UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED FEBRUARY 29, 2008
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER: 000-52193
USTELEMATICS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 20-3600207 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
335 Richert Drive, Wood Dale, Illinois 60191 | ||
(Address of principal executive offices) (Zip Code) |
Registrant’s telephone number, including area code: (630) 595-0049
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2) of the Act. Yes ¨ No x.
There were 22,430,226 shares of the registrant's common stock outstanding as of April 14, 2008.
USTELEMATICS, INC.
FORM 10-QSB FOR THE FISCAL QUARTER
ENDED FEBRUARY 29, 2008
TABLE OF CONTENTS
Page | ||||
PART I - FINANCIAL INFORMATION | ||||
Item 1. Financial Statements (Unaudited) | F-1 | |||
Item 2. Management’s Discussion and Analysis or Plan of Operation | 1 | |||
Item 3. Controls and Procedures | 12 | |||
PART II - OTHER INFORMATION | ||||
Item 1. Legal Proceedings | 13 | |||
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 13 | |||
Item 3. Defaults Upon Senior Securities | 13 | |||
Item 4. Submission of Matters to a Vote of Security Holders | 13 | |||
Item 5. Other Information | 13 | |||
Item 6. Exhibits | 13 | |||
SIGNATURES | 14 |
i
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
USTelematics, Inc.
(A Development Stage Company)
Balance Sheet
February 29, 2008
(Unaudited)
2008 | ||||
Assets | ||||
Current Assets | ||||
Cash and Cash Equivalents | $ | 714,115 | ||
Certificate of Deposit | 108,392 | |||
Inventory | 99,191 | |||
Prepaid Expenses | 11,722 | |||
Other Receivables | 10,214 | |||
Total Current Assets | 943,634 | |||
Fixed Assets | ||||
Vehicles | 66,335 | |||
Office and Lab Equipment | 87,540 | |||
Leasehold Improvements | 6,358 | |||
Website Development | 60,598 | |||
Assets Not Placed in Service | 6,495 | |||
Less Accumulated Depreciation and Amortization | (39,947 | ) | ||
Total Fixed Assets | 187,379 | |||
Other Assets | ||||
Deferred Financing Fees, net of accumulated amortization of $529,984 | 347,546 | |||
Deposits | 22,500 | |||
Other Intangible Assets | 26,375 | |||
Total Other Assets | 396,421 | |||
Total Assets | $ | 1,527,434 |
The accompanying notes are an integral part of these unaudited financial statements.
F-1
USTelematics, Inc.
(A Development Stage Company)
Balance Sheet
February 29, 2008
(Unaudited)
2008 | ||||
Liabilities | ||||
Current Liabilities | ||||
Convertible Notes Payable | $ | 2,985,576 | ||
Derivative Liabilities | 9,355,364 | |||
Accrued Interest | 800,001 | |||
Accrued Payroll and Taxes | 22,937 | |||
Accounts Payable | 448,396 | |||
Accrued Liquidated Damages | 198,726 | |||
Total Current Liabilities | 13,811,000 | |||
Noncurrent Liabilities | ||||
Deferred Rent Liability | 19,692 | |||
Total Liabilities | 13,830,692 | |||
Stockholders' Deficit | ||||
Common Stock: Par Value $.0001, 250,000,000 Shares Authorized; 21,996,434 Shares Issued and Outstanding | 2,200 | |||
Additional Paid in Capital | 818,914 | |||
Additional Paid in Capital - Warrants | 467,052 | |||
Deficit Accumulated During the Development Stage | (13,591,424 | ) | ||
Total Stockholders' Deficit | (12,303,258 | ) | ||
Total Liabilities and Stockholders' Deficit | $ | 1,527,434 |
The accompanying notes are an integral part of these unaudited financial statements.
F-2
USTelematics, Inc.
(A Development Stage Company)
Statements of Operations
For the Three and Nine Months Ended February 29, 2008 and February 28, 2007
and the Period from October 7, 2005 (Inception) through February 29, 2008
(Unaudited)
Three Months Ended February 29, 2008 | Nine Months Ended February 29, 2008 | Three Months Ended February 28, 2007 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||||||
Revenue | $ | 19,682 | $ | 21,670 | $ | - | $ | - | $ | 21,670 | ||||||
Cost of Revenue | 21,950 | 21,950 | - | - | 21,950 | |||||||||||
Gross Profit | (2,268 | ) | (280 | ) | - | - | (280 | ) | ||||||||
Operating Expenses | ||||||||||||||||
Research and Development | 52,486 | 376,825 | 200,030 | 416,335 | 999,194 | |||||||||||
General and Administrative | 615,995 | 1,971,074 | 227,019 | 719,058 | 3,094,369 | |||||||||||
Total Operating Expenses | 668,481 | 2,347,899 | 427,049 | 1,135,393 | 4,093,563 | |||||||||||
Loss from Operations | (670,749 | ) | (2,348,179 | ) | (427,049 | ) | (1,135,393 | ) | (4,093,843 | ) | ||||||
Other Income (Expense) | ||||||||||||||||
Derivative Income (Expense), Net | 2,758,343 | 733,180 | (2,550,811 | ) | (2,550,811 | ) | (1,466,259 | ) | ||||||||
Loss on Extinguishment of Debt | - | - | (4,181,659 | ) | (4,181,659 | ) | (4,248,928 | ) | ||||||||
Liquidated Damages | - | (129,894 | ) | - | - | (301,974 | ) | |||||||||
Interest Income | 7,816 | 43,142 | 27,705 | 40,882 | 113,024 | |||||||||||
Interest Expense | (756,297 | ) | (2,414,692 | ) | (476,995 | ) | (622,729 | ) | (3,582,573 | ) | ||||||
Other Income (Expense) | - | (10,970 | ) | 99 | 99 | (10,871 | ) | |||||||||
Total Other Income (Expense) | 2,009,862 | (1,779,234 | ) | (7,181,661 | ) | (7,314,218 | ) | (9,497,581 | ) | |||||||
Net Income (Loss) | $ | 1,339,113 | $ | (4,127,413 | ) | $ | (7,608,710 | ) | $ | (8,449,611 | ) | $ | (13,591,424 | ) | ||
Earnings (Loss) Per Share | ||||||||||||||||
Basic | $ | 0.06 | $ | (0.20 | ) | $ | (0.38 | ) | $ | (0.42 | ) | $ | (0.84 | ) | ||
Fully Diluted | $ | 0.05 | $ | (0.20 | ) | $ | (0.38 | ) | $ | (0.42 | ) | $ | (0.84 | ) | ||
Weighted Average Shares (Basic) | 21,735,981 | 20,904,983 | 20,024,000 | 20,021,802 | 16,159,962 | |||||||||||
Weighted Average Shares (Fully Diluted) | 34,572,865 | 20,904,983 | 20,024,000 | 20,021,802 | 16,159,962 |
The accompanying notes are an integral part of these unaudited financial statements.
F-3
USTelematics, Inc.
(A Development Stage Company)
Statements of Cash Flows
For the Nine Months Ended February 29, 2008 and February 28, 2007
and the Period from October 7, 2005 (Inception) through February 29, 2008
(Unaudited)
Nine Months Ended February 29, 2008 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||
Net Loss | $ | (4,127,413 | ) | $ | (8,449,611 | ) | $ | (13,591,424 | ) | |
Adjustments to Reconcile Net Loss to Net Cash Used in Operating Activities | ||||||||||
Interest Accrued on Certificate of Deposit | (1,094 | ) | (1,412 | ) | (1,289 | ) | ||||
Loss on Sale of Fixed Assets | (7,841 | ) | - | (7,841 | ) | |||||
Depreciation and Amortization of Fixed Assets | 31,164 | 7,218 | 44,284 | |||||||
Amortization of Deferred Financing Fees | 299,593 | 185,929 | 618,402 | |||||||
Amortization of Debt Discount | 1,182,262 | 242,147 | 1,713,713 | |||||||
Derivative Income (Expense), Net | (733,180 | ) | 2,550,811 | 1,466,259 | ||||||
Expenses Paid Via Issuance of Common Stock | 401,500 | 12,000 | 413,500 | |||||||
Expenses Paid Via Issuance of Stock Warrants | - | 1,261 | 1,261 | |||||||
Loss on Debt Extinguishment | - | 4,181,659 | 4,248,928 | |||||||
Unpaid Interest and Liquidated Damages Added to Convertible Notes Payable and Derivatives | - | 97,397 | 410,469 | |||||||
Expenses Paid Directly from Note Closing Proceeds | - | - | 1,578 | |||||||
Change in Operating Assets and Liabilities | ||||||||||
Inventory | (92,184 | ) | (7,007 | ) | (99,191 | ) | ||||
Prepaid Expenses | 21,116 | 38,672 | (7,504 | ) | ||||||
Employee Expense Advances | (4,430 | ) | (831 | ) | (5,000 | ) | ||||
Deposits | 57,285 | - | 57,285 | |||||||
Accounts Payable | 301,569 | 59,698 | 448,396 | |||||||
Accrued Expenses | - | 3,949 | - | |||||||
Accrued Payroll and Taxes | 15,386 | (6,609 | ) | 22,937 | ||||||
Accrued Interest | 932,837 | 97,256 | 943,237 | |||||||
Deferred Rent Liability | 1,721 | 9,797 | 19,692 | |||||||
Accrued Liquidated Damages | 129,894 | - | 198,726 | |||||||
Total Adjustments | 2,535,598 | 7,471,935 | 10,487,842 | |||||||
Net Cash Used in Operating Activities | (1,591,815 | ) | (977,676 | ) | (3,103,582 | ) |
The accompanying notes are an integral part of these unaudited financial statements.
F-4
USTelematics, Inc.
