Additional paid-in capital		19,881,485			18,579,269
Deferred compensation expense		(93,099	)		(11,681	)
Deficit accumulated during development stage		(20,065,297	)		(17,577,269	)
Total Stockholders’ (Deficiency) Equity		(274,776	)		992,305
TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIENCY) EQUITY	$	6,556,137		$	7,098,599

See accompanying notes to the condensed consolidated financial statements.

1

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	For the Three Months Ended September 30, 2006			For the Three Months Ended September 30, 2005			For the Nine months Ended September 30, 2006			For the Nine months Ended September 30, 2005			For the Period From July 17, 2002 (Inception) Through September 30, 2006
REVENUES	$	—		$	—		$	—		$	—		$	—
EXPENSES
Professional fees		97,241			237,950			602,799			886,545			8,515,078
General and administrative		228,286			234,897			930,753			627,783			3,259,449
Salaries and related taxes		181,792			122,922			478,118			386,534			1,840,472
Research and development		301,120			46,766			826,382			138,444			1,276,188
Litigation settlement expense		30,425			226,000			30,425			226,000			256,425
Merger costs		—			—			—			—			200,000
Machinery impairment		—			—			—			—			2,602,775
Parts inventory write-down		—			—			—			—			430,190
Total Expenses		838,864			868,535			2,868,477			2,265,306			18,380,577
INTEREST INCOME		20,326			3,287			48,975			8,158			67,543
GAIN (LOSS) ON FAIR VALUE ADJUSTMENT TO EMBEDDED DERIVATIVES		8,998,370			(3,283,641	)		3,158,395			(629,752	)		3,791,554
PRIVATE PLACEMENT EXPENSES		—			—			877,152			1,852,332			2,729,484
NET INCOME (LOSS)	$	8,179,832		$	(4,148,889	)	$	(538,259	)	$	(4,739,232	)	$	(17,250,964	)
Convertible preferred stock dividends		(772,234	)		(304,863	)		(1,949,769	)		(560,064	)
INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS	$	7,407,598		$	(4,453,752	)	$	(2,488,028	)	$	(5,299,296	)
NET INCOME (LOSS) PER SHARE – BASIC	$	0.35		$	(0.23	)	$	(0.12	)	$	(0.28	)
NET INCOME (LOSS) PER SHARE – DILUTED	$	0.26		$	(0.23	)	$	(0.12	)	$	(0.28	)
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING – BASIC		21,032,771			19,295,030			20,490,346			19,255,444
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING – DILUTED		31,787,514			19,295,030			20,490,346			19,255,444

See accompanying notes to the condensed consolidated financial statements.

2

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006

	Common Stock			Additional Paid-In Capital			Subscriptions Receivable			Deferred Compensation Expense			Note Receivable Related Party			Interest Receivable Related Party			Accumulated Deficit			Total
	Shares	Amount
Common stock issued for cash at inception	10,944,055	$	1,095	$	957,310		$	—		$	—		$	—		$	—		$	—		$	958,405
Common stock issued for license valued at $1.00 per share	3,500,000		350		3,499,650			—			—			—			—			—			3,500,000
Common stock issued for cash in December 2002 at $1.00 per share	100,000		10		99,990			—			—			—			—			—			100,000
Net loss, July 17, 2002 (inception) through December 31, 2002	—		—		—			—			—			—			—			(407,803	)		(407,803	)
Common stock issued for cash in January 2003 at $1.00 per share	200,000		20		199,980			—			—			—			—			—			200,000
Common stock issued for license in January 2003 at $1.00 per share	500,000		50		499,950			—			—			—			—			—			500,000
Note receivable – related party in February 2003	—		—		—			—			—			(235,000	)		—			—			(235,000	)
Interest receivable – related party	—		—		—			—			—			—			(3,074	)		—			(3,074	)
Common stock issued for cash in February, March and April 2003 at $1.00 per share	800,000		80		799,920			—			—			—			—			—			800,000
Recapitalization for merger in April 2003	429,000		43		(43	)		—			—			—			—			—			—
Common stock issued for cash in May 2003 at $1.00 per share	100,000		10		99,990			—			—			—			—			—			100,000
Common stock subscribed at $1.00 per share	1,500,000		150		1,499,850			(1,500,000	)		—			—			—			—			—
Collection of subscription receivable in July 2003	—		—		—			500,000			—			—			—			—			500,000
Warrants issued for consulting expense in April 2003	—		—		1,274,848			—			(1,274,848	)		—			—			—			—
Common stock issued for cash in July and August 2003 at $3.50 per share, net	502,714		50		1,020,444			—			—			—			—			—			1,020,494

See accompanying notes to the condensed consolidated financial statements.

3

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006

	Common Stock				Additional Paid-In Capital		Subscriptions Receivable	Deferred Compensation Expense		Note Receivable Related Party		Interest Receivable Related Party		Accumulated Deficit		Total
	Shares		Amount
Warrants issued with the sale of common stock in July and August 2003	—		—		563,056		—	—		—		—		—		563,056
Common stock issued for services in August and September 2003	175,000		17		1,298,233		—	(1,298,250	)	—		—		—		—
Common stock issued for settlement	60,000		6		464,994		—	—		—		—		—		465,000
Cancellation of subscription receivable	(1,000,000	)	(100	)	(999,900	)	1,000,000	—		—		—		—		—
Common stock issued for cash in October 2003 at $6.00 per share, net	904,334		90		2,896,206		—	—		—		—		—		2,896,296
Warrants issued with the sale of common stock in October 2003	—		—		1,962,114		—	—		—		—		—		1,962,114
Warrants issued for consulting expense in December 2003	—		—		29,761		—	(29,761	)	—		—		—		—
Options issued for consulting services in August and November 2003	—		—		181,010		—	(181,010	)	—		—		—		—
Amortization of deferred consulting expenses in 2003	—		—		—		—	1,427,336		—		—		—		1,427,336
Net loss, year ended December 31, 2003	—		—		—		—	—		—		—		(4,670,321	)	(4,670,321	)
BALANCE, December 31, 2003	18,715,103		1,871		16,347,363		—	(1,356,533	)	(235,000	)	(3,074	)	(5,078,124	)	(9,676,503	)
Common stock issued for accrued professional fees in February 2004 at $7.45 per share	10,000		1		74,499		—	—		—		—		—		74,500
Common stock issued for services in February 2004 at $4.30 per share	10,000		1		42,999		—	(43,000	)	—		—		—		—

See accompanying notes to the condensed consolidated financial statements.

