**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


****


**Washington,
D.C. 20549**











**FORM
10-KSB**


****


**x**
    **ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934**





For the
fiscal year ended June 30, 2005





** ̈**
    **TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934**








For the
transition period from  to





Commission
File Number 0-021403





**VOXWARE,
INC.**


**(Name
of Small Business Issuer in its Charter)**





**Delaware**
    
    **36-3934824****(State
      or Other Jurisdiction of**
      **Incorporation
      or Organization)**
    
    **(I.R.S.
      Employer**
      **Identification
      No.)**





**Lawrenceville
Office Park**


**168
Franklin Corner Road**


**Lawrenceville,
NJ 08648**


**609-514-4100**


**(Address,
including zip code, and telephone number (including area code) of registrant’s
principal executive office)**





**Securities
registered pursuant to Section 12(b) of the Act:**





**NONE**





**Securities
registered pursuant to Section 12(g) of the Act:**





**COMMON
STOCK, $0.001 par value per share**





Check
whether the issuer: (1) 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  ̈





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





Indicate
by check mark whether registrant is a shell company (as defined in Rule 12b-2 of
the Securities Exchange Act of 1934). Yes  ̈ No x





The
revenues for the fiscal year ended June 30, 2005, the most recent fiscal year,
were $17,502,000.





The
aggregate market value of the common voting stock held by non-affiliates of the
Registrant was approximately $19,643,000 as of August 31, 2005, based upon the
closing sale price of the Common Stock as quoted on the NASDAQ OTC Bulletin
Board.





The
number of shares of the Registrant’s Common Stock outstanding as of August 31,
2005 is 936,277,855.





**DOCUMENTS
INCORPORATED BY REFERENCE**


Certain
information required by Part III of this Annual Report on Form 10-KSB will be
set forth in, and is incorporated by reference from the Registrant's Proxy
Statement for the 2005 Annual Meeting of Stockholders.














**VOXWARE,
INC.**
 **ANNUAL
REPORT ON FORM 10-KSB**
 
 **TABLE
OF CONTENTS**
  **PART I**
    
    3ITEM 1.
    BUSINESS
    3ITEM 2.
    PROPERTIES
    10ITEM 3.
    LEGAL
      PROCEEDINGS
    11ITEM 4.
    SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
    11**PART
      II**
    
    12ITEM 5.
    MARKET
      FOR THE REGISTRANTS'S COMMON EQUITY AND RELATED STOCKHOLDER
      MATTERS
    12ITEM 6.
    MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
      CONDITION
    13ITEM 7.
    FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
    21ITEM 8.
    CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
    22ITEM 8A.
    CONTROLS
      AND PROCEDURES
    22ITEM
      8B.
    OTHER
      INFORMATION
    23**PART
      III**
    
    **24**ITEM 9.
    DIRECTORS,
      EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
      SECTION 16(a) OF THE EXCHANGE ACT
    24ITEM 10.
    EXECUTIVE
      COMPENSATION
    24ITEM 11.
    SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
    24ITEM 12.
    CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS
    24ITEM 13.
    EXHIBITS
      AND FINANCIAL STATEMENTS
    24ITEM 14.
    PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
    27
  **INDEX TO CONSOLIDATED FINANCIAL
      STATEMENTS**
    F-1
 Report of Independent Registered Public
      Accounting Firm
    F-2Consolidated Balance Sheets as of June 30,
      2005 and 2004
    F-3Consolidated
      Statements of Operations for the years ended June 30, 2005 and
    2004
    F-4Consolidated
      Statements of Stockholders’ Equity (Deficit) for the years ended June 30,
      2005 and 2004
    F-5Consolidated Statements of Cash Flows for the
      years ended June 30, 2005 and 2004
    F-7Summary
      of Accounting Policies and Notes to Consolidated Financial
      Statements
    F-8
 ****














**PART
I**







This
Annual Report on Form 10-KSB contains forward-looking statements as defined in
the Private Securities Litigation Reform Act of 1995 and information relating to
us that are based on the beliefs of our management, as well as assumptions made
by and the information currently available to our management. When used in this
Annual Report, the words “estimate”, “project”, “believe”, “anticipate”,
“intend”, “expect” and similar expressions are intended to identify
forward-looking statements. These statements reflect our current views with
respect to future events and are subject to risks and uncertainties that could
cause actual results to differ materially from those contemplated in these
forward-looking statements, including those risks discussed in this Annual
Report. You are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Annual Report. Except for
special circumstances in which a duty to update arises when prior disclosure
becomes materially misleading in light of subsequent circumstances, we do not
intend to update any of these forward-looking statements to reflect events or
circumstances after the date of this Annual Report, or to reflect the occurrence
of unanticipated events. You should carefully review the risk factors set forth
herein and in other reports or documents we file from time to time with the
Securities and Exchange Commission (the “SEC”).




**ITEM 1.** **BUSINESS** **.**





**Overview**





We are a
leading provider of voice-based technology that optimizes the front line
logistics and distribution center workforce. Our primary product,
VoiceLogistics®, enables warehouse workers to perform a wide array of logistics
tasks such as picking, receiving, put away, replenishment and returns processing
more efficiently and effectively. VoiceLogistics also gives distribution center
management an effective tool for reducing logistics costs and optimizing complex
materials handling processes.





The
VoiceLogistics solution is a combination of software, hardware and professional
services. Enabled by our patented speech recognition VoiceXML TM web
browser technology, the VoiceLogistics solution creates a dynamic, real-time
link between highly mobile workers, the warehouse management system (WMS) and
supervisory personnel. We believe that our patented solution is unique in the
industry because it is the first web-based, people-centric, interactive speech
recognition application engineered specifically to operate in highly demanding
industrial environments.





We sell
VoiceLogistics primarily to large companies that operate warehouses and
distribution centers. We have customers from a variety of industry sectors,
including food service, grocery, retail, consumer packaged goods, automotive
parts, third party logistics providers and wholesale distribution. Our
technology has the ability to integrate easily (generally in less than 90 days)
with an external WMS. VoiceLogistics revenues are generated from product sales,
license fees, professional services and maintenance fees.





**Products
and Services**





The
VoiceLogistics product line is the primary focus of our operations. It targets
the mobile, front line workforce in modernized distribution centers, providing a
highly interactive means of utilizing the powers of hearing and speech to
optimize many logistics tasks.





The
VoiceLogistics solution includes software and hardware components, and generally
some professional services elements. The software component includes two
important Voxware proprietary software technologies that are installed on each
wearable computer. These technologies are comprised of our noise-robust Voxware
Integrated Speech Recognition Engine (VISE TM ),
designed specifically for high performance industrial environments, and our
patented Voice Extensible Markup Language (VoiceXML) voice browser, called
VoxBrowser TM , which
uses standard web technologies to enable application-level functionality on the
wearable computer.





The
VoiceLogistics solution also generally includes Voxware proprietary application
software that is installed on a server that communicates with a central WMS (or
system of record) and many special purpose wearable computers that are worn by
individual warehouse workers. Using a wireless LAN, VoiceLogistics directs the
workers by giving them tasks and verifying what they do. Our solution also
updates the central system and is capable of responding immediately to a wide
variety of situations that can develop as the work shift progresses. With
VoiceLogistics, we believe workers are generally more productive and accurate
than would otherwise be possible.





During
most of fiscal 2004, the VoiceLogistics wearable computer was the VLS-310. It is
a highly rugged device that has been successfully deployed to thousands of
warehouse workers in North America and Europe. At the end of fiscal 2004 we
introduced our current VoiceLogistics wearable computer, the VLS-410, a
proprietary system manufactured by us.





We
believe that the VLS-410 offers some of the best internal components of any
voice-only wearable computer for today’s industrial markets, including a fast
400 Mhz Intel Xscale processor and 128 MB of SDRAM and 64MB Flash memory. We are
working with major vendors of handheld wireless computers to also provide the
VoiceLogistics software components on their devices; a development that will
give customers an additional choice of hardware in the future, and will allow us
to expand our product line with new, multi-modal versions of VoiceLogistics,
which will work both via speech recognition and other modes, such as keyboard,
screen, or barcode scanning, as appropriate.





The
VoiceLogistics solution includes software and hardware components, and generally
some combination of professional services, extended maintenance and customer
support elements. We offer customers the option to retain us to provide
installation, implementation and training services, as well as other assistance
in tailoring our solution to meet specific requirements within their facilities.
We also offer customers the option to enter into extended warranties on
hardware, and annual software maintenance and customer support arrangements with
us.








- 3
-








We
purchase parts and electronics assemblies for our wearable computer products
from external vendors. We also have external vendors perform major
sub-assemblies where appropriate and cost efficient. We have one sole source
vendor for a critical component. Our employees perform final assembly and
testing. We also offer customers the opportunity to purchase accessories such as
headsets and computer hardware that we purchase from third party vendors for
resale.





**Sales
and Distribution**





We sell
directly to large companies in North America and Europe. We also utilize third
parties such as consultants, value added resellers (VARs), barcode equipment
manufacturers and vendors, and systems integrators to sell or assist us in
selling our products. To date, we have signed agreements with several third
party partners. We believe that the establishment of a network of third party
partners with extensive knowledge of specific market sectors is important to our
long-term success in those sectors.