(A Development Stage Company)
Statements of Cash Flows (continued)
For the Nine Months Ended February 29, 2008 and February 28, 2007
and the Period from October 7, 2005 (Inception) through February 29, 2008
(Unaudited)
Nine Months Ended February 29, 2008 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||
Purchase of Certificate of Deposit | $ | (2,237 | ) | $ | (2,211 | ) | $ | (107,103 | ) | |
Due from Related Parties | - | (214 | ) | (214 | ) | |||||
Purchase of Fixed Assets | (46,264 | ) | (103,636 | ) | (182,922 | ) | ||||
Proceeds from Sale of Fixed Assets | 27,150 | - | 27,150 | |||||||
Payment of Deposits | (48,150 | ) | (20,735 | ) | (79,785 | ) | ||||
Purchase of Assets Not Placed in Service | (8,850 | ) | (35,865 | ) | (65,550 | ) | ||||
Purchase of Other Intangible Assets | (11,350 | ) | (13,426 | ) | (26,375 | ) | ||||
Net Cash Used in Investing Activities | (89,701 | ) | (176,087 | ) | (434,799 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||
Proceeds from Sale of Convertible Notes Payable | - | 3,045,496 | 4,327,496 | |||||||
Deferred Financing Fees | (4,075 | ) | (50,058 | ) | (75,000 | ) | ||||
Net Cash Provided by (Used in) Financing Activities | (4,075 | ) | 2,995,438 | 4,252,496 | ||||||
Net Increase (Decrease) in Cash and Cash Equivalents | (1,685,591 | ) | 1,841,675 | 714,115 | ||||||
Cash and Cash Equivalents, Beginning | 2,399,706 | 1,033,613 | - | |||||||
Cash and Cash Equivalents, Ending | $ | 714,115 | $ | 2,875,288 | $ | 714,115 |
The accompanying notes are an integral part of these unaudited financial statements.
F-5
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 1 - GENERAL
This summary of significant accounting policies of USTelematics, Inc. (the “Company”) is presented to assist in understanding the Company's financial statements. The financial statements and notes are representations of the Company's management, which is responsible for the integrity and objectivity of the financial statements. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.
A. NATURE OF BUSINESS
The Company has been in the development stage since its inception in October, 2005. It is primarily engaged in the development of its organization, structure and business plans; recruiting qualified advisors, agents and professional counselors for financing and to place securities; transitioning the engineering designs for its mobile digital television technology from a prototype state to production-ready state; researching, developing and establishing sources of component supply and manufacturing services; establishing strategic alliances for marketing and distribution; designing an online e-commerce, order-taking platform for marketing and sales to end users and wholesale channels; developing plans for supplementary products, product lines and service delivery; and developing plans for sales support, installation training and technical support.
The Company began development of a new line of internet-connected media center PCs for use in automobiles, based on proprietary software, which includes the Company’s software and service that voices email messages to users as they travel down the road. These products deliver Mobile Internet Protocol Television (Mobile IPTV) to automotive users, along with downloaded movies, downloaded music from sources including Apple’s iTunes, online games, web browsing, navigation and other capabilities not otherwise commonly available in rear seat-devices.
B. BASIS OF PRESENTATION
The accompanying unaudited financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC"). Certain information related to the Company’s organization, significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These unaudited financial statements reflect, in the opinion of management, all material adjustments (which include only normal recurring adjustments) necessary to fairly state the financial position and the results of operations for the periods presented.
Operating results for the interim periods are not necessarily indicative of the results that can be expected for a full year. These interim financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto for the year ended May 31, 2007 included in the Company’s Form 10-KSB as filed with the SEC.
C. REVENUE RECOGNITION
Revenues for the nine months ended February 29, 2008 resulted from commissions for marketing wireless services, known as “E-Services Re-Selling" and resale of vehicles equipped with the Company's products. The Company recognizes E-Services Re-Selling revenues when a customer's order is placed with the wireless company. The Company recognizes revenues from vehicle sales when the automobile is sold at auction.
D. INVENTORY
Inventory is stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. All inventory as of February 29, 2008 is considered to be finished goods.
F-6
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
E. INTANGIBLE ASSETS
Legal fees totaling $24,776 as of February 29, 2008, associated with filing patents, which are still pending, have been capitalized as intangible assets. Other intangibles of $1,599 as of February 29, 2008 are not subject to amortization and include a domain name and logo creation. These amounts are evaluated for impairment each year.
F. INCOME TAXES
Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to the difference in the basis of reporting development stage expenses for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The Company has recorded a valuation allowance against the deferred tax asset for the portion that may not be utilized in future periods.
The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
G. FINANCIAL INSTRUMENTS
Financial instruments, as defined in Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments" (SFAS No. 107), consist of cash, evidence of ownership in an entity and contracts that both (i) impose on one entity a contractual obligation to deliver cash or another financial instrument to a second entity, or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (ii) conveys to that second entity a contractual right (a) to receive cash or another financial instrument from the first entity, or (b) to exchange other financial instruments on potentially favorable terms with the first entity. Accordingly, our financial instruments consist of cash and cash equivalents, certificate of deposit, accounts payable, accrued expenses, convertible notes payable and derivative financial instruments.
The Company carries cash and cash equivalents, certificate of deposit, accounts payable, liquidated damages and accrued expenses at historical costs; their respective estimated fair values approximate carrying values due to their current nature. The Company carries convertible notes payable at fair value based upon the present value of the estimated cash flows at market interest rates applicable to similar instruments.
Derivative financial instruments, as defined in Financial Accounting Standard No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities" (SFAS No. 133), consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments". This standard amends the guidance in SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is 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 Company adopted SFAS No. 155 on June 1, 2007 with no material effect on the financial statements.
F-7
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
G. FINANCIAL INSTRUMENTS - CONTINUED
The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, we have entered into certain other financial instruments and contracts, such as debt financing arrangements and freestanding warrants with features that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by SFAS No. 133, these instruments are required to be carried as derivative liabilities, at fair value, in the financial statements.
The Company estimates fair values of derivative financial instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective measuring fair values. In selecting the appropriate technique, the Company considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. For less complex derivative instruments, such as free-standing warrants, the Company generally uses the Black-Scholes-Merton option valuation technique because it embodies all of the requisite assumptions (including trading volatility, estimated terms and risk-free rates) necessary to fair value these instruments. For complex derivative instruments, such as embedded conversion options, the Company generally uses the Flexible Monte Carlo valuation technique because it embodies all of the requisite assumptions (including credit risk, interest-rate risk and exercise/conversion behaviors) that are necessary to fair value these more complex instruments. For forward contracts that contingently require net-cash settlement as the principal means of settlement, the Company projects and discounts future cash flows applying probability-weightage to multiple possible outcomes. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s operating results will reflect the volatility in these estimate and assumption changes. The fair value of the compound and warrant derivatives is significantly affected by the estimate used in the Company’s trading stock price. Volatility in the market price of the Company's stock may create significant derivative income or expense due to the change in fair value of derivative liabilities.
H. GOING CONCERN
These financial statements have been prepared assuming that the Company will continue as a going concern. The Company is a development stage enterprise presently generating only minimal revenues and the Company has a deficit accumulated during the development stage of $13,591,424 as of February 29, 2008. Further, the Company used cash in operations of $1,591,815, $977,676, and $3,103,582 during the nine months ended February 29, 2008 and February 28, 2007, and the period from October 7, 2005 (inception) through February 29, 2008, respectively. The Company’s continued existence is dependent upon management’s ability to develop profitable operations and resolve its liquidity problems. The Company has funded its operations and development through the issuance of convertible debt as discussed in Note 4. The Company may require additional financing to fund operations and development until it achieves profitable results from its products currently under development. There can be no assurance that the Company will be successful in its effort to secure additional financing. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
I. RECLASSIFICATION
Certain amounts reported in the financial statements for the three and nine months ended February 28, 2007 and the period from October 7, 2005 (inception) through February 28, 2007 have been reclassified to conform with the classifications presented in the accompanying financial statements without affecting previously reported net loss or deficit accumulated during the development stage.
F-8
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 2 - CASH AND CASH EQUIVALENTS
As of February 29, 2008, Cash and Cash Equivalents consisted of the following:
2008 | ||||
Cash | $ | 667,114 | ||
Money Market Funds | 47,001 | |||
$ | 714,115 |
NOTE 3 - ACCRUED LIQUIDATED DAMAGES
Pursuant to the Registration Rights Agreement, because the Company's SB-2 registration statement was not declared effective on April 11, 2007, the Company was required to make payments as liquidated damages to each investor equal to 2% of the purchase price paid for the Debentures for each period of 30 days beginning on April 11, 2007 on a pro-rata basis until the registration was declared effective on July 9, 2007. Per the waiver agreement discussed in Note 4, liquidated damages of $103,248 for the 30-day period ended May 11, 2007 were added to the principal outstanding under the Debenture as of their original due date, May 11, 2007. Accrued liquidated damages includes $68,832 for the period from May 12, 2007 to May 31, 2007 and $129,894 for the period from June 1, 2007 to July 8, 2007.
NOTE 4 - CONVERTIBLE NOTES PAYABLE
Convertible notes with a face amount of $1,500,000 were issued on April 14 and April 21, 2006 for proceeds, net of expenses and retainers to professionals, of $1,282,000, and bore interest at 10% per annum (“Bridge Financing”). The notes and accrued interest were originally payable in full at maturity in October, 2007. The notes were secured by substantially all the assets of the Company. The secured debentures were automatically exchanged, upon the closing of the Qualified Offering (see below) (sale for cash by the Company of senior secured convertible notes at levels defined in the related Term Sheet) for Exchange Securities consisting of Exchange Debentures, Exchange Warrants and Exchange Bonus Warrants. Each secured debenture was automatically represented in the ownership of an Exchange Debenture in the principal amount of the outstanding principal and interest. The Exchange Debentures, at the option of the note holders, may have been converted to debentures with the same rights as debentures issued in the Qualified Offering except that they would have been at 75% of the conversion price of the debentures issued in the Qualified Offering. Exchange Warrants were issued to the holders of the secured debentures in a ratio equal to those issued to the purchasers under the Qualified Offering since the Qualified Offering consisted of issuance of securities combined with warrants. Each Exchange Warrant is exchangeable for one share of common stock by holder. Holders also received common stock purchase warrants, known as Exchange Bonus Warrants, exercisable for five years from the issue date for one share of common stock per each Exchange Bonus Warrant. Each holder received one Exchange Bonus Warrant for each four shares of common stock purchased with the holder having the same rights and benefits granted the holders of the Exchange Warrants. Exercise price of the Exchange Bonus Warrants is the same as the conversion price of the debentures issued in the Qualified Offering. In April 2006, the fair value of the warrants related to the secured debentures was deemed to be de minimus based on an independent appraisal.