4

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006

	Common Stock			Additional Paid-In Capital		Subscriptions Receivable		Deferred Compensation Expense			Note Receivable Related Party		Interest Receivable Related Party			Accumulated Deficit			Total
	Shares	Amount
Warrants issued for consulting expense in February 2004	—		—		42,454		—		(42,454	)		—		—			—			—
Warrants issued for consulting expense in April 2004	—		—		170,052		—		(170,052	)		—		—			—			—
Common stock issued for services in May 2004 at $2.55 per share	10,000		1		25,499		—		(25,500	)		—		—			—			—
Warrants issued for consulting expense in May 2004	—		—		12,165		—		(12,165	)		—		—			—			—
Common stock issued for cash in May 2004 at $3.30 per share, net	490,439		49		741,680		—		—			—		—			—			741,729
Warrants issued with the sale of common stock in May 2004	—		—		714,876		—		—			—		—			—			714,876
Amortization of deferred consulting expenses in 2004	—		—		—				1,576,825			—		—			—			1,576,825
Interest receivable related party in 2004	—		—		—		—		—			—		(1,844	)		—			(1,844	)
Forgiveness of note and interest receivable in July 2004	—		—		—		—		—			235,000		4,918			—			239,918
Net loss, year ended December 31, 2004	—		—		—		—		—			—		—			(6,990,752	)		(6,990,752	)
BALANCE, December 31, 2004	19,235,542	$	1,923	$	18,171,587	$	—	$	(72,879	)	$	—	$	—		$	(12,068,876	)	$	6,031,755

See accompanying notes to the condensed consolidated financial statements.

5

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006

	Common Stock			Additional Paid-In Capital			Subscriptions Receivable		Deferred Compensation Expense			Note Receivable Related Party		Interest Receivable Related Party		Accumulated Deficit			Total
	Shares	Amount
Warrants issued for consulting expense for August 2005	—		—		46,723			—		(46,723	)		—		—		—			—
Common stock issued for legal settlement	200,000		20		175,980			—		—			—		—		—			176,000
Amortization of deferred consulting expenses in 2005	—		—		—			—		107,921			—		—		—			107,921
Warrants issued for convertible preferred stock financing	—		—		101,646			—		—			—		—		—			101,646
Stock Issued for dividends on convertible preferred stock	161,565		16		83,360			—		—			—		—		—			83,376
Accretion of preferred stock to dividends	—		—		—			—		—			—		—		(770,314	)		(770,314	)
Dividends on preferred stock	—		—		—			—		—			—		—		(94,250	)		(94,250	)
Common stock issued in connection with merger in October 2005	267,095		27		(27	)		—		—			—		—		—			—
Net loss, year ended December 31, 2005	—		—		—			—		—			—		—		(4,643,829	)		(4,643,829	)
BALANCE, December 31, 2005	19,864,202	$	1,986	$	18,579,269		$	—	$	(11,681	)	$	—	$	—	$	(17,577,269	)	$	992,305

See accompanying notes to the condensed consolidated financial statements.

6

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2006

	Common Stock			Additional Paid-In Capital		Subscriptions Receivable		Deferred Compensation Expense			Note Receivable Related Party		Interest Receivable Related Party		Accumulated Deficit			Total
	Shares	Amount
Common stock issued for directors fees in January and June 2006	245,000		25		148,025		—		(148,050	)		—		—		—			—
Stock options issued to employees	—		—		27,300		—		—			—		—		—			27,300
Amortization of deferred consulting expenses in 2006	—		—		—		—		11,681			—		—		—			11,681
Amortization of deferred compensation expense for board of directors in 2006	—		—		109,915		—		54,951			—		—		—			164,866
Amortization of deferred compensation expense for employees in 2006	—		—		72,776		—		—			—		—		—			72,776
Warrants issued for convertible preferred stock financing	—		—		134,975		—		—			—		—		—			134,975
Stock issued for dividends on convertible preferred stock in March June and September 2006	438,967		44		201,974		—		—			—		—		—			202,018
Accretion reversal for partial conversion of preferred stock	—		—		119,792		—		—			—		—		—			119,792
Accretion of preferred stock to dividends	—		—		—		—		—			—		—		(1,728,334	)		(1,728,334	)
Common stock issued for preferred stock conversions in 2006	700,000		70		423,119		—		—			—		—		—			423,189
Common stock issued for services to related party	105,000		10		64,340														64,350
Dividends on preferred stock	—		—		—		—		—			—		—		(221,435	)		(221,435	)
Net loss, nine months ended September 30, 2006	—		—		—		—		—			—		—		(538,259	)		(538,259	)
BALANCE, September 30, 2006(UNAUDITED)	21,353,169	$	2,135	$	19,881,485	$	—	$	(93,099	)	$	—	$	—	$	(20,065,297	)	$	(274,776	)

See accompanying notes to the condensed consolidated financial statements.

7

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	For the Nine months Ended September 30, 2006			For the Nine months Ended September 30, 2005			For the Period From July 17, 2002 (Inception) Through September 30, 2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(538,259	)	$	(4,739,232	)	$	(17,250,964	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation expense		6,741			4,153			22,227
Machinery and deposits impairment		—			—			2,602,775
Parts inventory write-down		—			—			430,190
Amortization of deferred compensation expense		249,323			84,560			3,361,405
Settlement on legal payable		—			—			(350,000	)
Forgiveness of interest receivable		—			—			3,074
Common stock issued for legal settlement		—			—			176,000
Common stock issued for services		64,350			—			529,350
Stock options issued for services		27,300			—			27,300
Warrants issued for services		134,975			101,646			236,621
(Loss) gain on fair value adjustment to embedded derivatives		(3,158,395	)		629,752			(3,791,554	)
Valuation of embedded derivatives in excess of gross proceeds included in private placement expenses		2,190,412			1,533,186			3,723,597
Changes in operating assets and liabilities:
Inventory		236, 111			—			236,111
Prepaid expenses and other assets		318,579			229,263			(96,774	)
Accrued professional fees		(17,000	)		(17,009	)		484,500
Accounts payable and accrued expenses		(1,550,168	)		25,526			622,912
Net Cash Used In Operating Activities		(2,036,031	)		(2,148,155	)		(9,033,230	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit on purchase of machinery		—			—			(4,011,976	)
Refund of deposit on purchase of machinery		—			—			741,000
Purchases of fixed assets		(30,490	)		390			(190,413	)
Acquisition of license/patent		—			—			(700,000	)
Note receivable and accrued interest –related party		—			—			(238,074	)
Net Cash (Used In) Provided by Investing Activities		(30,490	)		390			(4,399,463	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Sales of common stock and warrants		—			—			10,556,970
Sale of convertible preferred stock		2,055,000			2,175,000			4,230,000
Net Cash Provided By Financing Activities		2,055,000			2,175,000			14,786,970
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(11,521	)		27,235			1,354,277
CASH AND CASH EQUIVALENTS – BEGINNING OF PERIOD		1,365,798			442,762			—
CASH AND CASH EQUIVALENTS – END OF PERIOD	$	1,354,277		$	469,997		$	1,354,277
NON CASH INVESTING AND FINANCING ACTIVITIES:
Accretion of convertible preferred stock	$	1,578,332		$	498,439		$	2,348,646
Dividends payable on convertible preferred stock	$	19,419		$	10,875		$	30,294
Common stock issued for dividends on convertible preferred stock	$	202,018		$	50,751		$	285,393
Common stock issued for conversion of preferred stock	$	423,189		$	—		$	423,189
Preferred stock to be issued at December 31, 2005 was issued in 2006 as Series B, 7% convertible preferred stock	$	1,567,500		$			$	1,567,500
Common stock issued for license valued at $1.00 per share	$	—		$	—		$	4,000,000
Warrants issued for deferred consulting services	$	—		$	—		$	1,509,519
Common stock issued for deferred consulting expenses	$	—		$	—		$	1,308,250
Common stock issued for accrued consulting expenses	$	—		$	—		$	74,500
Options issued for deferred consulting services	$	—		$	—		$	99,636
Common stock issued to consultant to settle contract dispute	$	—		$	—		$	60,000
Deposits transferred into fixed assets and inventory	$	—		$	—		$	1,307,087
Forgiveness and reclass of note receivable to acquisition of patent	$	—		$	—		$	235,000