In fiscal
2003, we acquired Voxware, n.v., which was a full-service office (sales,
marketing, professional services, support and finance) in Brugge, Belgium. We
further expanded our European presence with personnel additions in the United
Kingdom, France and Germany during fiscal 2003. Subsequently, we won initial
deals with new customers in a variety of European markets including the United
Kingdom, the Benelux region, France and Germany. At the end of fiscal 2004 we
decided to close our Belgium sales and support office and concentrate our
European efforts from an office in the United Kingdom.





While not
traditionally a major focus in the past, we have worked with third party
partners who purchase products from us at a discount and incorporate them into
application systems for various target markets and/or consult with us in the
development of application systems for end-users. These application systems
integrate our products with additional hardware and software components and
include service and product support. These partners then resell or lease the
application systems to end-user customers. Under these types of partnership
agreements, we warrant to repair, replace or refund the purchase price of any
defective product delivered to a third party partner or their customer, provided
that we are notified of the defective product generally within 90 days from
delivery of the product to the end-user in the case of software and up to one
year in the case of hardware. We expect to expand our partnership channel not
only in North America, but also abroad, with particular emphasis on the
development of strategic relationships with barcode equipment manufacturers and
vendors, VARs, logistics consultants and WMS vendors. We believe that in the
industrial speech recognition market, strategic partnerships with these various
parties are critical to success.





Building
a network of third party partners such as those described above takes time and
requires different sales and marketing expertise than that required to build a
direct to end user software distribution channel, or an original equipment
manufacturer (OEM) relationship for technology. There can be no assurance that
we will be successful in developing strategic relationships with channel
partners, hardware vendors, VARs, logistics consultants, or WMS
vendors.





**Customers**





Our
customers include some of the largest and best-known companies in their
respective industries, including 7-Eleven, Argos Limited, Somerfield Stores, US
Foodservice, and 99 Cent Only Stores. We grew our customer base in fiscal 2004
and 2005 and are optimistic our increased momentum in key market sectors such as
retail, consumer packaged goods and food service will continue. For the year
ended June 30, 2005, US Foodservice accounted for approximately 36% of our total
revenues. There can be no assurance that this customer will continue to seek our
products and services at the same levels as they have in the past, or at
all.





Our
standard warranty policy generally allows customers or end-users to return
defective products for repair, replacement or refund of purchase price, provided
that we are notified of the defective product generally within 90 days from
delivery of the product to the end-user in the case of software and up to one
year in the case of hardware. Substantially all components, parts and
subassemblies





- 4
-








purchased by Voxware are covered by manufacturer
warranties for periods ranging from 30 days to one year from date of purchase by
us.





**Competition**





We
encounter competition from two primary sources. We experience direct competition
from companies offering similar voice-based solutions. Additionally, our
solution competes with technologies that may be considered an alternative to
voice-based solutions.





The
VoiceLogistics solution integrates hardware, software and service components.
There are several alternative providers against whom we compete to market some
or all of those components. The major competitor offering a similar solution is
Vocollect, Inc. Vocollect, Inc. markets a wearable voice-based computer and
complementary software. Vocollect also indirectly sells voice-based systems
within the logistics and distribution market to resellers who also compete
against us. In addition to Vocollect, Inc. and their resellers, there are other
vendors who promote similar solutions, including Lucas Systems, Inc, FKI
Logistex, a subsidiary of FKI PLC, and SAE Systems. In July 2005, FKI Logistex
became an OEM reseller for us.





In each
application area, there exist alternatives to voice-based solutions. Barcode
scanning devices, for example, represent a competitive alternative to
voice-based products in certain warehouse picking applications. Thus, barcode
product companies such as Symbol Technologies, Inc., Intermec Technologies
Corporation (a subsidiary of UNOVA, Inc.), LXE Inc. (a wholly-owned subsidiary
of Electromagnetic Sciences, Inc.), and Psion Teklogix, can be considered
competitors in the logistics and fulfillment marketplace. However, while these
barcode product companies can sometimes be competitors to us, we also have begun
working on formalizing relationships with several of these companies to provide
potential customers with complementary joint product offerings to best meet
their specific needs. Likewise, in the package sorting and remittance processing
segments, keyboards are the most prevalent alternative along with an increasing
use of barcode scanning. Inspection, receiving, and inventory applications use
keyboards as well, but often pen and paper comprise the primary alternative
method in those cases. Many warehouse applications have access to more
technologically sophisticated alternatives, but few have implemented them. These
same barcode product companies are also modifying, or expected to modify, their
products to include “voice” capabilities, which will compete with our
hardware sales.





**Sale
of Speech Coding Business**





Prior to
our acquisition of the assets of Verbex Voice Systems, Inc. (Verbex) on February
18, 1999, we developed, marketed, licensed and supported digital speech and
audio technologies, solutions and applications. On September 21, 1999, our
stockholders approved the sale of substantially all of the assets of our speech
coding business to Ascend Communications, Inc. The sale to Ascend did not
include our rights and obligations under our then existing speech coding license
agreements. As part of the sale, we received a license from Ascend to use the
speech coding technologies necessary to service those existing licensees. With
the consent of Ascend, we may also license the speech coding technologies to new
licensees for uses that are not competitive with Ascend. Our revenue from
licensing speech coding technologies and audio compression technologies
represented 2% and 3% of total revenue in the years June 30, 2005 and 2004,
respectively. While we may continue to take advantage of favorable opportunities
to license our speech coding technologies in the future, we do not anticipate
dedicating resources to the development, marketing or licensing of our speech
coding technologies to potential new licensees.





**Patents
and Proprietary Information**





VoiceLogistics
is based on our VISE speech engine, which is a continuous speech recognizer, and
highly noise-tolerant. We believe it is the first speech recognizer to be
engineered specifically for use in highly demanding industrial environments.
VoiceLogistics and all of our other voice-based products sold to industrial
customers are based on VISE technology.





Our
proprietary VLS-410 wearable computer incorporates an embedded version of our
VISE speech recognition engine with a standards based interface that allows for
interfaces with a wide variety of WMS packages. This embedded engine is also
suitable for applications such as handheld, portable or mobile devices, and
other applications, which may benefit from a noise robust speech interface, and
employ some type of processing capability. Our VoiceLogistics solution also
employs our patented invention of systems and methods for using standard
Internet protocols in conjunction with VoiceXML web pages to remotely program
portable voice devices, such as our VoiceLogistics computer, that direct and
guide users through defined tasks and work. The United States Patent and
Trademark Office notified us that our application for patent protection of this
invention (Patent #6662163) was approved on December 9, 2003.





We
believe that owning and developing our core technologies represents a
significant strategic and competitive advantage for us. We have recently filed a patent application for
our VoiceLogistics wireless handheld unit, which incorporates applications of
some of our other patented technologies as well. We expect to routinely file
patent applications as deemed appropriate. Our success will depend in








- 5
-








part on
our ability to obtain patent protection for our products, preserve our trade
secrets and operate without infringing the proprietary rights of other parties.





The
software market has traditionally experienced widespread unauthorized
reproduction of products in violation of manufacturers intellectual property
rights. Such activity is difficult to detect and legal proceedings to enforce
the manufacturers intellectual property rights are often burdensome and involve
a high degree of uncertainty and costs.





Our
success is also dependent upon unpatented trade secrets, which are difficult to
protect. To help protect our rights, we require employees and consultants to
enter into confidentiality agreements that prohibit disclosure of our
proprietary information and require the assignment to us of their ideas,
developments, discoveries and inventions. We cannot assure you, however, that
these agreements will provide adequate protection for our trade secrets,
know-how, or other proprietary information in the event of any unauthorized use
or disclosures.





**Employees**





As of
June 30, 2005, we had 88 full-time employees and consultants, consisting of 42
in cost of goods sold (which includes professional services, customer support
and manufacturing), 20 in research and development, 15 in sales and marketing
and 11 in general and administrative. Fifty-two of our employees are located at
our Cambridge, Massachusetts facility, 22 are located at our corporate offices
in Lawrenceville, New Jersey, 5 work with our sales and customer support office
in the United Kingdom and 9 work elsewhere. None of our employees is represented
by a labor union or is subject to a collective bargaining agreement. We believe
we have good relations with our employees.





**Corporate
Information**





We were
incorporated on August 20, 1993. Our headquarters is located at Lawrenceville
Office Park, 168 Franklin Corner Road, Lawrenceville, NJ 08648. Our telephone
number is (609) 514-4100.





We file
annual, quarterly and current reports, proxy statements and other documents with
the SEC, under the Securities Exchange Act of 1934, as amended (the
“ Exchange
Act ”). You
may read and copy any materials that we file with the SEC at the SEC’s Public
Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 and at 233
Broadway, 16th Floor, New York, New York 10279. You may obtain information on
the operation of the Public Reference Room by calling the SEC at +1 800
SEC-0330. Our reports, proxy statements and other documents filed electronically
with the SEC are available at the website maintained by the SEC at http://www.sec.gov . In
addition, we also make available free of charge on or through our Internet
website, http://www.voxware.com , our
annual, quarterly and current reports, and, if applicable, amendments to those
reports, filed or furnished pursuant to Section 13(a) of the Exchange Act, as
soon as reasonably practicable after we electronically file such reports with
the SEC. Copies of our SEC filings may also be obtained by calling our main
number and asking for investor relations or emailing: ir@voxware.com .
Information on our website is not a part of this report.