On December 12, 2006, the Company entered into and consummated a securities purchase agreement, a Qualified Offering, with a group of accredited investors (the “Investors”) providing for the issuance to the Investors of the Company’s 9% Senior Secured Convertible Debentures in the principal amount of $3,565,000 (the “Debentures”). Interest is payable on the last day of each fiscal quarter in cash or, at the option of the Company, in registered shares of common stock of the Company. Upon an event of default, the stated interest rate of the Debentures will be increased to 18% per annum effective as of the Issue Date of the Debentures, which was December 12, 2006. The Debentures mature two years from the date of issuance. All amounts due under the Debentures may be converted at any time, in part or in whole, at the written election of the holder thereof, into shares of the Company’s common stock at a conversion price of $0.50 per share. No conversions may take place if it would cause a holder of the Debentures to become the beneficial owner of more than 4.99% of the outstanding shares of common stock of the Company, which limitation is subject to waiver by an Investor upon 61 days prior written notice to the Company. The Company has granted a security interest in all of its assets to secure its obligations under the Debentures.
F-9
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 4 - CONVERTIBLE NOTES PAYABLE - CONTINUED
The Company also issued to the holders of the Debentures, Class A Warrants to purchase 7,130,000 shares of the Company’s common stock at $0.55 per share and Class B Warrants to purchase 3,565,000 shares of Common Stock at $0.75 per share (collectively, with the Bonus Warrants, as defined below, the “Warrants”). All Warrants are exercisable for a period of five years.
In addition, the Company issued debentures (the “Exchange Debentures”) in the principal amount of $1,597,397 in exchange for debentures issued to a group of investors (the “Bridge Investors”) in the Bridge Financing. The Exchange Debentures are identical to the Debentures in all respects, except that the conversion price of the Exchange Debentures is $0.375. The Company also issued to the Bridge Investors, Class A Warrants to purchase 4,259,726 shares of the Company’s common stock and Class B Warrants to purchase 2,129,863 shares of Common Stock at $0.55 per share and $0.75 per share, respectively. In addition, they received five-year warrants (the “Bonus Warrants”) to purchase an aggregate of 1,064,932 shares of common stock of the Company at $0.375 per share. The terms of the exchange resulted in the treatment of the transaction as a debt extinguishment, resulting in a loss of $4,181,659, which was recorded in the quarter ended February 28, 2007.
In the valuation of both the Debentures and the Exchange Debentures, the Company concluded that the conversion features were not afforded the exemption as a conventional convertible instrument due to the anti-dilution protection; and they did not otherwise meet the conditions for equity classification. Since equity classification is not available for the conversion feature, the Company was required to bifurcate the embedded conversion feature and carry it as a derivative liability, at fair value. The compound derivative financial instrument includes certain put and redemption provisions (default put) that were considered not clearly and closely related to the host debt instrument. The Company concluded that the default put required bifurcation because it is indexed to certain events that are not associated with debt instruments. The Company combined all embedded features that required bifurcation into one compound instrument that is carried as a component of derivative liabilities. The Company also determined that the warrants did not meet the conditions for equity classification because these instruments did not meet all of the criteria necessary for equity classification. Therefore, the warrants are also required to be carried as a derivative liability, at fair value.
The aforementioned allocations to the compound and warrant derivatives resulted in the discount in the carrying value of the notes. This discount, along with related deferred finance costs and future interest payments, are amortized through periodic charges to interest expense using the effective interest method.
Although the Company made no interest payments as required under the Debentures, Exchange Debentures and Registration Rights Agreements for the three months ended February 28, 2007 and the three months ended May 31, 2007, the Investors waived any events of default as a possible result thereof. In addition, the Investors agreed that accrued interest due through May 31, 2007 would be payable through the issuance to each investor of up to 1,000 shares of common stock valued at $0.40 each, with the remaining balance of $209,824 plus liquidated damages of $103,248 (Note 3), to be added to the principal outstanding under each investor’s Debenture. The terms of the waiver agreement resulted in the treatment of the transaction as an extinguishment of interest and liquidated damages liabilities, resulting in a loss of $67,269.
The Company made no interest payments as required under the Debentures, Exchange Debentures and Registration Rights Agreements during the nine months ended February 29, 2008. Due to this event of default, on August 31, 2007 the stated interest rate increased to 18% per annum effective as of December 12, 2006. During the nine months ended February 29, 2008, the Company has accrued $932,837 of interest expense. Subsequent to February 29, 2008, the Company failed to timely deliver shares of common stock pursuant to elections to convert from two investors.
During the nine months ended February 29, 2008, the following instruments were converted into shares of common stock:
Face Value | Shares of Stock | ||||||
$3,565,000 Convertible Debentures | $ | 150,891 | 301,782 | ||||
$1,597,000 Convertible Exchange Debentures | 303,125 | 808,333 | |||||
$313,072 Convertible Debentures - capitalized interest and liquidated damages | 8,048 | 16,217 | |||||
Accrued interest | 132,836 | 267,602 | |||||
$ | 594,900 | 1,393,934 |
F-10
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 4 - CONVERTIBLE NOTES PAYABLE - CONTINUED
The following table summarizes the transactions in Convertible Notes Payable during the nine months ended February 29, 2008:
2008 | ||||
Balance, June 1, 2007 | $ | 2,021,023 | ||
Amortization of debt discount | 1,182,262 | |||
Conversion of debentures, at fair value | (217,709 | ) | ||
Balance, February 29, 2008 | $ | 2,985,576 |
NOTE 5 - DERIVATIVE LIABILITIES
As discussed in Note 4, the Company is carrying the embedded features that required bifurcation related to the convertible notes payable as a component of derivative liabilities. The Company is also carrying the warrants related to the convertible notes as a component of derivative liabilities.
The following table summarizes the components of derivative liabilities as of February 29, 2008:
Fair Value | ||||
Compound derivative financial instruments that have been bifurcated from the following financing arrangements: | ||||
$3,565,000 Convertible Debentures | $ | 1,952,790 | ||
$1,597,000 Convertible Exchange Debentures | 1,035,364 | |||
$313,072 Convertible Debentures - capitalized interest and liquidated damages | 182,073 | |||
Freestanding derivative contracts arising from financing arrangements: | ||||
Series A Warrants issued with $3,565,000 Convertible Debentures | 2,416,357 | |||
Series B Warrants issued with $3,565,000 Convertible Debentures | 1,209,961 | |||
Series A Warrants issued with $1,597,000 Convertible Exchange Debentures | 1,443,621 | |||
Series B Warrants issued with $1,597,000 Convertible Exchange Debentures | 722,876 | |||
Bonus Warrants issued with $1,597,000 Convertible Exchange Debentures | 392,322 | |||
$ | 9,355,364 |
The following table summarizes the number of common shares indexed to the derivative financial instruments associated with the convertible notes payable as of February 29, 2008:
Conversion Feature | Warrants | Total | ||||||||
Financing arrangement: | ||||||||||
$3,565,000 Convertible Debentures and Warrants | 6,828,219 | 10,695,000 | 17,523,219 | |||||||
$1,597,000 Convertible Exchange Debentures and Warrants | 3,451,391 | 7,454,521 | 10,905,912 | |||||||
$313,072 Convertible Debentures - interest and liquidated damages | 672,747 | - | 672,747 | |||||||
10,952,357 | 18,149,521 | 29,101,878 |
F-11
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 5 - DERIVATIVE LIABILITIES - CONTINUED
The following table illustrates fair value adjustments that the Company has recorded related to the derivative financial instruments associated with the convertible note financings:
Three Months Ended February 29, 2008 | Nine Months Ended February 29, 2008 | Three Months Ended February 28, 2007 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||||||
Derivative Income (Expense) | ||||||||||||||||
$3,565,000 Convertible Debentures and Warrants | ||||||||||||||||
Compound derivative | $ | 213,633 | $ | (390,487 | ) | $ | 29,168 | $ | 29,168 | $ | (27,542 | ) | ||||
Warrant derivative | 1,433,130 | 757,919 | 59,536 | 59,536 | 816,029 | |||||||||||
$1,597,000 Convertible Exchange Debentures and Warrants | ||||||||||||||||
Compound derivative | 109,876 | (99,671 | ) | 191,081 | 191,081 | 111,497 | ||||||||||
Warrant derivative | 996,882 | 513,722 | 40,468 | 40,468 | 553,124 | |||||||||||
$313,072 Convertible Debentures - capitalized interest and liquidated damages | 4,822 | (48,303 | ) | - | - | (48,303 | ) | |||||||||
Fair value adjustments, not including day-one losses | 2,758,343 | 733,180 | 320,253 | 320,253 | 1,404,805 | |||||||||||
Day-one loss on compound derivatives related to $3,565,000 Convertible Debentures | - | - | (2,871,064 | ) | (2,871,064 | ) | (2,871,064 | ) | ||||||||
$ | 2,758,343 | $ | 733,180 | $ | (2,550,811 | ) | $ | (2,550,811 | ) | $ | (1,466,259 | ) |
The derivative liabilities as of February 29, 2008 and our derivative losses during the three and nine months ended February 29, 2008 and the period from October 7, 2005 (inception) to February 29, 2008 are significant to the financial statements. The magnitude of the derivative income (expense) amounts for each of the periods reflects the following:
(a) | During the nine months ended February 29, 2008, the Company’s stock started trading on the OTC market. Recent stock transactions with market prices ranging from $0.47 to $0.80 per share were used in the calculations above. | |
(b) | During the nine months ended February 28, 2007, the Company entered into a $3,565,000 Convertible Debentures arrangement, more fully discussed in Note 4. In connection with our accounting for this financing, the Company encountered the unusual circumstance of a day-one loss related to the recognition of derivative instruments arising from the arrangement. That means that the fair value of the bifurcated compound derivative and warrants exceeded the proceeds that we received from the arrangement and we were required to record a loss to record the derivative financial instruments at fair value. The loss that we recorded amounted to $2,871,064. The Company did not enter into any other financing arrangements during the periods reported that reflected day-one losses. | |
(c) | As discussed in Note 4, during the nine months ended February 28, 2007 the Company obtained agreements from the Investors that added interest due under the Debenture Agreement and liquidated damages due under the Registration Rights Agreement to the principal outstanding under the Convertible Debentures. This transaction did not trigger a day-one loss related to the recognition of derivative instruments arising from the agreements. |
F-12
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 5 - DERIVATIVE LIABILITIES - CONTINUED
Derivative warrant fair values are calculated using the Black-Scholes-Merton valuation technique. Significant assumptions as of February 29, 2008, corresponding to each of the series of warrants, are as follows:
Series A | Series B | Placement Agent | ||||||||
Warrants related to $3,565,000 Convertible Debentures | ||||||||||
Trading Market Price | $ | 0.520 | $ | 0.520 | $ | 0.520 | ||||
Strike Price | $ | 0.550 | $ | 0.750 | $ | 0.500 | ||||
Volatility | 94.58 | % | 94.58 | % | 94.58 | % | ||||
Risk-free rate | 1.87 | % | 1.87 | % | 1.87 | % | ||||
Expected life (years) | 3.75 | 3.75 | 3.75 |
Series A | Series B | Bonus | ||||||||
Warrants related to $1,597,000 Convertible Exchange Debentures | ||||||||||
Trading Market Price | $ | 0.520 | $ | 0.520 | $ | 0.520 | ||||
Strike Price | $ | 0.550 | $ | 0.750 | $ | 0.375 | ||||
Volatility | 94.58 | % | 94.58 | % | 94.58 | % | ||||
Risk-free rate | 1.87 | % | 1.87 | % | 1.87 | % | ||||
Expected life (years) | 3.75 | 3.75 | 3.75 |
Compound derivative fair values are calculated using the Monte Carlo Simulation Model. Significant assumptions as of February 29, 2008, corresponding to each of the series of convertible debentures are as follows:
$3,565,000 Convertible Debentures | $1,597,000 Convertible Debentures | ||||||
Effective term | 0.727 | 0.685 | |||||
Equivalent volatility | 168.70 | % | 168.70 | % | |||
Equivalent yield | 10.79 | % | 10.79 | % | |||
Equivalent interest | 10.65 | % | 10.65 | % |
Changes in the fair value of the compound derivatives and, therefore, derivative income (expense) related to the compound derivatives is significantly affected by the credit risk associated with the Company’s financial instruments. The fair value of the compound and warrant derivatives is significantly affected by the estimate used in the Company’s trading stock price. Future changes in underlying market conditions will have a continuing effect on derivative income (expense) associated with these instruments.
The Company has estimated volatility by using a composite of nine publicly traded technology manufacturing sector entities as the Company's stock was only recently cleared for trading on the OTC Bulletin Board. The risk-free interest rate assumption is based upon U.S. Treasury Notes, which have a life that approximates the expected life of the warrants. Expected life has been estimated to be equal to the remaining life of the warrants as there has yet to be any exercises thereof. As previously discussed herein, changes in fair value of derivative financial instruments are reflected in the results of operations.
F-13
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 6 - WARRANTS PAYABLE
On October 31, 2007, the Company issued warrants to purchase 400,000 shares of common stock at $.50 per share in exchange for placement services related to the Bridge Financing, which closed in April 2006. The Company had recorded the warrants payable when the services were performed in April 2006 at an estimated value of zero dollars, based on a valuation prepared by an outside valuation firm as of May 31, 2006.
NOTE 7 - EARNINGS (LOSS) PER SHARE
Earnings (loss) per share (basic) is calculated by dividing earnings (loss) allocable to common shareholders by the weighted average number of shares of common stock outstanding during the three and nine months ended February 29, 2008 and February 28, 2007 and the period from October 7, 2005 (inception) to February 29, 2008. Earnings (loss) per share (fully diluted) is calculated by adjusting outstanding shares, assuming any dilutive effects of options and warrants using the treasury stock method and convertible debt using the "if converted" method.
The following reconciles the numerators and denominators of basic and fully diluted earnings (loss) per share:
Three Months Ended February 29, 2008 | Nine Months Ended February 29, 2008 | Three Months Ended February 28, 2007 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||||||
Net income (loss) - Basic | $ | 1,339,113 | $ | (4,127,413 | ) | $ | (7,608,710 | ) | $ | (8,449,611 | ) | $ | (13,591,424 | ) | ||
Interest on convertible notes | 756,897 | - | - | - | - | |||||||||||
Change in fair value of dilutive derivatives | (469,008 | ) | - | - | - | - | ||||||||||
Net income (loss) - Diluted | $ | 1,627,002 | $ | (4,127,413 | ) | $ | (7,608,710 | ) | $ | (8,449,611 | ) | $ | (13,591,424 | ) | ||
Weighted-average shares outstanding | 21,735,981 | 20,904,983 | 20,024,000 | 20,021,802 | 16,159,962 | |||||||||||
Warrants, convertible debt and other contingently issuable shares | 12,836,884 | 14,154,528 | 4,073,538 | 1,349,342 | 2,458,324 | |||||||||||
Antidilutive warrants, convertible debt and other contingently issuable shares | - | (14,154,528 | ) | (4,073,538 | ) | (1,349,342 | ) | (2,458,324 | ) | |||||||
Weighted-average shares outstanding assuming dilution | 34,572,865 | 20,904,983 | 20,024,000 | 20,021,802 | 16,159,962 |
F-14
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 8 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The Company had the following non-cash investing and financing transactions for the nine months ended February 29, 2008 and February 28, 2007 and for the period from October 7, 2005 (Inception) to February 29, 2008:
Nine Months Ended February 29, 2008 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||
Office and lab equipment exchanged for stock | $ | - | $ | - | $ | 2,500 | ||||
Deferred financing fees paid in exchange for stock | $ | - | $ | - | $ | 5,000 | ||||
Deferred financing fees paid out of proceeds from sale of convertible notes | $ | - | $ | 519,504 | $ | 726,708 | ||||
Deferred financing fees paid via issuance of stock warrants | $ | - | $ | 465,791 | $ | 465,791 | ||||
Deferred financing fees netted against issuance of stock | $ | 75,000 | $ | - | $ | 75,000 | ||||
Legal fees for related party paid out of proceeds from sale of convertible notes | $ | - | $ | - | $ | 5,000 | ||||
Prepaid expenses paid out of proceeds from sale of convertible notes | $ | - | $ | - | $ | 4,218 | ||||
Exchange of Bridge Financing for Exchange Debentures | $ | - | $ | 1,500,000 | $ | 1,500,000 | ||||
Accrued interest paid via issuance of stock | $ | 10,400 | $ | - | $ | 10,400 | ||||
Issuance of common stock in exchange for Convertible Notes Payable, which includes related compound derivative and deferred financing fees | $ | 464,714 | $ | - | $ | 464,714 |
The Company paid no cash for interest or income taxes for the nine months ended February 29, 2008 and February 28, 2007, as well as for the period from October 7, 2005 (inception) to February 29, 2008.
NOTE 9 - INCOME TAXES
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of SFAB Statement No. 109” (“FIN 48”) on June 1, 2007. As a result of the adoption of FIN 48, the Company recognized no adjustments to liabilities or stockholders' equity. The Company files income tax returns in the U.S. federal jurisdiction and the state of Illinois. The Company has not been subjected to U.S. federal or state income tax examinations by tax authorities and therefore all tax years remain open.
The reconciliation between the U.S. federal statutory income tax rate of 35% and the Company’s effective tax rate is as follows:
Three Months Ended February 29, 2008 | Nine Months Ended February 29, 2008 | Three Months Ended February 28, 2007 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||||||
Income tax provision (benefit) at U.S. federal statutory rates | $ | (278,700 | ) | $ | (1,158,100 | ) | $ | (198,400 | ) | $ | (471,400 | ) | $ | (1,913,200 | ) | |
State income taxes benefit | (62,000 | ) | (273,800 | ) | (39,800 | ) | (100,800 | ) | (416,000 | ) | ||||||
Adjustment of valuation allowance | 340,700 | 1,431,900 | 238,200 | 572,200 | 2,329,200 | |||||||||||
$ | - | $ | - | $ | - | $ | - | $ | - |
F-15
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 9 - INCOME TAXES - CONTINUED
The net deferred tax asset in the accompanying balance sheet includes the following components:
2007 | ||||
Total long-term deferred tax asset: | ||||
Temporary differences related to development stage expenses | $ | 1,492,900 | ||
Research and development tax credit | 64,900 | |||
Net operating loss carryforward | 358,400 | |||
Other temporary differences | 413,000 | |||
2,329,200 | ||||
Deferred tax asset valuation allowance | (2,329,200 | ) | ||
$ | - |
As of February 29, 2008, the Company had net operating loss ("NOL") and credit carryforwards of approximately $900,000 and $65,000, respectively, which may be available to offset future income tax liabilities and will expire in FY2026, FY2027 and FY2028.
NOTE 10 - RELATED PARTY TRANSACTIONS
During the nine months ended February 29, 2008, the Company paid to one of its directors $2,500 for director's fees, which were accrued for the year ended May 31, 2007, and $2,636 for travel expense reimbursement. During the nine months ended February 29, 2008, the Company issued 27,397 shares of common stock to a family member of a director in exchange for management consulting services totaling $20,548.