See accompanying notes to the condensed consolidated financial statements

8

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

NOTE 1 BACKGROUND

DDS Technologies USA, Inc. and subsidiary (collectively, the ”Company”) is a development stage company with no revenues since its inception on July 17, 2002. The Company has obtained the patent rights on a world wide basis for a dry disaggregation and micronization system that converts certain waste into value added products for further processing or resale.

Since its inception, the Company has been dependent upon the receipt of capital investment to fund its continuing activities. In addition to the normal risks associated with a new business venture, there can be no assurance that the Company’s product development will be successfully completed or that it will be a commercial success. The Company’s ability to execute its business plan will depend on its ability to obtain additional financing and achieve a profitable level of operations. There can be no assurance that sufficient financing will be obtained. Nor can the Company give any assurance that it will generate substantial revenues or that its business operations will prove to be profitable.

NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(A) Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of DDS Technologies USA, Inc. and its wholly owned subsidiary. All material intercompany accounts and transactions have been eliminated.

(B) Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts payable and accrued expenses and notes payable to related parties at September 30, 2006 and December 31, 2005, approximate their fair value because of their relatively short-term nature.

(C) Patent Valuation

The patent is valued at its original acquisition cost plus the forgiveness of the carrying amount of a note receivable. The acquisition cost is based on the issuance of 4 million shares of common stock plus cash consideration. The patent has a 20 year life which expires in May 2022. The patent will be amortized over the expiration term when the Company commences operations which generate revenues.

9

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

(D) Derivatives

The Company accounts for its long term warrants and the conversion feature of the convertible preferred stock issued in private placements with the 6% and 7% convertible preferred stock as derivatives under the guidance of Statement of Financial Accounting Standards (“SFAS”) No. 133,Accounting for Derivative Instruments and Hedging Activities, Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. 150-1,Issuer’s Accounting for Freestanding Financial Instruments Composed of More Than One Option or Forward Contract Embodying Obligations Under SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, and FSP No. 150-5,Issuer’s Accounting under SFAS No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable.

The long term warrants and the conversion feature of the convertible preferred stock are treated as a liability in the accompanying condensed consolidated balance sheets at September 30, 2006 and December 31, 2005 and are recorded at fair value. The change in fair value, for each reporting period, is recorded as other income (expense) in the accompanying condensed consolidated statements of operations for the nine months ended September 30, 2006. For the three and nine months ended September 30, 2006, the Company recorded other gain relating to the fair value adjustment of $8,998,370 and $3,158,395 respectively. Also see Note 5.

(E) Research and Development

Research and development consists of all expenses associated with the R&D facility, salaries, engineering and consulting fees incurred in the development of the Company’s technology and are expensed as incurred.

For the three and nine months ended September 30, 2006 and 2005, and for the period from July 17, 2002 (inception) through September 30, 2006, the Company incurred research and development expenses of $301,120, $826,382, $46,766, $138,444 and $1,276,188 respectively.

(F) Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

10

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

G) Earnings Per Share

Basic earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed similar to basic earnings 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 shares had been issued and if the additional common shares were dilutive. For the three and nine months ended September 30, 2005 and for the nine months ended September 30, 2006 12,543,527 and 24,480,336, respectively, of common stock equivalents were not included in the calculation of diluted loss per share as their effect would be anti-dilutive. Common stock equivalents to purchase approximately 13,353,630 shares of common stock were not included in the calculation of diluted earnings per share for the three months ended September 30, 2006 because the exercise prices were greater than the average market price of the Company’s common stock for the period.

Basic and diluted earnings per share are calculated as follows for the three months ended September 30, 2006:

Basic:
Income available to common stockholders	$	7,407,598
Weighted average shares outstanding during the period		21,032,771
Basic earnings per share	$	0.35
Diluted:
Income available to common stockholders	$	7,407,598
Weighted average shares outstanding during the period		21,032,771
Effect of dilutive securities:
Stock options		231,706
Convertible preferred shares, net of related preferred stock dividends paid in common shares		10,523,037
Diluted weighted common shares outstanding		31,787,514
Diluted earning per share	$	0.23

11

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

(H) Interim Consolidated Financial Statements

The condensed consolidated financial statements for the three and nine months ended September 30, 2006 and 2005, and for the period from July 17, 2002 (inception) through September 30, 2006, are unaudited. In the opinion of management, such condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) necessary for the fair presentation of the consolidated financial position and the consolidated results of operations. The condensed consolidated results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The consolidated balance sheet information as of December 31, 2005 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-KSB. The interim condensed consolidated financial statements should be read in conjunction with that report.

(I) Stock-Based Compensation

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Payment, and related interpretations, to account for share-based compensation using the modified prospective transition method and therefore will not restate our prior period results. SFAS 123(R) supersedes Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees and revises guidance in SFAS 123,Accounting for Stock-Based Compensation. Among other things, SFAS 123(R) requires that compensation expense be recognized in the financial statements for share-based awards based on the grant date fair value of those awards. The modified prospective transition method applies to (a) unvested stock options under our 2003 Stock Option Plan (“Option Plan”) and (b) any new share-based awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Additionally, share-based compensation expense includes an estimate for pre-vesting forfeitures and is recognized over the requisite service periods of the awards on a straight-line basis, which is not necessary commensurate with the vesting term. For the three and nine months ended September 30, 2006, the Company recorded $96,805 and $207,803, respectively, of share-based compensation expense, net of estimated forfeitures, as a result of our adoption of SFAS 123(R).