**Risk
Factors**





We
operate in a rapidly changing business environment that involves substantial
risk and uncertainty. The following discussion addresses some of the risks and
uncertainties that could cause, or contribute to causing, actual results to
differ materially from expectations. We caution all readers to pay particular
attention to the descriptions of risks and uncertainties described below and in
other sections of this report and our other filings with the Securities and
Exchange Commission.





If any of
the following risks actually occur, our business, financial condition or results
of operations could be materially adversely affected. In such case, the trading
price of our Common Stock could decline and we may be forced to consider
additional alternatives.





This
Annual Report on Form 10-KSB contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors,
including the risks described below and elsewhere in this Annual Report on Form
10-KSB.





**Risks
Relating to Our Business and Operations**





**If
we continue to incur operating losses, we may be unable to continue our
operations.** We have
incurred operating losses since we started our company in August 1993. During
fiscal 2005, the net loss of $760,000 contributed to an accumulated deficit of
$66,626,000 as of June 30, 2005. If we continue to incur operating losses and
fail consistently to be a profitable company, we may be unable to continue our
operations. In addition, given the funding raised in the August 2005 private
placement, we plan to increase spending in research and development along with
sales and marketing at levels higher than in the recent past and possibly








- 6
-








disproportionate
to revenue thus incurring net losses in the near term. Our future profitability
depends on our ability to obtain significant customers for our products, to
respond to competition, to introduce new and enhanced products, and to
successfully market and support our products. We cannot assure you that we will
achieve or sustain significant sales or profitability in the future.





**If
we cannot raise adequate capital in the future, we may be unable to continue our
product development, marketing and business generally.** In the
future, we may need to raise additional capital to fund operations, including
product development and marketing. Funding from any source may not be available
when needed or on favorable terms. If we cannot raise adequate funds to satisfy
our capital requirements, we may have to limit, delay, scale-back or eliminate
product development programs, marketing or other activities. We might be forced
to sell or license our technologies. Any of these actions might harm our
business. If additional financing is obtained, the financing may be dilutive to
our current stockholders.





**We
rely substantially on key customers.** Our
customer base is highly concentrated. For the year ended June 30, 2005, one
customer accounted for 36% of our total revenues. We believe that a substantial
portion of our net sales will continue to be derived from a concentrated group
of customers. However, the volume of sales to a specific customer is likely to
vary from period to period and a significant customer in one period may not
purchase our products in a subsequent period. In general, there are no ongoing
written commitments by customers to purchase our products. Our net sales in any
period generally have been, and likely will continue to be, in the near term,
derived from a relatively small number of sales transactions. Therefore, the
loss of one or more major customers could have a material adverse affect on our
results of operations.





**We
have a sole source vendor for a critical hardware component** . One of
our vendors provides a key component for our wearable computer hardware. Any
disruption in supply by this vendor would prohibit us from shipping product and
thus recognizing revenue. In addition, other vendors provide custom-made
components that would take time to reproduce with other suppliers should a
current vendor fail to deliver quality product in a timely manner.





**If
our VoiceLogistics family of products is not successful in the market, we will
not be able to generate substantial revenues or achieve sustained
profitability.** Our
success is substantially dependent on the success of our VoiceLogistics family
of products. If the market accepts our VoiceLogistics products, these products
will account for the vast majority of our net revenue in the future. If our
VoiceLogistics products are unsatisfactory, or if we are unable to generate
significant demand for these products, or we fail to develop other significant
products, our business will be materially and adversely affected.





**If
we do not develop or acquire and introduce new and enhanced products on a timely
basis, our products may be rendered obsolete.** The
markets for our speech recognition products and voice-based technologies are
characterized by rapidly changing technology. The introduction of products by
others based on new or more advanced technologies could render our products
obsolete and unmarketable. Therefore, our ability to build on our existing
technologies and products to develop and introduce new and enhanced products in
a cost effective and timely manner will be a critical factor in our ability to
grow and compete. We cannot assure you that we will develop new or enhanced
products successfully and in a timely manner. Further, we cannot assure you that
the market will accept new or enhanced products. Our failure to develop new or
enhanced products, including our failure to develop or acquire the technology
necessary to do so, would have a material adverse effect on our business.





**If
our competitors introduce better or cheaper products, our products may not be
profitable to sell or to continue to develop.** The
business in which we engage is highly competitive. Advances in technology,
product improvements and new product introductions, as well as marketing and
distribution capabilities, and price competition influence success. Failure to
keep pace with product and technological advances could adversely affect our
competitive position and prospects for growth. Our products compete with those
being offered by larger, traditional computer industry participants who have
substantially greater financial, technical, marketing and manufacturing
resources than us. We cannot assure you that we will be able to compete
successfully against these competitors or that competitive pressures faced by us
would not adversely affect our business or operating results.





**If
we cannot integrate our speech recognition products with other components of
customer systems, we may not be able to sell our products.** Although
state-of-the-art speech recognition technology is important to generating sales
in our target markets, other components of a voice-based system are also
necessary. Our products must be easily integrated with customers’ asset
management and information systems. The ability to incorporate speech
recognition products into customers’ systems quickly and without excessive cost
or disruption will be a key factor in our success. We do not now possess all the
necessary components for system integration. Acquisitions, joint ventures or
other strategic relationships may be required for us to develop or obtain access
to the necessary components to achieve market penetration. We cannot assure you
that our efforts will be successful and, to the extent we are unsuccessful, our
business may be materially adversely affected.





**There
are a number of factors which may cause substantial variability in our quarterly
operating results.** Our
revenue, gross profit, operating income or loss and net income or loss may vary
substantially from quarter-to-quarter due to a number of factors.








- 7
-








Many
factors, some of which are not within our control, may contribute to
fluctuations in operating results. These factors include, but are not limited
to, the following:





• market
acceptance of our products;


• timing
and levels of purchases by customers;


• interruption
and delays in production caused by vendor delays;


• new
product and service introductions by our competitors or us;


• market
factors affecting the availability or costs of qualified technical personnel;


• timing
and customer acceptance of our new product and service offerings;


• length of
sales cycle; and


• industry
and general economic conditions.





We cannot
assure you that any of these factors will not substantially influence our
quarterly operating results.





**If
our third-party partners do not effectively market and service our products, we
may not generate significant revenues or profits from sales of our
products.** We
expect to utilize third parties, such as hardware system vendors, consultants,
value added resellers, and system integrators, to sell and/or assist us in
selling our products. To date, we have signed agreements with several of these
third-party partners. We believe that the establishment of a network of
third-party partners with extensive and specific knowledge of the various
applications critical in the industrial market is important for us to succeed in
that market. Some third-party partners also purchase products from us at a
discount and incorporate them into application systems for various target
markets and/or consult us in the development of application systems for end
users. For the foreseeable future, we may sell fewer products if we cannot
attract and retain third-party partners to sell and service our products
effectively and that provide timely and cost-effective customer support. An
increasing number of companies compete for access to the types of partners we
use. Either party generally may terminate our current arrangements with
third-party partners at any time upon 30 days prior written notice. We cannot
assure you that our partners will continue to purchase and re-sell our products
or provide us with adequate levels of support. If our partner relationships are
terminated or otherwise disrupted our operating performance and financial
results may be adversely affected.





**If
we cannot attract and retain management and other personnel with experience in
the areas of our business focus, we will not be able to manage and grow our
business.** We have
been developing and selling our speech recognition products and voice-based
technologies since February 1999. Since that time, we have been hiring personnel
with skills and experience relevant to the development and sale of these
products and technologies. If we cannot continue to hire such personnel and to
retain any personnel hired, our ability to operate our business will be
materially adversely affected. Competition for qualified personnel is intense
and we cannot assure you that we will be able to attract, assimilate or retain
qualified personnel.





**If
we cannot protect our proprietary rights and trade secrets, or if we are found
to be infringing on the patents and proprietary rights of others, our business
would be substantially harmed.** Our
success depends in part on our ability to protect the proprietary nature of our
products, preserve our trade secrets and operate without infringing the
proprietary rights of others. If others obtain and copy our technology or others
claim that we are making unauthorized use of their proprietary technology, we
may get involved in lengthy and costly disputes to resolve questions of
ownership of the technology. If we are found to be infringing on the proprietary
rights of others, we could be required to seek licenses to use necessary
technology. We cannot assure you that licenses of third-party patents or
proprietary rights would be made available to us on acceptable terms, if at all.
In addition, the laws of certain countries may not protect our intellectual
property because the laws of some foreign countries do not protect proprietary
rights to the same extent as the laws of the United States, and many companies
have encountered significant problems and costs in protecting their proprietary
rights in these foreign countries. To protect our proprietary rights, we seek
patents and we enter into confidentiality agreements with our employees and
consultants with respect to proprietary rights and unpatented trade secrets. We
cannot assure you those patent applications in which we hold rights will result
in the issuance of patents. We cannot assure you that any issued patents will
provide significant protection for our technology and products. In addition, we
cannot assure you that others will not independently develop competing
technologies that are not covered by our patents. We cannot assure you that
confidentiality agreements will provide adequate protection for our trade
secrets, know-how, or other proprietary information in the event of any
unauthorized use or disclosures. Any unauthorized disclosure and use of our
proprietary technology could have a material adverse effect on our business.