NOTE 11 - RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets". This standard amends the guidance in SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". Among other requirements, SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations: (a) a transfer of the servicer’s financial assets that meets the requirements for sale accounting; (b) a transfer of the servicer’s financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities"; or (c) an acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. SFAS No. 156 did not have a material impact on the Company's financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. However, for some entities, the application of SFAS No. 157 will change current practice. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is permitted if the entity has not yet issued interim or annual financial statements for that fiscal year. The Company is currently evaluating the impact of SFAS No. 157 on its financial position, results of operations and cash flows.
F-16
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 11 - RECENT ACCOUNTING PRONOUNCEMENTS - CONTINUED
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, which provides companies with an option to report selected financial assets and liabilities at fair value. The standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. With certain limitations, early adoption is permitted. The Company is currently evaluating the impact of SFAS No. 159 on its financial position, results of operations and cash flows.
In June 2007, the FASB ratified the consensus in EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities” (EITF 07-3), which requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and amortized over the period that the goods are delivered or the related services are performed, subject to an assessment of recoverability. EITF 07-3 will be effective for fiscal years beginning after December 15, 2007. The Company does not expect that the adoption of EITF 07-3 will have a material impact on its financial position, results of operations or cash flows.
In June 2007, the Accounting Standards Executive Committee issued Statement of Position 07-1, “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (SOP 07-1). SOP 07-1 provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide Investment Companies (the “Audit Guide”). SOP 07-1 was originally determined to be effective for fiscal years beginning on or after December 15, 2007, however, on February 6, 2008, FASB issued a final Staff Position indefinitely deferring the effective date and prohibiting early adoption of SOP 07-1 while addressing implementation issues.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51". SFAS No. 160 establishes accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. It also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. This statement is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company currently does not have any minority interest and therefore under our current structure, the adoption of SFAS No. 160 will have no effect on its financial position, results of operations or cash flows.
In December 2007, the FASB ratified the consensus in EITF Issue No. 07-1, “Accounting for Collaborative Arrangements” (EITF 07-1). EITF 07-1 defines collaborative arrangements and requires collaborators to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) the other collaborators based on other applicable authoritative accounting literature, and in the absence of other applicable authoritative literature, on a reasonable, rational and consistent accounting policy is to be elected. EITF 07-1 also provides for disclosures regarding the nature and purpose of the arrangement, the entity’s rights and obligations, the accounting policy for the arrangement and the income statement classification and amounts arising from the agreement. EITF 07-1 will be effective for fiscal years beginning after December 15, 2008, which will be the Company’s fiscal year 2009, and will be applied as a change in accounting principle retrospectively for all collaborative arrangements existing as of the effective date. The Company has currently is not party to any collaborative arrangements and therefore does not expect the adoption of EITF 07-1 to have any effect on its financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141R (revised 2007), "Business Combinations" which, among other things, establishes principles and requirements for how the acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired business, (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The Company is required to adopt SFAS No. 141R for all business combinations for which the acquisition date is on or after January 1, 2009. Earlier adoption is prohibited. This standard will change the Company’s accounting treatment for business combinations (if any are consummated) on a prospective basis.
F-17
USTelematics, Inc.
(A Development Stage Company)
Condensed Notes to Financial Statements
February 29, 2008
NOTE 11 - RECENT ACCOUNTING PRONOUNCEMENTS - CONTINUED
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133." This statement changes the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company has not yet determined the effect that the application of SFAS No. 161 will have on its financial position, results of operations or cash flows.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company’s present or future financial statements.
F-18
Item 2. Management’s Discussion and Analysis or Plan of Operation.
The information in this report contains forward-looking statements. All statements other than statements of historical fact made in report are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. These forward-looking statements can be identified by the use of words such as “believes,” “estimates,” “could,” “possibly,” “probably,” anticipates,” “projects,” “expects,” “may,” “will,” or “should” or other variations or similar words. No assurances can be given that the future results anticipated by the forward-looking statements will be achieved. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Our actual results may differ significantly from management’s expectations.
The following discussion and analysis should be read in conjunction with our financial statements, included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.
Background
The Company was incorporated in October 2005 in the State of Delaware as Mobilier, Inc., which subsequently changed its name to USTelematics, Inc. on June 5, 2006, for the purpose of engaging in the research, development, manufacturing and marketing of proprietary broadband telecommunications products for use in moving vehicles. Our initial principal hardware products include: VoyagerÔ, a line of devices for receiving digital television in moving vehicles; and ViveeÔ, an online service with associated products that “speak” email and text messages, from a human-like avatar, to unify mobile messaging and enhance the safety of communicating while driving. ViveeÔ is also patent pending. The Company is a development stage company and, to the date of this report, has generated only minimal revenues.
Revenue Lines
We plan to generate four distinct lines of revenue in operationally unique ways as outlined here:
· | Telecommunication hardware manufacturing; |
· | E-services re-selling; |
· | Integration services; and |
· | Online retail store |
“Telecommunication Hardware” refers to high technology custom manufacturing of physical electronic hardware systems including software, most of which are built or are being built according to our own proprietary designs. Our target gross margin in this category is 50%.
“E-Services Re-Selling” means that we will act, during the initial activation of hardware products that we sell, as an agent to market certain wireless services that are made possible or better by our hardware products. DirecTV, Dish Network, Verizon and Sprint all offer sales commissions to us under these circumstances. Income in this category goes almost directly to our bottom line, with little associated expense.
“Integration Services” means (a) services performed at our own facility to install our hardware products into vehicles; and (b) installation performed by sub-contractors whereby we purchase such services at a discounted wholesale price and re-sell them to customers who purchase our hardware products. This includes installation services, activation services, and e-system-to-vehicle technical integration processes. The Integration Services operation we are building at our headquarters facility is intended to be an ongoing, experimental-yet-profit-generating pilot business model for the eventual establishment of franchise or agency operations as “stores-within-stores” at auto, marine and RV dealerships.
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“Online Retail Store” refers to the Internet presence we are establishing at USTelematics.com. This online store will offer our own products and services as well as certain items and services produced by others that are complimentary to our product line. In keeping with our plan to create a pilot operation for licensing or franchising to auto, marine and RV dealerships, we also plan to partner with a national vehicle leasing finance institution and market new vehicles fully integrated with our technology, from our retail website. We will use our website as a marketing channel for a leasing company or companies that “sells cars” to consumers, whereby these cars are outfitted with our telecommunications products prior to consumer delivery.
Results of Operations for the Three Months Ended February 29, 2008
Revenue
Revenue for the three months ended February 29, 2008, were approximately $20,000 related to reselling e-services and sales of vehicles that were purchased at auction and equipped with Voyager for the purpose of reselling. There was no revenue for the three months ended February 28, 2007. As we are in the development stage, we did not generate significant revenue for either quarter.
Operating Expenses
General and administrative expenses increased by approximately $389,000 to approximately $616,000 for the three months ended February 29, 2008 compared to approximately $227,000 for the three months ended February 28, 2007. General and administrative expenses increased by approximately $113,000 for investor relations consulting expenses, approximately $70,000 for legal, accounting and consulting services, approximately $18,000 for payroll, approximately $111,000 for marketing and approximately $77,000 for various other factors. Research and development expenses decreased by approximately $148,000 to approximately $52,000 for the three months ended February 29, 2008 compared to approximately $200,000 for the three months ended February 28, 2007, which was attributable to the gradual shift from development of products to marketing.
Other Income (Expense)
We had other income, net of other expense, of approximately $2,010,000 for the three months ended February 29, 2008 compared to other expense, net of other income, of approximately ($7,182,000) for the three months ended February 28, 2007. The most significant item was a non-cash gain of approximately $2,758,000 on the change in value of derivatives for warrants and convertible debt outstanding for the three months ended February 29, 2008 compared to a loss of approximately ($2,551,000) for the three months ended February 28, 2007. Compound and warrant derivatives are calculated using the Monte Carlo Simulation Model and the Black-Scholes-Merton valuation technique. Additional information and significant assumptions as of February 29, 2008, can be found in Note 4 to the unaudited interim financial statements. The fair value changes in warrants are significantly influenced by our trading common stock prices. During the three months ended February 29, 2008, our traded market price decreased to $0.52 per share from $0.60 per share as of November 30, 2007, which was the primary reason for the derivative gains during the three months ended February 29, 2008. Other expense for the three months ended February 28, 2007 also contained a loss on extinguishment of debt of $4,181,659. Interest expense increased by approximately $279,000 to approximately $756,000 for the three months ended February 29, 2008 compared to approximately $477,000 for the three months ended February 28, 2007 due to increased levels of outstanding convertible debt.
Income Taxes
We recorded a full valuation allowance against all tax benefits as we are in the developmental stage.
Net Income (Loss)
Net income was approximately $1,339,000 for the three months ended February 29, 2008 compared to a net loss of approximately ($7,609,000) for the three months ended February 28, 2007 as a result of the factors discussed above.
Results of Operations for the Nine Months Ended February 29, 2008
Revenue
Revenue for the nine months ended February 29, 2008, were approximately $22,000 related to reselling e-services and sales of vehicles equipped with Voyager. There was no revenue for the nine months ended February 28, 2007. As we are in the development stage, we did not generate significant revenue for either period.
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Operating Expenses
General and administrative expenses increased by approximately $1,252,000 to approximately $1,971,000 for the nine months ended February 29, 2008, compared to approximately $719,000 for the nine months ended February 28, 2007. General and administrative expenses increased by approximately $430,000 for investor relations consulting expenses, approximately $209,000 for legal, accounting and consulting services, approximately $135,000 for payroll, approximately $224,000 for marketing and approximately $254,000 for various other factors. Research and development expenses decreased by approximately $39,000 to approximately $377,000 for the nine months ended February 29, 2008, compared to approximately $416,000 for the nine months ended February 28, 2007. The decrease in research and development expenses was attributable to the gradual shift from development of products to marketing.