Prior to January 1, 2006, the Company accounted for all stock option agreements in accordance with APB No. 25 and related interpretations. Accordingly, compensation expense for a stock option grant was recognized only if the exercise price was less than the market value of the Company’s common stock on the grant date. Prior to our adoption of SFAS 123(R), as required under the disclosure provisions of SFAS 123, as amended by SFAS 148, the Company provided pro forma net income for each period as if the Company had applied the fair value method to measure share-based compensation expense.

12

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

SFAS 123(R) requires the benefits associated with tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow as previously required. For the three and nine months ended September 30, 2006, the Company did not record any excess tax benefit generated from stock option exercises since the Company is in a net operating loss position and the income tax deduction will not yet reduce income taxes payable.

The table below shows the effect of adopting SFAS No. 123(R) on selected items and what those items would have been under previous guidance under APB No. 25 and SFAS No. 123 for the nine months ended September 30, 2006.

	As Reported			Under APB No. 25
Net loss	$	(538,259	)	$	(330,456	)
Net cash used in operating activities (1)	$	2,036,031		$	2,036,031
Net cash provided by financing activities (1)	$	2,055,000		$	2,055,000

(1) For the nine months ended September 30, 2006, the Company did not record any excess tax benefit generated from stock option exercises since the Company is in a net operating loss position and the income tax deduction will not yet reduce income taxes payable.

The Company estimates the fair value of each stock option at the grant date by using the Black- Scholes option pricing model under SFAS 123(R), which is the same valuation technique the Company previously used for pro forma disclosures under SFAS 123 with the following weighted average assumptions: no dividend yield for all years; expected volatility from 142% to 158%; risk-free interest rate of 3% and an expected life of 10 years.

SFAS 123(R) requires us to measure share-based compensation liability instruments at fair value as of January 1, 2006. Previously, the Company measured those liability instruments at their intrinsic value determined as of their grant date. There is no transition impact of adopting SFAS No. 123(R) attributable to measuring such liability instruments at fair value.

Additionally, SFAS 123(R) requires us to estimate pre-vesting option forfeitures at the time of grant and periodically revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company records share-based compensation expense only for those awards expected to vest using an estimated forfeiture rate based on our historical pre-vesting forfeiture data. Previously, the Company accounted for forfeitures as they occurred under the pro forma disclosure provisions of SFAS 123 for periods prior to 2006. The transition impact of adopting SFAS No. 123(R), attributable to accruing for expected forfeitures on outstanding share-based awards, totaled $1,759,768

13

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

For the three and nine months ended September 30, 2006 and 2005 the weighted average grant date fair value of options granted was $0, $0.63, $0.81 and $0.81 per share, respectively, net of estimated option forfeitures.

As of September 30, 2006, there was a total of $778,216 of unrecognized compensation cost related to stock option grants.

(J) Recent Accounting Pronouncement

FASB Statement of Financial Accounting Standards (SFAS) No. 157,Fair Value Measurements,issued in September 2006, establishes a formal framework for measuring fair value under GAAP. It defines and codifies the many definitions of fair value included among various other authoritative literature, clarifies and, in some instances, expands on the guidance for implementing fair value measurements, and increases the level of disclosure required for fair value measurements. Although SFAS No. 157 applies to and amends the provisions of existing FASB and AICPA pronouncements, it does not, of itself, require any new fair value measurements, nor does it establish valuation standards. SFAS No. 157 applies to all other accounting pronouncements requiring or permitting fair value measurements, except for: SFAS No. 123(R), share-based payment and related pronouncements, the practicability exceptions to fair value determinations allowed by various other authoritative pronouncements, and AICPA Statements of Position 97-2 and 98-9 that deal with software revenue recognition. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.

(K) Reclassifications

Certain amounts from prior periods have been reclassified to conform to the current period’s presentation.

NOTE 3 RELATED PARTY TRANSACTIONS

For the three and nine months ended September 30, 2006 and 2005, and for the period from July 17, 2002 (inception) through September 30, 2006, the Company incurred consulting expenses of $69,182, $196,941, $45,000, $135,000 and $1,303,441 respectively, from stockholders of the Company.

For the three and nine months ended September 30, 2006 and 2005, and for the period from July 17, 2002 (inception) through September 30, 2006, the Company incurred fees to members of the Board of Directors of $15,000, $40,000, $38,750, $122,250 and $203,583, respectively.

For the three and nine months ended September 30, 2006 and 2005, and for the period from July 17, 2002 (inception) through September 30, 2006, the Company incurred in share-based compensation to members of the Board of Directors of $52,843, $114,187, $0, $0, and $114,187, respectively.

14

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

For the three and nine months ended September 30, 2006 and 2005, and for the period from July 17, 2002 (inception) through September 30, 2006, the Company incurred in share-based compensation to employees of $43,962, $113,742, $0, $0, and $113,742, respectively.

For the fees payable as of December 31, 2005, which amounted to $81,569 ($77,500 principal and $4,069 accrued interest), the Company entered into subordinated promissory notes on January 6, 2006. The promissory notes are subordinated to all other obligations of the Company and will become payable only when the Company becomes cash flow positive. The notes accrue interest at prime rate.

NOTE 4 STOCK OPTIONS

A summary of the status of the Company’s option plans as of and for the nine months ended September 30, 2006 is presented below:

	Shares			Weighted Average Exercise Price
Outstanding at December 31, 2005		2,600,000		$	3.93
Granted		1,191,706		$	1.10
Forfeited		(1,400,000	)	$	4.20
Outstanding at September 30, 2006		2,391,706		$	2.53
Options exercisable at September 30, 2006		2,191,706		$	2.66
Weighted average fair value of options granted to employees during the period from July 17, 2002 (Inception) through September 30, 2006	$	2.53

15

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

The following table summarizes information about the stock options outstanding at September 30, 2006:

Options Outstanding					Options Exercisable
Exercise Price	Number Outstanding at September 30, 2006	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable at September 30, 2006	Weighted Average Exercise Price
$      3.40	100,000	7.75	$	3.40	100,000	$	3.40
$      3.96	50,000	7.50	$	3.96	50,000	$	3.96
$      5.00	600,000	6.62	$	5.00	600,000	$	5.00
$      8.00	50,000	7.08	$	8.00	50,000	$	8.00
$      1.00	400,000	8.50	$	1.00	200,000	$	1.00
$      1.39	750,000	9.62	$	1.39	750,000	$	1.39
$      1.00	50,000	9.75	$	1.00	50,000	$	1.00
$      0.75	160,000	9.75	$	0.75	160,000	$	0.75
$      0.41	231,706	9.33	$	0.41	231,706	$	0.41

NOTE 5 PRIVATE PLACEMENT

(A) Series A Convertible Preferred Stock

The Company accounted for the Series A convertible preferred stock based on Staff Accounting Bulletin (“SAB”) Topic No. D-98,Classification and Measurement of Redeemable Securitiesand SEC Accounting Series Release No. 268,Redeemable Preferred Stock. As such the convertible preferred stock is presented as mezzanine equity between the liabilities and equity sections in the accompanying condensed consolidated balance sheet at September 30, 2006.