**Risks
Relating to Our Securities**





**The
price of our Common Stock has been highly volatile due to factors that will
continue to affect the price of our stock.** Our
Common Stock closed as high as $0.095 and as low as $0.030 per share between
July 1, 2004 and June 30, 2005. Historically, the over-the-counter markets for
securities such as our Common Stock have experienced extreme price fluctuations.
Some of the factors leading to this volatility include:








- 8
-





•
    fluctuations
      in our quarterly revenue and operating results;


•
    announcements
      of product releases by us or our competitors;


•
    announcements
      of acquisitions and/or partnerships by us or our competitors;
 •           
increases in outstanding shares of Common Stock upon exercise or conversion of
derivative securities and the issuances of Common Stock pursuant to our
 private placement transactions; and


• delays in
producing finished goods inventory for shipment.





There is
no assurance that the price of our stock will not continue to be volatile in the
future.





**Future
sales of our Common Stock in the public market could adversely affect the price
of our Common Stock.** Sales of
substantial amounts of our Common Stock in the public market that are not
currently freely tradable, or even the potential for such sales, could impair
the ability of our stockholders to recoup their investment or make a profit. As
of August 31, 2005, these shares include:





•
    approximately
      36,445,677 shares of our Common Stock owned by our executive officers and
      directors;


•
    approximately
      302,147,182 shares of our Common Stock issuable to warrant holders and
      option holders, which may be sold under various prospectuses filedunder the
      Securities Act of 1933, as amended, or the Securities
Act.





The sale
of substantial amounts of our Common Stock by certain affiliates, including our
largest stockholders, or the sale of substantial amounts of our Common Stock
received through the exercise of outstanding options and/or warrants, or the
perception of such sales, may have a material adverse effect on our stock
price.





If the
holders of the warrants and options to purchase our Common Stock elect to have
their collective holdings assumed by a potential acquirer of us, the potential
acquirer could be deterred from completing an acquisition of us. Also, if the
holders of the warrants and options to purchase our Common Stock elect to have
their holdings remain outstanding after an acquisition of us, the potential
acquirer could be deterred from completing an acquisition of us.





**Our
management and other affiliates have significant control of our Common Stock and
could control our actions in a manner that conflicts with our interests and the
interests of other stockholders.** As of
August 31, 2005, our executive officers, directors and affiliated entities
together beneficially own approximately 764,238,877 shares of our Common Stock,
assuming the exercise of options, warrants and other Common Stock equivalents
which are currently exercisable, held by these stockholders. As a result, these
stockholders, acting together, will be able to exercise considerable influence
over matters requiring approval by our stockholders, including the election of
directors, and may not always act in the best interests of other stockholders.
Such a concentration of ownership may have the effect of delaying or preventing
a change in our control, including transactions in which our stockholders might
otherwise receive a premium for their shares over then current market prices.





**Our
Common Stock is considered “a penny stock” and may be difficult to sell.** The SEC
has adopted regulations which generally define “penny stock” to be an equity
security that has a market price of less than $5.00 per share or an exercise
price of less than $5.00 per share, subject to specific exemptions. Presently,
the market price of our Common Stock is substantially less than $5.00 per share
and therefore is designated as a “penny stock” according to SEC rules. This
designation requires any broker or dealer selling these securities to disclose
certain information concerning the transaction, obtain a written agreement from
the purchaser and determine that the purchaser is reasonably suitable to
purchase the securities. These rules may restrict the ability of brokers or
dealers to sell our Common Stock and may affect the ability of investors to sell
their shares. In addition, since our Common Stock is traded on the OTC Bulletin
Board, investors may find it difficult to obtain accurate quotations of our
Common Stock.





**Risks
Relating to Accounting Rules and Internal Controls**





**Changes
in, or interpretations of, accounting rules and regulations, such as expensing
of stock options, could result in unfavorable accounting
charges.**





We
prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America. These principles
are subject to interpretation by the SEC and various bodies formed to interpret
and create appropriate accounting policies. A change in these policies can have
a significant effect on our reported results and may even retroactively affect
previously reported transactions. Our accounting policies that recently have
been or may be affected by changes in the accounting rules are as
follows:





·
    revenue
      recognition;


·
    accounting
      for share-based payments; and


·
    accounting
      for income taxes.






- 9
-





In
particular, the FASB recently enacted SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R") which we will adopt effective in the third quarter of
fiscal 2006. As a result, we expect that SFAS 123R will have a significant
adverse effect on our reported financial results and may impact the way in which
we conduct our business, which may affect our stock price.





**Our
auditors determined that there was a material weakness in our internal controls
over financial reporting during fiscal 2004 and we only recently were able to
conclude that our disclosure controls were effective.** In
connection with their audit of our financial statements for the fiscal year
ended June 30, 2004, our independent registered public accountants reported a
material weakness in our internal controls over financial reporting. A material
weakness is a reportable condition in which the design or operation of one or
more internal control components does not reduce to a relatively low level the
risk that misstatements caused by error or fraud, in amounts that would be
material in relation to the financial statements being audited, may occur and
not be detected within a timely period by employees in the normal course of
performing their assigned functions.





The
material weakness reported for fiscal year 2004 related to the fact that we did
not have sufficient competent accounting personnel that resulted in deficiencies
in processes relating to account analyses and reconciliations, including lack of
timely management review. For example, the lack of timely management review
contributed to a restatement of our Form 10-K for the year ended June 30, 2003
and the restatements of our Form 10-Qs for the quarters ended September 30, 2003
and December 31, 2003. In addition, these issues contributed to our need to file
an extension of time to file our Form 10-K for the year ended June 30, 2004. Our
auditors advised us that they consider these matters to be “material weaknesses”
that, by themselves or in combination, result in a more than remote likelihood
that a material misstatement in our financial statements will not be prevented
or detected by our employees in the normal course of performing their assigned
functions.





We have
taken steps to improve the controls in this area. For example, we consolidated
our financial reporting functions and hired a new Chief Financial Officer in
June 2004, a new Controller in December 2004, a new Accounting Manager in
January 2005, and other accounting personnel to oversee internal controls for
financial reporting. The implementation of this process began during the fourth
quarter of fiscal 2004 and was completed during the fourth quarter of fiscal
2005. We do not believe that the costs associated with consolidating the
reporting process and the hiring of the new personnel had a material adverse
effect on our financial condition because these employees replaced former
employees and consultants performing similar functions. However, despite these
steps and our conclusion that our controls were effective as of June 30, 2005,
we may experience reportable conditions and material weaknesses in the future,
which, if not remediated, may render us unable to detect in a timely manner
misstatements that could occur in our financial statements in amounts that may
be material.




**ITEM 2.** **PROPERTIES** **.**




Effective
July 1, 2000, we entered into a lease for our headquarters facility, which
contains approximately 4,000 square feet of office space in Lawrenceville, New
Jersey. The initial term of this lease expired on June 30, 2003. This lease has
been extended and will expire on March 31, 2006. On July 27, 2005, the lease was
amended to include an additional 1,350 square feet. Payments under this lease
consist of a base rent of $19.00 per square foot to December 31, 2004, $19.76
per square foot from January 1, 2005 to November 30, 2005, and $20.29 per square
foot from December 1, 2005 to March 31, 2006. Beginning in 2005, the lease
requires us to pay for escalations for property operating expenses, property
taxes and other items.





Our
principal facility, which is located in Cambridge, Massachusetts, contains
approximately 9,500 square feet of office space. We lease this space for
research and development, customer support, professional services, product
marketing, product engineering, and final assembly and testing. Total payments
under this lease consist of a base rent of $27.00 per square foot, an
electricity charge of $1.50 per square foot, and an expense charge of 14.9% of
the landlord’s building expenses. On October 1, 2003, the base rent was reduced
to $20.00 per square foot. The existing term for the lease of this office space
will expire on June 30, 2007.





In June
2004, we leased approximately 400 square feet in Reading, England. This facility
serves as a sales and service office for our customers based in the United
Kingdom. The initial lease term expired in June 2005, but renews automatically
in three-month increments until terminated in writing. We are obligated to pay
minimum lease payments of approximately £2,250 per month, plus a pro rata share
of operating expenses for the building.





Our
European facility, which was located in Brugge, Belgium, contained approximately
4,000 square feet of office space. We leased this space for customer support,
professional services, product marketing and sales. Total payments under this
lease consisted of a base rent of $4.00 per square foot, plus escalations for
property operating expenses, property taxes and other items. This office was
closed at the end of June 2004.





We expect
to lease additional space to meet our growing needs during the fiscal year
ending June 30, 2006.






- 10
-




**ITEM 3.** **LEGAL
PROCEEDINGS** **.**




We are
subject to various legal proceedings and claims, either asserted or unasserted,
which arise in the ordinary course of business. While the outcome of these
claims cannot be predicted with certainty, we do not believe that the outcome of
any of these legal matters will have a material adverse effect on our business,
operating results or financial condition.




**ITEM 4.** **SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS** **.**




Not
applicable.