Other Income (Expense)
Other expense, net of other income, decreased by approximately $5,535,000 to approximately $1,779,000 for the nine months ended February 29, 2008 compared to approximately $7,314,000 for the nine months ended February 28, 2007. Other expense during the nine months ended February 29, 2008, primarily was related to a charge of approximately $2,415,000 for interest expense on the convertible debt and approximately $733,000 of other income related to the change in value of derivative for warrants and convertible debt outstanding. The change in value of derivatives for warrants and convertible debt outstanding was a loss of approximately $2,551,000 for the nine months ended February 28, 2007. Compound and warrant derivatives are calculated using the Monte Carlo Simulation Model and the Black-Scholes-Merton valuation technique. Additional information and significant assumptions as of February 29, 2008, can be found in Note 4 to the unaudited interim financial statements. The fair value changes in warrants are significantly influenced by assumptions of volatility and the risk free rate. During the nine months ended February 29, 2008, volatility decreased from 122.11% as of May 31, 2007 to 94.58% and the risk free rate decreased from 4.86% as of May 31, 2007 to 1.87%, which were the primary reasons for the derivative gain during the nine months ended February 29, 2008. Other expense for the nine months ended February 28, 2007 also contained a loss on extinguishment of debt of $4,181,659. Interest expense increased by approximately $1,792,000 to approximately $2,415,000 for the nine months ended February 29, 2008 compared to approximately $623,000 for the nine months ended February 28, 2007 due to increased levels of outstanding convertible debt. Liquidated damages expense was approximately $130,000 for the nine months ended February 29, 2008 compared to $0 for the nine months ended February 28, 2007.
Income Taxes
We recorded a full valuation allowance against all tax benefits as we are in the developmental stage.
Net Loss
Net loss was approximately $4,128,000 for the nine months ended February 29, 2008 compared to approximately $8,450,000 for the nine months ended February 28, 2007 as a result of the factors discussed above.
Liquidity and Capital Resources
As of February 29, 2008, the Company had cash on hand of $714,115, a decrease of $1,685,591 from May 31, 2007. During the nine months ended February 29, 2008, cash used in operating activities was $1,591,815, consisting primarily of the net loss of ($4,127,413) offset by interest accrued on certificate of deposit of ($1,094); loss on sale of fixed assets of ($7,841); depreciation and amortization of $31,164; amortization of deferred financing fees of $299,593; amortization of debt discount of $1,182,262; change in fair value of derivatives of ($733,180); stock issued in exchange for services of $401,500; and changes in operating assets and liabilities in the net amount of $1,363,194. Cash used in investing activities was $89,701, which consisted of the purchase of a certificate of deposit of $2,237; purchase of fixed assets of $46,264; payment of deposits of $48,150; purchase of assets not placed in service of $8,850; and purchase of other intangible assets of $11,350, offset by proceeds from the sale of fixed assets of $27,150. Cash used in financing activities was $4,075 for deferred financing fees.
We had negative cash flows from operations for the nine months ended February 29, 2008 and February 28, 2007 and the period from October 7, 2005 (inception) through February 29, 2008 of $1,591,815, $977,676 and $3,103,582, respectively. Since inception, we have been dependent upon proceeds from capital investment (discussed below under Debentures, Exchange Debentures, and Waiver Agreements) to fund our continuing activities.
Our earnings (loss) before interest, taxes, depreciation and amortization (EBITDA) amounted to $2,107,938, ($1,681,557), ($7,127,637), ($7,819,664) and ($9,964,567) for the three and nine months ended February 29, 2008 and February 28, 2007 and the period from October 7, 2005 (inception) through February 29, 2008, respectively. We provide information and analysis regarding our EBITDA, which is a non-GAAP measure, because our investors have advised us that such information is relevant and important to their investment decisions.
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EBITDA for each period reflects our actual net income (loss) of $1,339,113, ($4,127,413), ($7,608,710), ($8,449,611) and ($13,591,424) for the three and nine months ended February 29, 2008 and February 28, 2007 and the period from our October 7, 2005 (inception) through February 29, 2008, respectively, less depreciation and amortization on our long-lived assets and interest, amounting to $768,825, $2,445,856, $481,073, $629,947 and $3,626,857, respectively.
The following table illustrates the reconciliation between EBITDA and the closest comparable GAAP measure, net cash used in operating activities, discussed elsewhere herein:
Nine Months Ended February 29, 2008 | Nine Months Ended February 28, 2007 | October 7, 2005 (Inception) through February 29, 2008 | ||||||||
EBITDA | $ | (1,681,557 | ) | $ | (7,819,664 | ) | $ | (9,964,567 | ) | |
Loss on debt extinguishment | - | 4,181,659 | 4,248,928 | |||||||
Derivative expense, net | (733,180 | ) | 2,550,811 | 1,466,259 | ||||||
Liquidated damages paid with convertible debt | - | - | 104,826 | |||||||
Expenses paid with common stock and warrants | 401,500 | 13,261 | 414,761 | |||||||
Other noncash operating items | (8,935 | ) | (1,412 | ) | (9,130 | ) | ||||
Changes in operating assets and liabilities, excepting accrued interest | 430,357 | 97,669 | 635,341 | |||||||
Net cash used in operating activities | $ | (1,591,815 | ) | $ | (977,676 | ) | $ | (3,103,582 | ) |
Working capital deficit was ($12,867,366) as of February 29, 2008, which was due to current liabilities consisting of convertible notes payable of $2,985,576; derivative liabilities of $9,355,364; accrued interest of $800,001; accrued payroll and taxes of $22,937; accounts payable of $448,396; and accrued liquidated damages of $198,726, in excess of current assets consisting of cash and cash equivalents of $714,115; certificate of deposit of $108,392; inventory of $99,191; prepaid expenses of $11,722; and other receivables of $10,214.
Historically, cash has been used to fund product development; legal, accounting and investor relations costs of being a public-owned company; and administrative operations. To date we have not generated any significant revenues.
The unaudited interim financial statements have been prepared assuming that the Company will continue as a going concern. The Company is a development stage enterprise presently generating only minimal revenues and the Company has a deficit accumulated during the development stage of $13,591,424 as of February 29, 2008. The Company’s continued existence is dependent upon management’s ability to develop profitable operations and resolve its liquidity problems. The Company has funded its operations and development through the issuance of convertible debt as discussed in Note 4 to the unaudited interim financial statements. The Company may require additional financing to fund operations and development until it achieves profitable results from its products currently under development. There can be no assurance that the Company will be successful in its effort to secure additional financing. The unaudited interim financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
Debentures
During April 2006, we issued 10% secured debentures in the total principal amount of approximately $1,500,000 due in October 2007 to fourteen accredited investors. The debentures were exchanged in a financing completed in December 2006 that is discussed below in "Exchange Debentures".
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On December 12, 2006, we entered into and consummated a securities purchase agreement with a group of 12 accredited investors for the issuance of our 9% Senior Secured Convertible Debentures in the principal amount of $3,565,000 (the “Debentures”). Interest is payable in cash or, at our option, in registered shares of our common stock (at a 20% discount to the average of the lowest 3 intra-day trading prices during the 20 trading days immediately prior to the interest payment due date). Principal payments may only be made in cash, unless the holder of the Debentures elects to convert all or part of the principal, as described below. Upon an event of default, the interest rate of the Debentures will be increased to 18% effective as of the Issue Date, which was December 12, 2006. Although we made no principal or interest payments under the Debentures for the three months ended February 28, 2007 and the three months ended May 31, 2007 under the Debentures and Registration Rights Agreements, the Investors waived any events of default as a possible result thereof. In addition, the Investors agreed that accrued interest due through May 31, 2007 and liquidated damages due through May 11, 2007 would be payable through the issuance to each investor of up 1,000 shares of common stock valued at $0.40 each, with the balance to be added to the principal outstanding under each investor’s Debenture. The Debentures mature two years from the date of issuance. We have granted a security interest in all of our assets to secure our obligations under the Debentures. We made no principal or interest payments under the Debentures for the nine months ended February 29, 2008. We have initiated discussions with the Investors to waive any event of default as a possible result thereof. As of February 29, 2008, we have accrued $932,837, which represents interest at the rate of 18% for the period from the Issue Date (December 12, 2006) through February 29, 2008 less any interest previously added to the principal outstanding under the Debentures or paid with common stock.
All amounts due under the Debentures may be converted at any time, in part or in whole, at the written election of the holder thereof, into shares of our common stock at a fixed conversion price of $0.50. No conversions may take place if it would cause a holder of the Debentures to become the beneficial owner of more than 4.99% of the outstanding shares of our common stock, which limitation is subject to waiver by an investor upon 61 days prior written notice to us.
All Debentures and Warrants contain anti-dilution protections in the event we issue shares or securities convertible into shares at a price per share that is below the then applicable conversion price or exercise, respectively. As a result, as long as any of the Debentures or Warrants remain outstanding, their conversion price or exercise price, as the case may be, will be reduced to such lower price (except, generally, if the lower priced securities are issued pursuant to a stock option plan, or are issued in connection with a strategic transaction).
Our cash flow may not permit us to pay the full amount of the debentures due in cash. If we are unable to repay the Debentures in cash, we will be required to issue shares in lieu of cash, if and when requested by the holders of the Debentures. Such share issuances, if any occur, would be dilutive.
During the nine months ended February 29, 2008, the Company issued 516,663 shares of common stock in exchange for $280,832 (at face value) of the $3,565,000 Convertible Debentures and accrued interest thereon.
We also issued to the holders of the Debentures, Class A Warrants to purchase 7,130,000 shares of our common stock at $0.55 per share and Class B Warrants to purchase 3,565,000 shares of Common Stock at $0.75 per share. All warrants are exercisable for a period of five years.
Exchange Debentures
Also on December 12, 2006, we issued debentures (the “Exchange Debentures”) in the principal amount of approximately $1,597,397 in exchange for debentures issued to a group of 15 investors (the “Bridge Investors”) in April 2006 (the “Bridge Financing”). The Exchange Debentures are identical to the Debentures in all respects, except that the fixed conversion price of the Exchange Debentures is $0.375.
During the nine months ended February 29, 2008, the Company issued 816,054 shares of common stock in exchange for $306,020 (at face value) of the $1,597,000 Convertible Exchange Debentures and accrued interest thereon.