The accounting for the long and short term warrants issued with the preferred stock was determined under the guidance of SFAS 133, FASB FSP No. 150-1, FASB FPS No 150-5 and Emerging Issues Task Force (“EITF”) No. 00-19,Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock. Accordingly the warrants are treated as derivatives and classified as a liability. The long term warrants are recorded at a fair value, based on the Black-Scholes pricing model, and revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006 the fair value adjustment resulted in a gain of $109,267. In April 2006, prior to the expiration of the short term warrants, a majority of the short term warrants were exercised pursuant to the terms of the agreement. See (C) below for exercise of short term warrants. The unexercised warrants expired on April 12, 2006. The short term warrants were recorded at fair value, as determined by an independent valuation services firm, and were revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006 the fair value adjustment resulted in a loss of $114,604.

The beneficial conversion feature relating to the preferred stock is also treated as an embedded derivative and is therefore classified as a current liability in accordance with SFAS 133. The

16

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

conversion feature of the convertible preferred stock is recorded at fair value, as determined by an independent valuation services firm, and revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006, the fair value adjustment resulted in a gain of $177,436.

In May 2006, pursuant to the Securities Purchase Agreement dated April 12, 2005, one of the investors exercised a partial conversion of their convertible preferred stock. 250 shares of the convertible preferred stock, with a stated value of $1,000 per share, were converted into 500,000 shares of common stock at a conversion price of $0.50 per share, as per the terms of the agreement. In recording this transaction, the conversion feature of the associated convertible preferred stock was revalued as of the conversion date resulting in a valuation adjustment of $328,999 to the related embedded derivatives and a valuation adjustment of $10,417 to the convertible preferred stock. Additionally, an adjustment of $119,792 was recorded to convertible stock to reflect the reversal of prior period accretions.

The Company is required to make quarterly dividend payments of 6% on the $2,055,000 that it raised from the sale of 6% Series A convertible preferred stock. The initial dividend payment was due on June 1, 2005 and quarterly thereafter. The payment is payable in either cash or common stock based on certain conditions being met. Dividends on preferred stock for the nine months ended September 30, 2006 were $94,125. At September 30, 2006 the Company accrued dividends amounting to $10,875 which is included in accounts payable and accrued expenses.

(B) Series B Convertible Preferred Stock

The Company accounted for the Series B convertible preferred stock based on SAB Topic No. D-98,Classification and Measurement of Redeemable Securities and SEC Accounting Series Release No 268,Redeemable Preferred Stock. As such the convertible preferred stock is presented as mezzanine equity between the liabilities and equity sections in the accompanying condensed consolidated balance sheet at September 30, 2006.

The accounting for the long warrants issued with the preferred stock was determined under the guidance of SFAS 133, FASB FSP No. 150-1, FASB FPS No 150-5 and (EITF) No. 00-19,Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock. Accordingly, the warrants are treated as derivatives and classified as a liability. The long term warrants are recorded at fair value, based on the Black-Scholes pricing model, and revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006 the fair value adjustment resulted in a gain of $547,693.

The beneficial conversion feature relating to the preferred stock is also treated as an embedded derivative and is therefore classified as a current liability in accordance with SFAS 133. The

17

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

conversion feature of the convertible preferred stock is recorded at fair value, as determined by an independent valuation services firm, and revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006, the fair value adjustment resulted in a gain of $411,566.

Since the long term warrants and the conversion feature were deemed to be embedded derivatives, the Company recorded the entire fair value of all the embedded derivatives at the transaction date as a liability. Since the total fair value of $2,127,893 exceeded the proceeds from the private placement, a $1 value was ascribed to the preferred stock, and the resulting difference between the value of the embedded derivatives and the proceeds from the private placement of $560,394 was recorded as private placement expense in the accompanying condensed consolidated statements of operations for the three months ended September 30, 2006. Additionally the redemption value of the preferred stock of $1,567,500 is accreted to dividends over the redemption period of two years, which resulted in dividends of $569,064 for the nine months ended September 30, 2006.

The Company is required to make quarterly dividend payments of 7% on the $1,567,500 that it raised from the sale of 7% Series B convertible preferred stock. The initial dividend payment was due on March 1, 2006 and quarterly thereafter. The payment is payable in either cash or common stock based on certain conditions being met. Dividends on preferred stock for the nine months ended September 30, 2006 were $71,930. At September 30, 2006 the Company accrued dividends amounting to $9,144 which is included in accounts payable and accrued expenses.

In connection with the private placement, the Company incurred cash commissions of $84,250 and issued 301,750 warrants to the selling agents. The warrants were valued using the Black-Scholes pricing model. The fair value of these warrants is reflected as private placement expense and recorded as additional paid-in capital in the condensed consolidated financial statements. The cash payment of $84,250 is also treated as private placement expense in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2006.

In July 2006, pursuant to a Securities Purchase Agreement dated May 17, 2006, one of the shareholders exercised a partial conversion of its convertible preferred stock. 50 shares of the convertible preferred stock, with a stated value of $1,000 per share, were converted into 100,000 shares of the Company’s common stock at a conversion price of $0.50 per share, according to the terms of the agreement. In recording this transaction, the conversion feature of the associated convertible preferred stock was re-valued as of the conversion date resulting in a valuation adjustment of $32,254 to the related embedded derivatives and a valuation adjustment of $14,583 to the convertible preferred stock.

(C) Series A-1 Convertible Preferred Stock

The Company accounted for the convertible preferred stock based on Staff Accounting Bulletin (“SAB”) Topic No. D-98,Classification and Measurement of Redeemable Securities and SEC

18

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

Accounting Series Release No 268,Redeemable Preferred Stock. As such the convertible preferred stock is presented as mezzanine equity between the liabilities and equity sections in the accompanying condensed consolidated balance sheet at September 30, 2006.

The accounting for the long warrants issued with the preferred stock was determined under the guidance of SFAS 133, FASB FSP No. 150-1, FASB FPS No 150-5 (EITF) No. 00-19,Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock. Accordingly the warrants are treated as derivatives and classified as a liability. The long term warrants are recorded at fair value, based on the Black-Scholes pricing model, and revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006, the fair value adjustment resulted in a gain of $719,370.