- 11
-










**PART
II** ****






**ITEM 5.** **MARKET
FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS** **.**





**Market
Information**





Since
March 1, 2001, our Common Stock has traded on the Nasdaq OTC Bulletin Board
under the symbol VOXW.ob. The following table sets forth the high and low sale
prices per share as quoted on the Nasdaq OTC Bulletin Board for our two most
recent fiscal years:





**High**
    
    
    **Low**Fiscal
      Year Ended June 30, 2004:Quarter
      ended September 30, 2003
    
    $
    0.225
    
    $
    0.065Quarter
      ended December 31, 2003
    
    $
    0.185
    
    $
    0.090Quarter
      ended March 31, 2004
    
    $
    0.170
    
    $
    0.050Quarter
      ended June 30, 2004
    
    $
    0.060
    
    $
    0.035Fiscal
      Year Ended June 30, 2005:Quarter
      ended September 30, 2004
    
    $
    0.055
    
    $
    0.032Quarter
      ended December 31, 2004
    
    $
    0.095
    
    $
    0.030Quarter
      ended March 31, 2005
    
    $
    0.071
    
    $
    0.041Quarter
      ended June 30, 2005
    
    $
    0.065
    
    $
    0.033





As of
June 30, 2005, there were approximately 260 holders of record of our Common
Stock. We have never declared nor paid any cash dividends on our Common Stock.
We do not anticipate paying any cash dividends in the foreseeable
future .





**Securities
Authorized for Issuance Under Equity Compensation Plans**




The
following table provides information as of June 30, 2005 with respect to the
shares of our Common Stock that may be issued under our existing equity
compensation plans.
  Plan
      Category
    Number
      of
      Securities
      to be
      Issued
      Upon
      Exercise
      of
      Outstanding
      Options
    Weighted
      Average Exercise Price of Outstanding
      Options
    Number
      of Securities
      Available
      for Future
      Issuance
      Under
      Equity
      Compensation
      PlansEquity compensation plans that have been approved by
      security holders
    105,393,317
    $
      0.0291
    72,037,932
  There are
no equity compensation plans that have not been approved by security
holders.
  **Sale
of Unregistered Securities**





On August
11, 2005, the Company entered into a Common Stock Purchase Agreement with
certain accredited investors, pursuant to which the Company agreed to issue an
aggregate of up to 206,250,000 shares of its Common Stock, $0.001 par value per
share, in a private placement. On August 11, 2005, the Company issued and sold
an aggregate of 188,860,967 shares of Common Stock, and on August 22, 2005, the
private placement's second and final closing, the Company issued and sold an
additional 17,389,030 shares of Common Stock. A total of 206,249,997 shares of
Common Stock were issued through the August 2005 private placement. In
connection with the private placement, the holders of a majority of the
Company's Series D Preferred Stock agreed to convert all of the Company's
outstanding shares of Series D Preferred into shares of Common Stock. As a
result, 649,016,089 shares of Common Stock were
issued upon conversion all of the outstanding shares of Series D
Preferred Stock and 1,902,857 shares of Common Stock were issued in lieu of
paying cash dividends on the Series D Preferred Stock from July 1, 2005 to
August 11, 2005. Warrants to purchase 156,879,326 shares of Common Stock were
issued to the holders of warrants to purchase Series D Preferred Stock as a
result of the conversion of the Series D Preferred Stock.





The
Company did not employ an underwriter in connection with the issuance of the
securities described above. We believe that the issuance of the foregoing
securities was exempt from registration under Section 4(2) of the Securities Act
of 1933, as amended, as transactions not involving a public offering. Each of
the investors represented to us that it was an
accredited investor , **** acquired
the securities for investment purposes only and not with a view to distribution
and had adequate information about the Company.





**Purchase
of Equity Securities by the Small Business Issuer and Affiliated
Purchases**





None.






- 12
-







**ITEM 6.** **MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION** **.**





This
report contains forward-looking statements. Such statements are subject to
certain factors that may cause our plans to differ or results to vary from those
expected, including the risks associated with: our need to introduce new and
enhanced products and services in order to increase market penetration, and the
risk of obsolescence of its products and services due to technological change;
our need to attract and retain key management and other personnel with
experience in providing integrated voice-based solutions for e-logistics,
specializing in the supply chain sector; the potential for substantial
fluctuations in our results of operations; competition from others; our evolving
distribution strategy and dependence on its distribution channels; the potential
that voice-based products will not be widely accepted; and a variety of risks
set forth from time to time in our filings with the SEC. We undertake no
obligation to publicly release results of any of these forward-looking
statements that may be made to reflect events or circumstances after the date
hereof, or to reflect the occurrences of unexpected results.





**Overview**





We are a
leading provider of voice-based technology that optimizes the front line
logistics and distribution center workforce. Our primary product,
VoiceLogistics®, enables warehouse workers to perform a wide array of logistics
tasks such as picking, receiving, put away, replenishment and returns processing
more efficiently and effectively. VoiceLogistics also gives distribution center
management an effective tool for reducing logistics costs and optimizing complex
materials handling processes.





The
VoiceLogistics solution is a combination of software, hardware and professional
services. Enabled by our patented speech recognition VoiceXML TM web
browser technology, the VoiceLogistics solution creates a dynamic, real-time
link between highly mobile workers, the warehouse management system (WMS) and
supervisory personnel. We believe that our patented solution is unique in the
industry because it is the first web-based, people-centric, interactive speech
recognition application engineered specifically to operate in highly demanding
industrial environments.





We sell
VoiceLogistics primarily to large companies that operate warehouses and
distribution centers. We have customers from a variety of industry sectors,
including food service, grocery, retail, consumer packaged goods, automotive
parts, third party logistics providers and wholesale distribution. Our
technology has the ability to integrate easily (generally in less than 90 days)
with an external WMS. VoiceLogistics revenues are generated from product sales,
license fees, professional services and maintenance fees.





**Selected
Financial Data**





The
selected statement of operations data for the years ended June 30, 2005 and
2004, and the selected balance sheet data as of June 30, 2005 and 2004 have been
derived from our audited financial statements, which are included elsewhere in
this Annual Report on Form 10-KSB. The selected statements of operations data
for the fiscal years ended June 30, 2003, 2002 and 2001, and the balance sheet
data as of June 30, 2003, 2002 and 2001, have been derived from our audited
financial statements not included herein. The selected statement of operations
data set forth below should be read in conjunction with Management’s Discussion
and Analysis of Results of Operations and Financial Condition and the financial
statements and notes thereto included elsewhere in this Annual Report on Form
10-KSB.








- 13
-








**Year
      Ended June
      30,****2001**
    
    **2002**
    
    **2003**
    
    **2004**
    
    **2005**Statement
      of Operations Data:Total
      revenues
    
    $
    2,045
    
    $
    4,501
    
    $
    8,392
    
    $
    11,650
    
    $
    17,502Total
      cost of revenues
    
    $
    1,533
    
    $
    2,417
    
    $
    4,342
    
    $
    7,669
    
    $
    8,065Net
      loss applicable to commonstockholders
    
    $
    (19,234
    )
    $
    (53,917
    )
    $
    (7,644
    )
    $
    (10,326
    )
    $
    (1,456
    )Net
      loss per share applicable tocommon
      stockholders - basic anddiluted
    
    $
    (1.32
    )
    $
    (0.32
    )
    $
    (0.31
    )
    $
    (0.29
    )
    $
    (0.03
    )Weighted
      average number of sharesused
      in computing net loss percommon
      share-basic and diluted
    
    
    14,517
    
    
    18,575
    
    
    24,399
    
    
    35,312
    
    
    57,854**As
      of June 30,****2001**
    
    
    **2002**
    
    
    **2003**
    
    
    **2004**
    
    
    **2005**Balance
      Sheet Data:Cash,
      cash equivalents, cash held inattorney's
      escrow account, andshort
      term investments
    
    $
    578
    
    $
    6
    
    $
    4,247
    
    $
    1,124
    
    $
    3,639Working
      capital (deficit)
    
    $
    573
    
    $
    (327
    )
    $
    2,550
    
    $
    (1,942
    )
    $
    604Total
      assets
    
    $
    5,813
    
    $
    3,191
    
    $
    8,847
    
    $
    5,413
    
    $
    7,414Long-term
      debt
    
    $
    -
    
    $
    -
    
    $
    38
    
    $
    1,013
    
    $
    334Series
      A, B and C mandatorilyredeemable
      convertible preferredstock
    
    $
    3,193
    
    $
    4,342
    
    $
    -
    
    $
    -
    
    $
    -Stockholders'
      equity (deficit)
    
    $
    285
    
    $
    (3,559
    )
    $
    3,772
    
    $
    (2,241
    )
    $
    810





**Critical
Accounting Policies**





The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States of America
requires management to make judgments, assumptions and estimates that affect the
amounts reported in our consolidated financial statements and accompanying
notes. We base our estimates and judgments on historical experience and on
various other assumptions that we believe are reasonable under the
circumstances. However, future events are subject to change and the best
estimates and judgments routinely require adjustment. The amounts of assets and
liabilities reported in our balance sheets and the amounts of revenues and
expenses reported for each of our fiscal periods are affected by estimates and
assumptions which are used for, but not limited to, the accounting for allowance
for doubtful accounts, warranty costs, goodwill and intangible asset
impairments, restructurings, inventory and income taxes. Actual results could
differ from these estimates. The following critical accounting policies are
significantly affected by judgments, assumptions and estimates used in the
preparation of our consolidated financial statements.