We also issued to the Bridge Investors Class A Warrants to purchase 4,259,726 shares of the Company’s common stock at $0.55 per share and Class B Warrants to purchase 2,129,863 shares of common stock at $0.75 per share. In addition, the Bridge Investors received five-year warrants (referred to in the securities purchase agreement as Exchange Bonus Warrants) to purchase an aggregate of 1,064,932 shares of common stock of the Company at $0.375 per share. Other than the exercise price, the Exchange Bonus Warrants are identical to the Class A Warrants and the Class B Warrants.
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Waiver Agreement
As discussed in "Debentures" above, accrued interest due through May 31, 2007 and liquidated damages due through May 11, 2007, less certain amounts paid via issuance of common stock, was added to the principal outstanding under each investor’s Debenture during the quarter ended May 31, 2007. During the nine months ended February 29, 2008, the Company issued 16,217 shares of common stock in exchange for $8,048 of the capitalized interest and liquidated damages.
NEW CAPITAL RAISING
Under current operating plans and assumptions, management believes that projected cash flows from operations and current cash on hand may be insufficient to satisfy our anticipated cash requirements to bring Voyager to market as discussed below in "VOYAGER MOBILE TV PRODUCT LINE", and sustain operations during the next twelve months. To address the anticipated cash requirements, we are in the final stages of negotiating a purchase order and receivables funding credit line. It is expected that the prospective lender will require our debenture holders to subordinate their lien positions against the inventory and receivables to be used as collateral for the credit line. As of the date of this report, none of the debenture holders have been presented with these subordination documents and none have been executed. In the event that a majority of the debenture holders fails to ratify such subordination, the Company’s prospects for viability will be in serious jeopardy.
In addition to the purchase order and receivables funding line, we are formulating a plan to raise $2-$3 million in new capital. Although we have identified a seemingly clear path to additional operating capital, there can be no guarantee that we will succeed. Our failure to succeed in this pursuit would raise significant concerns on behalf of management as to the ongoing viability of the Company. If we fail to raise additional capital we may be forced to curtail our activities.
We currently plan to start shipping our first products during the quarter ending May 31, 2008, and have received customer purchase orders for Voyager supporting that forecast. We may not be able to start selling our products when planned or to forecast that we will become profitable from our other operations in the future. We have incurred net losses in each fiscal period since inception of our operations.
Our focus during the next twelve months is the finalization of a number of strategic alliances, the continuation of a public relations campaign and the rolling out of our products. We have engaged two public relations firms to generate unpaid broadcast news media coverage for our products. During July and August 2007, numerous interviews with our staff and stories about our ViveeÔ product and company were broadcast and published nationally. A partial archive of such publicity is visible on our website at www.ustelematics.com. We also expect to hire approximately six new employees who will operate our Vehicular Systems Integration Center and approximately ten employees to work in other areas.
From January 7-10, 2008 we displayed our product line at the 2008 International Consumer Electronics Show in Las Vegas (CES). As a result of this trade convention we have concluded as follows:
VOYAGER MOBILE TV PRODUCT LINE
Acceptance and uptake of Voyager into the wholesale distribution channels ("sell-in") for vehicular consumer electronics appears high. A great deal of positive news media coverage of Voyager was generated during CES; much of which is documented under the "About Us" link on our website at www.ustelematics.com.
"Sell-through" to end user consumers of Voyager is yet unknown and difficult to predict based solely on trade feedback. Regardless of sell-in, no product can succeed financially without sell-through at retail.
In order to complete the steps from sell-in to sell-through and determine factually whether or not the Voyager product line will become a financial success, we will be required to 1) commit significant sums of cash to build-out finished inventory goods and then 2) be prepared to rapidly build up a great deal more finished inventory in response to anticipated sell-through. Our cash on hand is not adequate for either of these two purposes.
VIVEE PRODUCT LINE
Our conclusion about Vivee after CES is that our energy and capital focus must be applied where it is most likely to produce the highest immediate return: the Voyager Mobile TV product line. Our going-forward strategy about Vivee is to abandon our plan to bundle it into our own hardware and instead license the software to makers of mobile phones, GPS mapping software and hardware. We believe that this strategy will not require additional capital resources.
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Off-Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
Critical Accounting Policies
The SEC has requested that all registrants include in their MD&A, a description of their most critical accounting policies, the judgments and uncertainties affecting the application of those policies, and the likelihood that materially different amounts would be reported under different conditions using different assumptions. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of the company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that the following accounting policies fit this definition:
Deferred Charges - Financing fees incurred in connection with the placement of the convertible notes have been deferred and are being amortized over the 24-month term of the notes. Financing fees incurred in connection with the SB-2 registration statement will be netted against the proceeds from the stock offered by the Company in the prospectus dated July 9, 2007.
Assets not Placed in Service - Assets not placed in service represents costs associated with designing and building the Company’s website. The Company’s website is still in development and therefore these assets are not being depreciated.
Income Taxes - Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to the difference in the basis of reporting development stage expenses for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The Company has recorded a valuation allowance against the deferred tax asset for the portion that may not be utilized in future periods.
Research and Development - The Company expenses the cost of research and development as incurred.
Financial Instruments - Financial instruments, as defined in Financial Accounting Standard No. 107, Disclosures about Fair Value of Financial Instruments (SFAS 107), consist of cash, evidence of ownership in an entity and contracts that both (i) impose on one entity a contractual obligation to deliver cash or another financial instrument to a second entity, or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (ii) conveys to that second entity a contractual right (a) to receive cash or another financial instrument from the first entity, or (b) to exchange other financial instruments on potentially favorable terms with the first entity. Accordingly, our financial instruments consist of cash and cash equivalents, certificate of deposit, accounts payable, accrued expenses, convertible notes payable and derivative financial instruments.
The Company carries cash and cash equivalents, certificate of deposit, accounts receivable, accounts payable and accrued expenses at historical costs; their respective estimated fair values approximate carrying values due to their current nature. The Company carries convertible notes payable at fair value based upon the present value of the estimated cash flows at market interest rates applicable to similar instruments.
Derivative financial instruments, as defined in Financial Accounting Standard No. 133, Accounting for Derivative Financial Instruments and Hedging Activities (SFAS 133), consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be freestanding or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. This standard amends the guidance in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Statement 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. Statement 155 is 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 Company adopted this SFAS on June 1, 2007 with no material effect on the financial statements.
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The Company generally does not use derivative financial instruments to hedge exposures to cash flow, market or foreign-currency risks. However, we have entered into certain other financial instruments and contracts, such as debt financing arrangements and freestanding warrants with features that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by SFAS 133, these instruments are required to be carried as derivative liabilities, at fair value, in the financial statements.
The Company estimates fair values of derivative financial instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective measuring of fair values. In selecting the appropriate technique, the Company considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. For less complex derivative instruments, such as freestanding warrants, the Company generally uses the Black-Scholes-Merton option valuation technique because it embodies all of the requisite assumptions (including trading volatility, estimated terms and risk-free rates) necessary to fair value these instruments. For complex derivative instruments, such as embedded conversion options, the Company generally uses the Flexible Monte Carlo valuation technique because it embodies all of the requisite assumptions (including credit risk, interest-rate risk and exercise/conversion behaviors) that are necessary to fair value these more complex instruments. For forward contracts that contingently require net-cash settlement as the principal means of settlement, the Company projects and discounts future cash flows applying probability-weightage to multiple possible outcomes. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s income will reflect the volatility in these estimate and assumption changes.
Recent Pronouncements
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets". This standard amends the guidance in SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". Among other requirements, SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations: (a) a transfer of the servicer’s financial assets that meets the requirements for sale accounting; (b) a transfer of the servicer’s financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities"; or (c) an acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. SFAS No. 156 did not have a material impact on the Company's financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. However, for some entities, the application of SFAS No. 157 will change current practice. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is permitted if the entity has not yet issued interim or annual financial statements for that fiscal year. The Company is currently evaluating the impact of SFAS No. 157 on its financial position, results of operations and cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, which provides companies with an option to report selected financial assets and liabilities at fair value. The standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. With certain limitations, early adoption is permitted. The Company is currently evaluating the impact of SFAS No. 159 on its financial position, results of operations and cash flows.
In June 2007, the FASB ratified the consensus in EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities” (EITF 07-3), which requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and amortized over the period that the goods are delivered or the related services are performed, subject to an assessment of recoverability. EITF 07-3 will be effective for fiscal years beginning after December 15, 2007. The Company does not expect that the adoption of EITF 07-3 will have a material impact on its financial position, results of operations or cash flows.
In June 2007, the Accounting Standards Executive Committee issued Statement of Position 07-1, “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (SOP 07-1). SOP 07-1 provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide Investment Companies (the “Audit Guide”). SOP 07-1 was originally determined to be effective for fiscal years beginning on or after December 15, 2007, however, on February 6, 2008, FASB issued a final Staff Position indefinitely deferring the effective date and prohibiting early adoption of SOP 07-1 while addressing implementation issues.
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In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51". SFAS No. 160 establishes accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. It also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. This statement is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company currently does not have any minority interest and therefore under our current structure, the adoption of SFAS No. 160 will have no effect on its financial position, results of operations or cash flows.
In December 2007, the FASB ratified the consensus in EITF Issue No. 07-1, “Accounting for Collaborative Arrangements” (EITF 07-1). EITF 07-1 defines collaborative arrangements and requires collaborators to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) the other collaborators based on other applicable authoritative accounting literature, and in the absence of other applicable authoritative literature, on a reasonable, rational and consistent accounting policy is to be elected. EITF 07-1 also provides for disclosures regarding the nature and purpose of the arrangement, the entity’s rights and obligations, the accounting policy for the arrangement and the income statement classification and amounts arising from the agreement. EITF 07-1 will be effective for fiscal years beginning after December 15, 2008, which will be the Company’s fiscal year 2009, and will be applied as a change in accounting principle retrospectively for all collaborative arrangements existing as of the effective date. The Company has currently is not party to any collaborative arrangements and therefore does not expect the adoption of EITF 07-1 to have any effect on its financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141R (revised 2007), "Business Combinations" which, among other things, establishes principles and requirements for how the acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired business, (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The Company is required to adopt SFAS No. 141R for all business combinations for which the acquisition date is on or after January 1, 2009. Earlier adoption is prohibited. This standard will change the Company’s accounting treatment for business combinations (if any are consummated) on a prospective basis.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133." This statement changes the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company has not yet determined the effect that the application of SFAS No. 161 will have on its financial position, results of operations or cash flows.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company’s present or future financial statements.