The beneficial conversion feature relating to the preferred stock is also treated as an embedded derivative and is therefore classified as a current liability in accordance with SFAS 133. The conversion feature of the convertible preferred stock is recorded at fair value, as determined by an independent valuation services firm, and revalued each reporting period with the change in fair value recorded as other income (expense). For the nine months ended September 30, 2006 the fair value adjustment resulted in a gain of $1,307,667.

Since the long term warrants and the conversion feature were deemed to be embedded derivatives, the Company recorded the entire fair value of all the embedded derivatives at the transaction date as a liability. Since the total fair value of $3,080,584 exceeded the proceeds from the private placement, a $1 value was ascribed to the preferred stock, and the resulting difference between the value of the embedded derivatives and the proceeds from the private placement of $16,533 was recorded as private placement expense in the accompanying condensed consolidated statements of operations for the nine months ended September 30, 2006. Additionally, the redemption value of the preferred stock of $2,055,000 is accreted to dividends over the redemption period of two years, which resulted in dividends of $375,937 for the nine months ended September 30, 2006.

The Company is required to make quarterly dividend payments of 6% on the $2,055,000 that it raised from the sale of 6% Series A-1 convertible preferred stock. The initial dividend payment was due on June 1, 2006 and quarterly thereafter. The payment is payable in either cash or common stock based on certain conditions being met. Dividends on preferred stock for the nine months ended September 30, 2006 were $35,963. At September 30, 2006 the Company accrued dividends amounting to $10,275 which is included in accounts payable and accrued expenses.

In connection with the private placement, the Company incurred cash commissions of $56,000 to the selling agents. The cash payment is also treated as private placement expense in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2006.

19

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

One of the original holders of Short Term Warrants exercised half of its Short Term Warrants and assigned the other half to certain other persons, including Robert L. Devereux, a director of the Company, and Kenny Securities Corp. The Company paid $25,000 to the original holder and the transferees collectively also paid $25,000 to the original holder in consideration for the transfer.

In July 2006, pursuant to a Securities Purchase Agreement dated May 17, 2006, one of the investors exercised a partial conversion of their convertible preferred stock. 50 shares of the convertible preferred stock, with a stated value of $1,000 per share, were converted into 100,000 shares of common stock at a conversion price of $0.50 per share, according to the terms of the agreement. In recording this transaction, the conversion feature of the associated convertible preferred stock was revalued as of the conversion date resulting in a valuation adjustment of $31,728 to the related embedded derivatives and a valuation adjustment of $5,208 to the convertible preferred stock.

NOTE 6 COMMON STOCK

During the first quarter of 2006, the Company issued 105,000 shares of common stock as partial compensation for three non-employee Board members as approved by the Board of Directors. The shares were valued at $43,050 based on the stock price on the date of grant.

In May 2006, in conjunction with the Securities Purchase Agreement, dated April 12, 2005, for the sale of 6% Series A convertible preferred stock, the Company issued 500,000 shares of common stock to one of its investors as a partial conversion of their convertible preferred shares.

During the third quarter of 2006, the Company issued 200,000 shares of common stock as partial conversion associated with the Series B and Series A1 convertible preferred stock.

During the third quarter of 2006, the Company issued 140,000 shares of common stock as partial compensation for four non-employee Board members as approved by the Board of Directors. The shares were valued at $105,000 based on the stock price on the day of the grant.

During the third quarter of 2006, the Company issued 105,000 shares of common stock as partial compensation, in the amount of $64,350, to a related party. The shares were valued based on the stock price on the day of the grant.

Pursuant to the Securities Purchase Agreement, dated April 12, 2005 for the sale of 6% Series A convertible preferred stock, for the nine months ended September 30, 2006, the Company issued 202,960 shares of common stock as payments of dividends valued at $94,125.

20

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

Pursuant to the Securities Purchase Agreement, dated January 4, 2006 for the sale of 7% Series B convertible preferred stock, for the nine months ended September 30, 2006, the Company issued 151,591 shares of common stock as payments of dividends valued at $71,930.

Pursuant to the Securities Purchase Agreement, dated May 17, 2006 for the sale of 6% Series A1 convertible preferred stock, for the nine months ended September 30, 2006, the Company issued 84,415 shares of common stock as payments of dividends valued at $35,963.

NOTE 7 COMMITMENTS AND CONTINGENCIES

Litigation

The Company was a defendant in a lawsuit whereby the plaintiff contended that it was entitled to a commission for allegedly procuring financing for a transaction. The plaintiff was seeking damages totaling $175,584, plus interest from December 31, 2002. In September 2006, the Company reached a Stipulation and Settlement Agreement with the plaintiff whereby the Company made a payment of $30,000 in full consideration for the dismissal, with prejudice, of all claims filed against the Company.

On January 19, 2006 the Company was served with a third party summons in the Circuit Court of Palm Beach County, Florida by a plaintiff who is a defendant in a dispute over a share transaction. The Company filed a motion to dismiss on February 8, 2006. The Company believes that the complaint is without merit and is vigorously defending its position. In the opinion of management, this suit will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

The Company is a defendant in a lawsuit whereby a stockholder and former president of the Company contends that he is entitled to receive consulting fees under a consulting agreement. The Company suspended payments and terminated the consulting agreement due to non compliance by the plaintiff with the terms of the agreement. The Company has filed a counterclaim against the plaintiff for breach of contract and breach of fiduciary duty.

Liquidated Damages

The Company’s registration rights agreements applicable to the Company’s Series A and Series B preferred stock require the Company to pay liquidated damages, and potentially trigger early premium redemption rights, if the Company does not timely file required registration statements, or if the Company does not keep them continuously effective for the required amount of time. The Company’s registration statement filings applicable to the Series A and Series B preferred stock registration statements were not effective timely. The filings became effective in July 2006. Liquidated damages pertaining to the non-effectiveness of the registration statements amounted to $343,766 and have been accrued in the accompanying condensed consolidated financial statements. No amounts have been or will be accrued for any potential redemption rights unless such rights are exercised.

21

DDS TECHNOLOGIES USA, INC.

AND SUBSIDIARY

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(UNAUDITED)

NOTE 8 SUBSEQUENT EVENTS

During October 2006 the Company amended stock options issued to one of its employee’s. The Company decreased the option exercise price from $5 per share to $1 per share on all 600,000 fully vested options. In re-valuing the options, using the Black-Scholes pricing model, there was no incremental charge to our operating results.

22

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

The following is management’s discussion and analysis of certain significant factors that have affected the Company’s financial condition, results of operations and cash flows during the periods included in the accompanying unaudited consolidated financial statements. This discussion should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2005 (“2005 Annual Report”).