Revenue
is recognized when earned in accordance with applicable accounting standards,
including AICPA Statement of Position (SOP) No. 97-2, “Software Revenue
Recognition,” as amended. SOP No. 81-1, “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts,” applies to the initial
site implementation for certain customers requiring significant customization to
our software. Revenues from product sales and license fees generally are
recognized upon shipment of hardware and applicable software, provided
collection is determined to be probable and there are no significant
post-delivery obligations. Revenues for implementation services are generally
recognized upon completion of the implementation. If an acceptance period is
required to ensure satisfactory delivery of customized software development or
implementation services, as typically occurs for the initial site implementation
for new customers, revenues are recognized upon customer acceptance.
Vendor-specific objective evidence of the fair value of hardware, services, and
most software is determined based upon the price of those elements when sold
separately. Vendor-specific objective evidence of the fair value of certain
software elements that are not sold separately is determined using the residual
method.







- 14
-





Deferred
revenue consists of unearned customer deposits and postcontract customer support
(“PCS”) arrangements. Customer deposits are recognized as revenue upon customer
acceptance of the underlying product and services in conjunction with the
recognition of deferred project costs. PCS arrangements include extended
hardware warranty, software maintenance revenues and depot management service
fees. These arrangements, which sometimes include amounts bundled with initial
revenues, are deferred upon invoicing and recognized as revenue over the term of
the warranty or service period, which is typically one year.





We
continue to generate royalty revenues from its speech coding technologies in the
form of royalties, periodic license renewal fees, and maintenance fees. Royalty
revenues are recognized at the time of the customer’s shipment of products
incorporating the our technology. Periodic license fees generally are recognized
at the inception of the renewal period, provided that persuasive evidence of an
arrangement exists, pricing is fixed or determinable, the payment is due within
one year, and collection of the resulting receivable is deemed probable.
Maintenance revenue, including the amounts bundled with initial or recurring
revenues, are recognized over the term of the maintenance support period, which
is typically one year.





The
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts and an assessment of international and economic
risk, as well as the aging of the accounts receivable. If there is a change in a
major customer’s credit worthiness or actual defaults differ from our historical
experience, our estimates of recoverability of amounts due us could be affected.





Research
and development expenditures are charged to operations as incurred. Pursuant to
Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the
Cost of Computer Software to be Sold, Leased or Otherwise Marketed, development
costs incurred in connection with the research and development of software
products and enhancements to existing software products are charged to expense
as incurred until technological feasibility has been established, at which time
such costs are capitalized until the product is available for general release to
customers. To date, the establishment of the technological feasibility of our
products and general release substantially coincided. As a result, costs we
incurred between completion of the working model and the point at which the
product is ready for general release have been insignificant and, therefore, we
have not capitalized any such costs.





We accrue
for warranty costs based on our assessment of expected repair cost per unit,
service policies and specific known issues. If we experience claims or
significant changes in costs of services, such as third party vendor charges,
materials or freight, which could be higher or lower than our historical
experience, our cost of revenues could be affected.





Under
SFAS No. 144, Accounting for the Disposal of Long-Lived Assets, intangible
assets are evaluated whenever events or changes in circumstances indicate that
the carrying value of the asset may be impaired. An impairment loss is
recognized for an intangible asset to the extent that the asset’s carrying value
exceeds its fair value, which is determined based upon the estimated future cash
flows expected to result from the use of the asset, including disposition. Cash
flow estimates used in evaluating for impairment represent management’s best
estimates using appropriate assumptions and projections at the time.





Inventory
purchases and purchase commitments are based upon forecasts of future demand. We
value our inventory at the lower of average cost or market. If we believe that
demand no longer allows us to sell our inventory above cost or at all, then we
write down that inventory to market or write-off excess inventory levels. If
customer demand subsequently differs from our forecasts, requirements for
inventory write-offs could differ from our estimates.





Our
deferred tax assets represent net operating loss carry-forwards and temporary
differences that will result in deductible amounts in future years if we have
taxable income. We have established a 100% valuation allowance against our net
deferred tax assets based on estimates and certain tax planning strategies. The
carrying value of our net deferred tax assets assumes that it is more likely
than not that we will not be able to utilize the benefit of these tax assets to
offset future taxable income in certain tax jurisdictions. If these estimates
and related assumptions change in the future, we may be required to adjust the
valuation allowance in future years.





Our key
accounting estimates and policies are reviewed with the Audit Committee of our
Board of Directors.





**Off-Balance
Sheet Arrangements**





We do not
have any material off-balance sheet arrangements.








- 15
-







**Results
of Operations**





**Fiscal
2005 Versus Fiscal 2004**




Year
      Ended June 30, 2005 and 2004Year
      ended
      June
      30, 2005
    
    %
      of Total Revenue
    
    Year
      ended
      June
      30, 2004
    
    %
      of Total Revenue
    
    $
      Change
    
    %
      ChangeProduct
      revenues
    
    $
    13,859
    
    
    79.2
    %
    $
    8,190
    
    
    70.3
    %
    $
    5,669
    
    
    69.2
    %Services
      revenues
    
    
    3,643
    
    
    20.8
    %
    
    3,460
    
    
    29.7
    %
    
    183
    
    
    5.3
    %Total
      revenues
    
    
    17,502
    
    
    100.0
    %
    
    11,650
    
    
    100.0
    %
    
    5,852
    
    
    50.2
    %Cost
      of product revenues
    
    
    4,380
    
    
    25.0
    %
    
    4,460
    
    
    38.3
    %
    
    (80
    )
    
    (1.8
    %)Cost
      of service revenues
    
    
    3,685
    
    
    21.1
    %
    
    3,174
    
    
    27.2
    %
    
    511
    
    
    16.1
    %Total
      cost of revenues
    
    
    8,065
    
    
    46.1
    %
    
    7,634
    
    
    65.5
    %
    
    431
    
    
    5.6
    %Gross
      profit
    
    
    9,437
    
    
    53.9
    %
    
    4,016
    
    
    34.5
    %
    
    5,421
    
    
    135.0
    %Research
      and development
    
    
    2,274
    
    
    13.0
    %
    
    1,974
    
    
    16.9
    %
    
    300
    
    
    15.2
    %Sales
      and marketing
    
    
    2,985
    
    
    17.1
    %
    
    3,554
    
    
    30.5
    %
    
    (569
    )
    
    (16.0
    %)General
      and administrative
    
    
    2,992
    
    
    17.1
    %
    
    3,791
    
    
    32.5
    %
    
    (799
    )
    
    (21.1
    %)Amortization
      of deferredemployee
      compensation
    
    
    1,630
    
    
    9.4
    %
    
    1,149
    
    
    9.9
    %
    
    481
    
    
    41.9
    %Impairment
      of purchasedintangibles
    
    
    -
    
    
    0.0
    %
    
    1,039
    
    
    8.9
    %
    
    (1,039
    )
    
    (100.0
    %)Total
      operating expenses
    
    
    9,881
    
    
    56.5
    %
    
    11,507
    
    
    98.8
    %
    
    (1,626
    )
    
    (14.1
    %)Operating
      loss
    
    
    (444
    )
    
    (2.5
    %)
    
    (7,491
    )
    
    (64.3
    %)
    
    7,047
    
    
    (94.1
    %)Interest
      expense
    
    
    (247
    )
    
    (1.4
    %)
    
    (115
    )
    
    (1.0
    %)
    
    (132
    )
    
    114.8
    %Other
      expenses, net
    
    
    (69
    )
    
    (0.4
    %)
    
    (97
    )
    
    (0.8
    %)
    
    28
    
    
    (28.9
    %)Net
      loss
    
    $
    (760
    )
    
    (4.3
    %)
    $
    (7,703
    )
    
    (66.1
    %)
    $
    6,943
    
    
    (90.1
    %)





Certain
amounts contained in the accompanying 2004 Consolidated Financial Statements
have been reclassified to conform to the 2005 presentation.





**Revenue**





Our total
revenues were $17,502,000 for the fiscal year ended June 30, 2005 compared to
total revenues of $11,650,000 for the fiscal year ended June 30, 2004. The
$5,852,000 (50%) increase in total revenues reflects an increase in product
sales, license fees, service fees and maintenance revenues. The increase in
revenues is responsive to the expanded acceptance of our VoiceLogistics product
line in the marketplace. Product revenues accounted for 79% of revenues during
the fiscal year ended June 30, 2005 as compared to 70% during the fiscal year
ended June 30, 2004. Service revenues accounted for 21% of revenue during the
fiscal year ended June 30, 2005 as compared to 30% during the prior
year.





Total
product revenues increased $5,669,000 (69%) to 13,859,000 during the fiscal year
ended June 30, 2005 from $8,190,000 in the fiscal year ended June 30, 2004.
During late fiscal year 2004, we introduced the VLS410 client hardware unit as a
replacement to the VLS310. The increase in product revenues for fiscal 2005 was
driven by an 87% increase in number of units shipped during the fiscal year
offset by a lower average price per unit. The lower price per unit is due to
client software not being included in upgrades of VLS410 units as replacements
to VLS310 units at existing customer sites and increased competitive
pressures.