Management Information System
Our website is being built on top of NetSuite, an Oracle-based accounting system that also serves as a management information system (M.I.S.), enterprise requirements planning system, and customer relationship management system for all aspects of our business. We have hired one person who is dedicated to managing our M.I.S. NetSuite can be accessed online by our management and accountants at any time of day, from any internet access point in the world, and is protected by encrypted, password-controlled security measures.
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Internal Accounting & Financial Controls
We have hired temporary and permanent accounting staff to prepare our quarterly and year-end financial statements for presentation to our certified auditors, RBSM LLP. Our Chief Financial Officer is responsible for ensuring our accounting and financial controls are appropriate.
Implementation of Section 404 of the Sarbanes-Oxley Act of 2002 on a Timely Basis
The SEC, as directed by Section 404 of the Sarbanes-Oxley Act, adopted rules generally requiring each public company to include a report of management on the Company's internal controls over financial reporting in its annual report on Form 10-KSB that contains an assessment by management of the effectiveness of the Company's internal controls over financial reporting. This requirement will first apply to our annual report on Form 10-KSB for the fiscal year ending May 31, 2008. Under current rules, commencing with our annual report for the fiscal year ending May 31, 2009 our independent registered accounting firm must attest to and report on management's assessment of the effectiveness of our internal controls over financial reporting.
We have not yet developed a Section 404 implementation plan. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. How companies should be implementing these new requirements including internal control reforms to comply with Section 404's requirements and how independent auditors will apply these requirements and test companies' internal controls, is still reasonably uncertain.
We expect that we will need to hire and/or engage additional personnel and incur incremental costs in order to complete the work required by Section 404. We may not be able to complete a Section 404 plan on a timely basis. Additionally, upon completion of a Section 404 plan, we may not be able to conclude that our internal controls are effective, or in the event that we conclude that our internal controls are effective, our independent accountants may disagree with our assessment and may issue a report that is qualified. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.
Product & Technology Evolution Since Inception
Since the Company was organized in August 2005, a number of significant technological and cost advancements have occurred, both inside and outside of the Company. These involve two distinct areas: 1) The technical protocol for the delivery of Mobile Digital TV content within our products; and 2) The emergence and importance of our Vivee™ Unified Wireless Messaging products and services. Following is an analysis of this evolution:
Technical Protocol for Mobile Digital TV Content Delivery
USTelematics was founded on the advancements made by our founders in lowering the cost and raising the reliability of receiving DBS satellite TV signals into moving vehicles. The original VoyagerOTR (Over-the-Road, or “VOTR”) product performs very well during open road traveling and has always been limited during travel in urban areas due to obstructions in the line-of-sight to satellites, including buildings, bridges and dense trees. VoyagerOTR employs essentially the same analog-to-analog or analog-to-digital delivery protocols as used in conventional home television programming content delivery.
As VoyagerOTR was developed and tested, it became apparent to us that the majority of families with children - our target market - reside in urban and close-in suburban areas of the United States. This means that we needed a solution to the limitations of VoyagerOTR within such areas.
As a response to this need, we developed VoyagerME (MetroEdition) or VME. VME is a Mobile Internet Protocol Television (or Mobile IPTV) platform, which is significantly smaller, less expensive to manufacture, own and install than VOTR. It is 100% digital and utilizes wide area wireless Internet connectivity technology to receive streaming video and audio programs for display in automobile rear seats. VME also provides access to a plethora of online interactive games and programs for children that are impossible to receive directly from DBS satellites as when using VoyagerOTR. VME also delivers a full web browsing experience for back seat occupants along with the capability of running any Windows-compatible software without limitation, including business programs like MS Office, Outlook, ViveeÔ Mail, normal email and GPS navigation.
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VME is much smaller than VOTR and is entirely contained (with the exception of an unobtrusive, optional outside antenna) within a housing the size of a commonly available automotive flipdown DVD player system. The VME housing is integrated with and includes a video monitor; whereas VOTR requires a separate monitor and supporting equipment adding several hundred dollars to the cost of ownership. VME also plays CDs and DVDs anywhere, including areas where EVDO coverage is unavailable. It can store 40 downloaded movies or more, along with thousands of downloaded songs.
We plan to offer certain VME models which act additionally as a wireless hotspot within moving vehicles. The benefits of such a rolling hotspot include providing front seat passengers with laptops or handhelds with continuous internet access and back seat passengers with access to online services like Microsoft’s Xbox Live.
VME takes advantage of current technology in wireless wide area Internet connectivity and is fully capable of adapting to emerging advancements. Presently VME connects to the Internet through Verizon Wireless’ Third Generation (3G) Broadband EVDO service. We have a contract with Verizon Wireless to receive significant commissions or “bounties” for every new subscriber that we connect to Verizon’s network while activating our product.
We consider EVDO to be a transitional connectivity technology. Average EVDO Revision A data transfer rates under normal conditions range from 200-300kb per second. Video streamed at this rate equals or exceeds the resolution (or picture fidelity) of Sirius’ 3 channels of rear seat TV being marketed now in certain Chrysler Corporation vehicles. Most importantly, EVDO service is at this writing propagated in more than 200 markets in the United States and Canada.
Emerging at a very rapid pace is WiMax technology, with infrastructure now being built-out throughout North America by Sprint/Nextel and also ClearWire. According to a press release issued by Sprint/Nextel [see http://www2.sprint.com/mr/news_dtl.do?id=17520], Sprint/Nextel and ClearWire in partnership “expect to build out network coverage to approximately 100 million people (in the U.S.) by the end of 2008”.
WiMax is similar to WiFi and widely available in homes, hotels, and airports- except the range is hundreds of times greater. We anticipate that within the next 12-24 months WiMax service will be available in at least as many markets as EVDO. The delivery speed of WiMax is truly broadband - at least the same or better than home DSL wired delivery; or 700-1500kb per second. This delivery speed is fast enough to stream full screen video into moving vehicles over large areas, in real time with quality as good or nearly as good as home television.
It is our belief that the advent of WiMax will render our original VoyagerOTR (VOTR) design and delivery protocol obsolete. VoyagerME however will be enhanced and made more useful and deliver much greater value as wide area wireless broadband services proliferate. For the later point when WiMax extinguishes the market for EVDO service, VoyagerME's architecture renders it fully compatible with WiMax connectivity devices. For these reasons, we plan to focus our effort, energy and resources on building and delivering VoyagerME in several different models with varying screen sizes and differing levels of optional features.
It is our belief that the buyer’s market for VME as it enters distribution is much larger and naturally presents fewer limitations than that for VOTR. Given our cash and other resources at this point, we cannot introduce and properly market three major products simultaneously. Accordingly, we plan to limit the first broad introduction from our Mobile TV product line to VME. As profits are retained, cash increases and our market capitalization increases, we will re-address marketing and distribution opportunities for VOTR.
VIVEE™ Unified Wireless Messaging Products & Services
ViveeÔ was originally conceived as merely a capability or service: the technical ability to receive email messages from a mobile device without distracting the driver. It has evolved into a series of software products and related services that safely unify and simplify mobile messaging, both for handheld devices and for hardware installed in automobiles.
ViveeÔ is a client/server system that uses the software installed onto mobile devices to communicate with the Vivee.com server at our headquarters facility. Our online service at Vivee.com works with any and all internet-connected devices, provided such devices contain our ViveeÔ application (client) software. We are developing ViveeÔ software for the widest possible variety of devices, not all of which can use identical client software.
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We have fully developed ViveeÔ for Windows XP, Windows Vista, and Windows Mobile for Pocket PC. These versions of the ViveeÔ software are fully commercialized and available for purchase by end users. We have prototyped a version of ViveeÔ for Windows Mobile SmartPhone Edition; which is similar but not identical to Windows Mobile for Pocket PC.
We are working on designs for ViveeÔ versions to be run under variations of Mobile Java, including Brew, J2me and others. Successful development of a future, planned Brew version of the ViveeÔ client software would theoretically broadly increase our market as it will address nearly all of the many consumer-oriented handsets which are not “smart” phones, but do have audio and video playing capabilities.
In response to requests from several wireless telecoms, we have prototyped a version of ViveeÔ that translates incoming messages from one language to another. Presently an English-to-Japanese prototype works in one direction (English-Japanese). We foresee significant revenue opportunities among enterprise-class customers for equipping their cross-border workforces with Multi-Lingual ViveeÔ phone handsets.
Item 3. Controls and Procedures.
As of February 29, 2008, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures in accordance with Exchange Act Rules 13a-15(e) and 15d - 15(e). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of that date our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. There was no change in our internal controls or in other factors that could affect these controls during our last fiscal quarter that has materially affected, or it is reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
As of the date this report was filed, we were not involved as litigants in any legal proceedings. We have however received an inquiry from a court regarding the assets of one of our shareholders.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None
Item 3. Defaults Upon Senior Securities.
We issued convertible notes with a face value of $5,162,397. We did not meet certain of our obligations under the documents relating to this issuance. These lapses include not timely paying interest and not timely issuing shares pursuant to elections to convert.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
31.1* | Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) | |
31.2* | Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) | |
32.1* | Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code | |
32.2* | Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code |
* Filed herewith.
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SIGNATURES
Pursuant to the requirements 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.
USTELEMATICS, INC. | ||
| | |
Date: April 21, 2008 | By: | /s/ Howard Leventhal |
Howard Leventhal | ||
Director, Chief Executive and Financial Officer |
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