Cautionary Note Regarding Forward-Looking Statements and Future Prospects

Certain statements made in this Quarterly Report on Form 10-QSB, or made by us in other reports, filings with the Securities and Exchange Commission, press releases, conferences or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,” “will be,” “will continue,” “will likely result,” “plan,” or words or phrases of similar meaning.

Forward-looking statements involve risks, uncertainties or other factors which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by the forward-looking statements. These statements are based on the Company’s management beliefs and assumptions, which in turn are based on currently available information. Certain risks, uncertainties or other important factors are detailed in this Quarterly Report on Form 10-QSB and may be detailed from time to time in other reports the Company files with the Securities and Exchange Commission, including on Forms 8-K and 10-KSB.

Examples of forward looking statements in this Quarterly Report on Form 10-QSB include, but are not limited to, the Company’s expectations regarding the Company’s ability to generate operating cash flows and to fund the Company’s working capital and capital expenditure requirements. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding demand for the Company’s products, pricing levels, the timing and cost of capital expenditures, outcomes of pending litigation, competitive conditions and general economic conditions. These assumptions could prove inaccurate. Although the Company believes that the estimates and projections reflected in the forward-looking statements are reasonable, the Company’s expectations may prove to be incorrect. Important factors that could cause actual results to differ materially from the results and events anticipated or implied by such forward-looking statements include:

• the risks of a development stage company;

• the availability of additional capital to finance the Company’s development;

• the Company’s dependence on management and need to recruit additional personnel;

• the limited trading market for the Company’s Common Stock;

• advances by the Company’s competitors;

• agricultural risks of certain of the Company’s customers;

23

• foreign market risks; and

• other risks, including those described in “Risk Factors” in the Company’s other Securities and Exchange Commission filings.

The Company operates in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for us to predict all of those risks, nor can the Company assess the impact of all of those risks on the Company’s business or the extent to which any factor may cause actual results to differ materially from those contained in any forward-looking statement. The Company believes these forward-looking statements are reasonable. Further, forward-looking statements speak only as of the date they are made, and unless required by law, the Company expressly disclaims any obligation or undertaking to update publicly any of them in light of new information or future events. You should not place undue reliance on any forward-looking statements.

In this Quarterly Report on Form 10-QSB, “Company,” “the Company,” “us,” “our” and “DDS” refer to DDS Technologies USA, Inc., a Nevada corporation and its subsidiary, unless the context requires otherwise.

Background

The Company is currently a development stage company with no revenues to date. The Company holds a patent for a dry disaggregation technology, which dry separates agricultural products and sorts them according to various properties. The technology may have applications across numerous industries. The Company intends to fully commercialize its technology. The technology is expected to produce, as a final product, either highly micronized particles, based on customers requirements, or various fractions of separated materials.

The Company commenced business in July 2002 when its founders formed DDS Holdings, Inc. to acquire rights to, and commercialize a patented dry disaggregation system technology in North, South and Central America, the Caribbean (excluding Cuba) and Africa. The founders and initial investors subsequently acquired control of Black Diamond Industries, Inc., a Florida corporation, in a reverse merger on November 14, 2002. Black Diamond Industries, Inc. was a public company that conducted no business other than to seek a suitable acquisition partner. Thereafter (in December 2002), Black Diamond Industries, Inc. reincorporated in Delaware and changed its name to DDS Technologies USA, Inc. (“DDS Delaware”). On April 4, 2003, the holders of approximately 88% of the outstanding shares of DDS Delaware exchanged their shares for shares representing approximately 97% of the shares of Fishtheworld Holdings, Inc., a Florida corporation. Thereafter (in May 2003), Fishtheworld Holdings, Inc. effected a reincorporation merger in the State of Nevada and changed the name of the corporation to DDS Technologies USA, Inc. (“DDS Nevada”). Fishtheworld Holdings, Inc. was a public company that conducted no business other than to seek a suitable acquisition partner. On October 17, 2005, the Company merged DDS Delaware into us and DDS Holdings became a direct wholly-owned subsidiary of ours. The Company has never been subject to any bankruptcy, receivership or similar proceedings.

24

Generally accepted accounting principles in the United States of America require that a company whose stockholders retain a majority interest in a business combination be treated as the acquirer for accounting purposes. Since Black Diamond and Fishtheworld were public shells and DDS Holdings, Inc. is a development stage company with no revenues, the transactions were treated as recapitalizations of the Company.

Initial work on the production version of the Company’s dry disaggregation machine by the Company’s consulting engineers has revealed that it does not fully disaggregate organic material to the extent that a prototype research machine does, and therefore requires additional development work. However, the production version does micronize very effectively to particle sizes of between 5 and 20 microns, which management believes should provide application opportunities and commercial potential in a number of industries.

Critical Accounting Policies

The Securities and Exchange Commission issued Financial Reporting Release No. 60,“Cautionary Advice Regarding Disclosure About Critical Accounting Policies” suggesting that companies provide additional disclosure and commentary on their most critical accounting policies. In Financial Reporting Release No. 60, the Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Company has identified the following significant policies as critical to the understanding of our condensed consolidated financial statements. The preparation of our condensed consolidated 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 condensed consolidated financial statements and the reported amounts of expenses during the reporting periods. Areas where significant estimation judgments are made and where actual results could differ materially from these estimates are:

A. The carrying amount of our patent.

B. The assumptions used in calculating the fair value of our stock options and warrants issued using the Black-Scholes pricing model and other independent valuation service firm.

The Company believes the following are among the most critical accounting policies that impact our condensed consolidated financial statements. The Company suggests that our significant accounting policies, as described in our consolidated financial statements in the Summary of Significant Accounting Policies and Organization, be read in conjunction with this Management’s Discussion and Analysis of Financial Condition or Plan of Operations:

A. The Company evaluates impairment of our long-lived assets by applying the provisions of SFAS No. 144. In applying those provisions, the Company has recognized an impairment charge of $2,602,775 on our long-lived assets during the year ended December 31, 2005.

25

B. The Company accounts for its embedded derivatives by applying the provisions of SFAS 133. In applying those provisions, the Company recognized a loss from the fair value adjustment to the embedded derivatives of $3,185,395 for the nine months ended September 30, 2006.

Results of Operations

From July 17, 2002 (inception) through September 30, 2006, the Company has incurred an accumulated deficit of $20,065,297.

To date, the Company has yet to achieve revenues from operations. During the nine months ended September 30, 2006 and 2005, the Company incurred operating expenses of $2,868,477 and $2,265,306, respectively. The increase in operating expenses is primarily due to; a) establishment of an R&D facility including the cost associated with the reclassification of a DDS machine for developmental purposes, b) recording of charges for potential liquidated damages pursuant registration rights agreement c) a decrease in professional fees and d) a decrease in legal fees. Private placement expenses of $877,152 primarily represent the valuation of embedded derivatives in excess of gross proceeds and the cash paid and the fair value of warrants issued in association with the funds raised in the private placement completed during this period. During the nine months ended September 30, 2006, the Company also recognized a gain of $3,158,395 as a result of revaluing the embedded derivatives as of September 30, 2006 related to the sale of the series A, Series B and Series A1 convertible preferred stock.