Service
revenues were primarily attributable to customer support and professional
service fees relating to voice-based solutions. For the fiscal year ended June
30, 2005, service revenues totaled $3,643,000, reflecting an increase of
$183,000 (5%) from service revenues of $3,460,000 for the fiscal year ended June
30, 2004. The increase in service revenues is attributable to an increased
number of VoiceLogistics implementations and existing customer service
agreements during the fiscal year ended June 30, 2005 than in the prior fiscal
year. The rate of growth of services revenue (5%) was less than product revenue
(69%) during fiscal 2005 because subsequent sales








- 16
-








of
VoiceLogistics to existing customers generally require less professional
services than the initial deployment combined with competitive pressures. We are
also working on enhancing our software’s capabilities allowing faster and less
expensive implementations in the future, which may lead to lower service
revenues on new customers.





**Cost
of Revenues**





Total
cost of revenues increased $431,000 (6%) from $7,634,000 for the fiscal year
ended June 30, 2004 to $8,065,000 for the fiscal year ended June 30,
2005.





Cost of
product revenues decreased $80,000 (2%) from $4,460,000 in the fiscal year ended
June 30, 2004 to $4,380,000 in the fiscal year ended June 30, 2005. Such costs
reflect materials, labor and overhead associated with the sale of our
voice-based products. As of June 30, 2005 and 2004, our manufacturing staff,
comprised of 6 and 4 individuals, respectively, is included in cost of product
revenues. The decrease in cost of product revenues is primarily attributable to
the introduction of VLS410 units late during fiscal year 2004 and increased
economies of scale. These units are less expensive to manufacture than their
predecessors, the VLS310, and have proven more reliable, yielding lower warranty
costs during fiscal 2005.





Cost of
services revenues consists primarily of the expenses associated with customer
maintenance support and professional services, including employee compensation
and travel expenditures. Cost of service revenues increased $511,000 (16%) from
$3,174,000 in the fiscal year ended June 30, 2004 to $3,685,000 in the fiscal
year ended June 30, 2005. As of June 30, 2005 and 2004, our customer support and
professional services staff, comprised of 36 and 26 individuals, respectively,
is included in the cost of service revenues. The increase in cost of service
revenues during fiscal 2005 reflects the increased number of employees on the
professional services and customer support teams servicing more sites and users
equipped with the VoiceLogistics product line.





**Operating
Expenses**





Total
operating expenses decreased by $1,626,000 (14%) to $9,881,000 in the fiscal
year ended June 30, 2005 from $11,507,000 in the fiscal year ended June 30,
2004. As of June 30, 2005, headcount associated with operating expenses
(Research & Development, Sales, Marketing and General & Administrative)
totaled 46 compared to 66 at June 30, 2004.





Research
and development expenses primarily consist of employee compensation, consulting
fees and other costs associated with our voice recognition technology, hardware
platform and VoiceLogistics software suite. As of June 30, 2005, our research
and development team was comprised of 20 employees compared to 18 employees at
June 30, 2004. Our research and development expenses increased $300,000 (15%) to
$2,274,000 in the fiscal year ended June 30, 2005 from $1,974,000 in the fiscal
year ended June 30, 2004. The operations of Voxware n.v, which were terminated
effective June 30, 2004, accounted for $192,000 research and development costs
during fiscal 2004. Excluding the impact of Voxware n.v., research and
development charges increased $492,000 during the fiscal year ended June 30,
2005, due to an increased number of employees and outside consultants focusing
on the development of the next generation VoiceLogistics suite of products.





Sales and
marketing expenses primarily consist of employee compensation (including direct
sales commissions), third party partnership fees, travel expenses and trade
shows. As of June 30, 2005, our sales and marketing staff was comprised of 15
employees compared to 10 employees at June 30, 2004. Sales and marketing
expenses decreased $569,000 (16%) to $2,985,000 in the fiscal year ended June
30, 2005 from $3,554,000 in the fiscal year ended June 30, 2004. Fiscal 2004
sales and marketing charges included $1,114,000 of costs related to Voxware n.v.
as compared to $0 in fiscal 2005. Excluding the impact of Voxware n.v., sales
and marketing expenses increased $545,000 during the fiscal year ended June 30,
2005. This increase in sales and marketing expenses during fiscal 2005 is due
primarily to the increased number of sales staff and commissions of $158,000
earned by third party channel partners.





General
and administrative expenses consist primarily of employee compensation and fees
for insurance, rent, office expenses and professional services. As of June 30,
2005, the general and administrative staff was comprised of 11employees compared
to 8 employees at June 30, 2004. General and administrative expenses decreased
$799,000 (21%) to $2,992,000 in the fiscal year ended June 30, 2005 from
$3,791,000 in the fiscal year ended June 30, 2004. The decrease in general and
administrative expenses is due to fiscal 2004 costs of $1,005,000 related to
Voxware n.v. compared to $0 in fiscal 2005 and a decrease in bad debt charges of
$412,000. These cost reductions were offset primarily by an increase of $283,000
in payroll costs caused by the larger general and administrative staff and a
one-time write-off of interest and charges associated with the late filing of
payroll taxes due in 2002 that reduced fiscal 2004 expenses by $325,000.
Excluding the impact of Voxware n.v., general and administrative expenses
increased $206,000 during the fiscal year ended June 30, 2005.








- 17
-








**Interest
Expense**





Interest
expense for the fiscal year ended June 30, 2005 was $247,000 compared to
$115,000 for the fiscal year ended June 30, 2004, an increase of $132,000.
Interest expense is primarily related to the term loan and working capital line
of credit with Silicon Valley Bank, which were in place for six months of fiscal
2004 and all of fiscal 2005. The term loan and working capital line of credit
allow us to borrow up to $2,000,000. In addition, an equipment loan with KBC
Bank Roselare related to Voxware n.v was paid off in fiscal 2005.





**Other
Expense**





Other
expenses, primarily related to fluctuations in foreign currency exchange rates,
totaled $69,000 for the fiscal year ended June 30, 2005 compared to $97,000 for
the fiscal year ended June 30, 2004, a decrease of $28,000.





**Income
Taxes**





As of
June 30, 2005, we had approximately $38,000,000 of federal net operating loss
carry-forwards, which will begin to expire in 2009 if not utilized. The Tax
Reform Act of 1986 enacted a complex set of rules limiting the potential
utilization of net operating loss and tax credit carry-forwards in periods
following a corporate “ownership change.” In general, for federal income tax
purposes, an ownership change is deemed to occur if the percentage of stock of a
loss corporation owned (actually, constructively and, in some cases, deemed) by
one or more “5% shareholders” has increased by more than 50 percentage points
over the lowest percentage of such stock owned during a three-year testing
period. During 2003, such a change in ownership occurred. As a result of the
change, our ability to utilize certain of our net operating loss carry-forwards
will be limited. As of June 30, 2005 and 2004, a full valuation allowance has
been provided on our net deferred tax assets because of the uncertainty
regarding realization of the deferred assets.





**Liquidity
and Capital Resources**





As of
June 30, 2005, we had $3,639,000 in cash and cash equivalents. As of June 30,
2004, we had $1,124,000 in cash and cash equivalents.





Net cash
provided by operating activities totaled $1,869,000 for fiscal 2005, primarily
consisting of net loss of $760,000, an increase in deferred revenue of $758,000,
a decrease of $444,000 in accounts receivable, a decrease of $412,000 in
accounts payables and accrued expenses, an increase in inventory of $292,000, a
decrease of $336,000 in prepaid and other current assets, an increase of
$119,000 of deferred project costs, as well as non-cash charges of $1,630,000
for amortization of deferred employee compensation, $172,000 for amortization of
deferred finance charges, and $94,000 of amortization and depreciation. Our
increased sales volume during fiscal 2005 was the primary factor leading to the
increase in deferred revenue, inventory and deferred project costs. Accounts
receivable decreased due to additional staff focusing on collections. Accounts
payable decreased in fiscal 2005 as improved operations allowed for payments to
satisfy legacy obligations carried forward from the prior year. The reduction in
prepaid and other current assets relates primarily to the recovery during fiscal
2005 of European VAT paid in fiscal 2004. Net cash used in operating activities
totaled $6,239,000 for fiscal 2004, primarily consisting of net loss of
$7,703,000, a decrease of $946,000 in accounts payables and accrued expenses, an
increase of $637,000 in accounts receivable, a decrease in inventory of
$491,000, an increase in deferred revenue of $195,000, an increase in prepaid
and other current assets of $130,000, as well as non-cash charges of impairment
of goodwill of $1,039,000, amortization of deferred employee compensation of
$1,149,000, and amortization and depreciation of $198,000.





In fiscal
2005, net cash used in investing activities totaled $108,000 as a result of
purchases totaling $161,000 of property and equipment netted against proceeds of
$53,000 for the disposal of assets. In fiscal 2004, cash provided by investing
activities totaled $3,607,000 as a result of $3,891,000 held in an attorney’s
escrow account relating to the June 2003 offering which was released in July
2003, offset by the purchase of $285,000 of other property and equipment and
proceeds of $1,000 for the disposal of assets.





Net cash
provided by financing activities totaled $742,000 and $3,398,000 in fiscal years
2005 and 2004, respectively. In fiscal 2005, $1,300,000 was provided by short
term borrowing against the working line of credit, of which $300,000 was repaid.
$376,000 was paid against long-term debt, while proceeds from the exercise of
stock options totaled $118,000. In fiscal 2004, $2,051,000 was provided by the
issuance of shares of our Series D Preferred Stock, net of financing related
expenses, and $1,309,000 was provided by the issuance of long-term
debt.