During the three months ended September 30, 2006 and 2005, the Company incurred operating expenses of $838,864 and $868,535, respectively. The decrease in operating expenses is primarily due to: a) establishment of an R&D facility including the cost associated with the reclassification of a DDS machine for developmental purposes, b) recording of charges for potential liquidated damages pursuant registration rights agreement, c) an increase in salaries, d) a decrease in professional fees and e) a decrease litigation settlement. During this quarter the Company also recognized a gain of $8,998,370 as a result of revaluing the embedded derivatives as of September 30, 2006 related to the sale of the series A, Series B and Series A1 convertible preferred stock.

The Company anticipates that losses from operations will continue for the remainder of the year primarily due to our relatively long sales cycle and the significant due diligence and testing conducted by our prospective customers. Testing includes the preparation of various sample products for processing using our proprietary technology process through our testing facility and submitting our analysis of results to third party labs for independent verification as well as reviewing the results with the prospective client. However, if the Company is unable to successfully implement its business model, the Company may never achieve profitability.

The registration rights agreements applicable to our Series A, Series B and Series A1 preferred stock require us to pay liquidated damages, and potentially trigger early premium redemption rights, if the Company does not timely file required registration statements, or if the Company does not keep them continuously effective for the required amount of time. Liquidated damages

26

pertaining to the non effectiveness of the registration statements have been accrued in the accompanying condensed consolidated financial statements (See Note 7 in the accompanying condensed consolidated financial statements). No amounts have been or will be accrued for any potential redemption rights unless such rights are exercised.

New Accounting Pronouncement

FASB Statement of Financial Accounting Standards (SFAS) No. 157,Fair Value Measurements,issued in September 2006, establishes a formal framework for measuring fair value under GAAP. It defines and codifies the many definitions of fair value included among various other authoritative literature, clarifies and, in some instances, expands on the guidance for implementing fair value measurements, and increases the level of disclosure required for fair value measurements. Although SFAS No. 157 applies to and amends the provisions of existing FASB and AICPA pronouncements, it does not, of itself, require any new fair value measurements, nor does it establish valuation standards. SFAS No. 157 applies to all other accounting pronouncements requiring or permitting fair value measurements, except for; SFAS No. 123 (R), share-based payment and related pronouncements, the practicability exceptions to fair value determinations allowed by various other authoritative pronouncements, and AICPA Statements of Position 97-2 and 98-9 that deal with software revenue recognition. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.

Liquidity and Capital Resources

To date, the Company has funded its losses, license payments and patent acquisitions through the private sale of common and preferred stock and financing from accredited investors. On May 17, 2006 the Company completed a private placement for the sale of convertible preferred stock to accredited investors resulting in net proceeds of $1,999,000. This sale was the result of the exercise of the majority of the short term warrants that were issued in connection with the Series A convertible preferred stock in April 2005. Our cash balance at September 30, 2006 was $1,354,277. Based on this balance the Company believes that it will be able to fund our operations into the first quarter of 2007. Subsequently, the Company plans to fund its operation partially from potential initial sales and from seeking to raise additional funds through another private placement. Without demonstrating commercial feasibility, securing customers or both, the Company believes that it may not be able to secure additional capital necessary to fund operations through private placements of our securities, or achieve sufficient revenues to operate at a cash flow breakeven.

In connection with this most recent private placement, the Company is required to make a 6% annual dividend payment, payable quarterly in arrears in cash, or in common stock if certain “Equity Conditions”, as defined, are met. Having met these “Equity Conditions” in September, the Company issued shares of common stock in partial settlement of dividends payable.

ITEM 3. CONTROLS AND PROCEDURES

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, the Company conducted an evaluation of its disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated

27

under the Securities Exchange Act of 1934, as amended, as of the end of the reporting period (June 30, 2006). Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

Pursuant to SEC Release No. 34-52492, the Company is not required to comply with the provisions of Exchange Act Rule 13a-15(d) until the Company files its Form 10-QSB for the first quarter of 2008; accordingly, there could have been no change in the Company’s internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) that occurred during the fourth quarter of 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company was a defendant in a lawsuit whereby the plaintiff contended that it was entitled to a commission for allegedly procuring financing for a transaction. The plaintiff was seeking damages totaling $175,584, plus interest from December 31, 2002. In September the Company reached a Stipulation and Settlement Agreement with the plaintiff whereby the Company agreed to make a payment of $30,000 in full consideration for the dismissal, with prejudice, of all claims filed against the Company.

On January 19, 2006 the Company was served with a third party summons in the Circuit Court of Palm Beach County, Florida by a plaintiff who is a defendant in a dispute over a share transaction. The Company filed a motion to dismiss on February 8, 2006. The Company believes that the complaint is without merit and is vigorously defending its position. In the opinion of management, this suit will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

The Company is a defendant in a lawsuit whereby a stockholder and former president of the Company contends that he is entitled to receive consulting fees under a consulting agreement (See Note 3). The Company suspended payments and terminated the consulting agreement due to breach of the terms of the agreement. The Company has filed an Answer and Affirmative Defenses and a Counterclaim alleging breach of the consulting agreement and breach of fiduciary duty.

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

During the third quarter of 2006, the Company issued 219,209 shares of common stock as dividend payment due pursuant to the: a) April 12, 2005 sale of 6% Series A Convertible Preferred Stock, b) January 4, 2006 sale of 7% Series B Convertible Preferred Stock and c) May 17, 2006 sale of 6% Series A1 Convertible Preferred Stock.

During the third quarter of 2006, the Company issued 200,000 shares of common stock as partial conversion associated with the Series B and Series A1 convertible preferred stock.

28

During the third quarter of 2006, the Company issued 140,000 shares of common stock as partial compensation for four non-employee Board members as approved by the Board of Directors.

During the third quarter of 2006, the Company issued 105,000 shares of common stock as partial compensation for a consultant according to the terms of the consulting agreement.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

The following exhibits, which are furnished with this Quarterly Report or incorporated herein by reference, are filed as part of this Quarterly Report.

Exhibit Number	Exhibit Description
31.1	Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

29

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 13^th day of November 2006.

Date: November 13, 2006	By:	/s/ Spencer L. Sterling
		Spencer L. Sterling
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: November 13, 2006	By:	/s/ Joseph N. Fasciglione
		Joseph N. Fasciglione
		Chief Financial Officer
		(Principal Accounting Officer)

30

Exhibit Index

Exhibit Number	Exhibit Description
31.1	Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

31