On April
30, 2004, we completed a private placement of Series D Preferred Stock. We
received $2,051,000 in proceeds and issued 136,730,000 shares of our Series D
Preferred Stock, at a price of $0.015 per share. In addition to the cash
transaction costs, we issued 716,500 shares of our Series D Preferred Stock
(valued at $10,748) to a placement agent as partial payment of the
fees.





On
September 9, 2004, the Securities and Exchange Commission asserted, among other
things, a violation of Section 5 of the Securities Act in connection with these
transactions. As such, the purchasers of the Series D Preferred Stock related to
the April 2004








- 18
-








offering
obtained the right to require us to repurchase the shares sold to the purchasers
in the Series D Private Placement at the original purchase price, plus statutory
interest from the date of purchase for a period of one year following the date
of violation.





Upon
learning of the SEC’s position in September 2004, we sought and obtained waivers
of any right of rescission from the affected shareholders for 100% of the
shares. However, As of June 30, 2004, the company recorded a contingent
liability of $2,051,000. This liability was reversed during fiscal year 2005
when we received the written acknowledgement of 100% of the affected
stockholders stating that they will not exercise their respective rescission
rights.





On June
27, 2003, we completed a private placement of Series D Preferred Stock and
Series D Preferred Stock warrants and Common Stock warrants to purchase up to
93,333,333 shares (37,111,111 warrants issued) of Series D Preferred stock and
18,666,667 shares of Common Stock to various accredited investors. As a result
of the restatement of revenue as of June 30, 2003, the Company issued an
additional 23,777,778 warrants to holders of the Company’s Series D Preferred
Stock in accordance with the terms set forth in the agreements. The remaining
32,444,444 warrants were cancelled as of December 31, 2003 in accordance with
the terms set forth in the agreements. In total, we issued 485,267,267 shares of
Series D Preferred Stock, which shares were convertible into 485,267,267 shares
of Common Stock, which resulted in proceeds to us of approximately $5,063,000,
net of transaction costs. In addition to cash transaction costs, we issued
warrants to acquire 9,333,333 shares of Common Stock to Ridgecrest Capital
Partners, an investment banker advisor, as an advisory fee. The exercise price
for such warrants is $0.015 per share and the warrants expire in 10 years. The
Series D Preferred Stock has a 7% dividend payable in cash or equity, at our
election, and is initially convertible into our Common Stock on a one-for-one
basis.





Pursuant
to the transaction documents relating to our Series D Private Placements
consummated in June 2003 and April 2004, we agreed to provide certain
registration rights to the purchasers. Accordingly, we filed a registration
statement in a timely manner as required by the transaction documents and have
received comments from the Securities and Exchange Commission regarding, among
other things, a potential violation of Section 5 of the Securities Act in
connection with our April 2004 Series D Private Placement. We do not believe
that our private placement of Series D Preferred Stock and Series D Preferred
Stock Warrants nor our issuance of Series D Preferred Stock warrants in December
2003 to two of our stockholders as consideration for acting as guarantors of our
credit facility constitute a violation of Section 5 of the Securities Act.
However, if such action was held by a court or other governmental body to be a
violation of the Act, we could be required to repurchase the shares sold to the
purchasers in the Series D Private Placement at the original purchase price,
plus statutory interest from the date of purchase for a period of one year
following the date of violation. We would contest vigorously any claim that a
violation of the Securities Act occurred. As of June 30, 2004, the company
recorded a contingent liability of $2,051,000. This liability was reversed
during fiscal year 2005 when we received the written acknowledgement of 100% of
the affected stockholders stating that they will not exercise their respective
rescission rights.





On
December 30, 2003, we entered into a credit facility with Silicon Valley Bank
(the “SVB facility”). The SVB facility initially provided us with $2,000,000 in
financing, comprised of a $1,500,000 term loan and $500,000 working capital
facility. The term loan is payable in monthly installments over a 36-month
period commencing February 1, 2004. The SVB facility bears interest at a rate of
prime (6 % as of June 30, 2005) plus 1⁄2 percent per annum and is secured by all
of our assets, including our intellectual property and a guarantee of our two
largest shareholders. In exchange for the SVB facility guarantee, the
shareholders were granted 133,333,333 Series D warrants to purchase shares of
our Series D Preferred Stock. The warrants are exercisable into shares of our
Series D Preferred Stock at an exercise price of $0.015 per share.





We
engaged Hempstead & Co. as a valuation expert to assist in determining the
fair value of the guarantee for which the warrants were issued. Based on the
work performed by Hempstead & Co., as a valuation expert, we recorded a
deferred financing asset of $500,000 on our balance sheet as of December 31,
2003. This deferred asset is being amortized over 36 months commencing on
January 1, 2004 and has a remaining balance of $250,000 as of June 30,
2005.





On May
28, 2004, we entered into a modification agreement to the term loan deferring
the seven monthly principal payments originally scheduled to occur from June 1,
2004 through December 1, 2004. Commencing on January 1, 2005, and over the
remaining twenty-four (24) payments, the deferred principal payments will be
amortized and added to the original principal payment amount. The initial term
of the loan has not been extended and the final term loan payment, due on
December 1, 2006, shall include all outstanding term loan principal and accrued
interest.





On
December 8, 2004, we entered into a second loan modification agreement with
Silicon Valley Bank wherein, among other factors, the working capital line of
credit was renewed to December 27, 2005 and increased from $500,000 to
$2,000,000. The terms of the modification agreement allowed for immediate
availability of $666,667 under this working capital line of credit. The amount
of availability is determined by subtracting from $2,000,000 the amount
outstanding under the term loan. The principal amount due








- 19
-








under the
term loan was $1,000,000 as of June 30, 2005, leaving $1,000,000 available under
the working capital line of credit at that date. Effective January 1, 2005, the
monthly principal payment under the term loan is approximately $56,000. These
monthly principal payments under the term loan have the effect of increasing the
available working capital line of credit by an equal amount. The renewal
interest rate is at prime plus one-half percent with a floor rate of prime of
4.5%.





Proceeds
from the $1,500,000 term loan were used to satisfy $1,310,000 of outstanding
Federal and State payroll tax liabilities including related interest of $59,000.
The remaining $190,000 was used for operating activities. As of June 30, 2005,
we borrowed the full $1,000,000 of the available working capital line of
credit.





SVB
granted us an extension to deliver our audited financial statements for June
2004, and our interim financial statements for July 2004 and August 2004, until
October 15, 2004. Due to the Company’s restatements during the previous year
combined with the installation of new management, federal and state income tax
filings were filed late. Silicon Valley Bank waived the requirement for current
reporting and payment of taxes, and allowed the Company until October 13, 2004
to file the required tax returns. All required past due reports and filings were
made as of October 12, 2004 and the Company is in compliance as of this filing
date.





Our
wholly-owned subsidiary, Voxware n.v., had an equipment loan with KBC Bank
Roeselare. The original amount of this loan was €70,000. This equipment loan was
due November 13, 2005, and was payable in 36 equal installments of €2,136.
Interest on the facility was charged at 6.12% per annum, and was secured by a
blanket lien on equipment. This loan was paid in full and closed in December
2004.





As of
June 30, 2005, 1,500,000,000 shares of Common Stock were authorized, of which
78,203,061 were issued and outstanding. The following table summarizes the
dilutive impact in the event of conversion of all Series D Preferred Stock into
Common Stock, and the exercise of all options and warrants to purchase stock,
including options and warrants whose strike price exceeds the market value of
our Common Stock. In addition to those shares of Common Stock available for
issuance, we issue Common Stock as payment of quarterly dividends to holders of
Series D preferred stock. During the year ended June 30, 2005, 14,952,957 shares
of Common Stock were issued as dividends to holders of Series D Preferred
Stock.







- 20
-







**Dilutive
      Effect of Preferred Stock, Options and Warrants as of June 30,
      2005**Common
      stock issued and outstanding as of June 30, 2005
    
    
    78,203,061Dilutive
      instruments:Series
      D Preferred Stock issued and outstanding, eachconvertible
      into one share of Common Stock
    
    
    649,621,940Outstanding
      warrants to purchase Series D PreferredStock,
      each convertible into one share of Common Stock
    
    
    156,879,326Outstanding
      warrants to purchase Common Stock *
    
    
    29,662,846Outstanding
      options to purchase Common Stock *
    
    
    105,393,316Common
      Stock plus dilutive instruments outstanding
    
    
    1,019,760,489Options
      to purchase Common Stock available to issuepursuant
      to various stock option plans
    
    
    72,281,682Common
      Stock outstanding if all dilutive instrumentsare
      converted and exercised
    
    
    1,092,042,171
   *Includes
      all "in-the-money" and "out-of-the-money" warrants and
      options.


In
connection with the August 2005 Private Placement described below, all issued
and outstanding shares of Series D Preferred Stock and warrants to purchase
Series D Preferred Stock were converted to shares of Common Stock and warrants
to purchase Common Stock, respectively.
 On August
11, 2005, we entered into a Common Stock Purchase Agreement with certain
accredited investors, pursuant to which we agreed to issue an aggregate of
up to 206,250,000 shares of its Common Stock, $0.001 par value per share, in a
private placement. On August 11, 2005, we issued and sold an aggregate of
188,860,967 shares of Common Stock, and on August 22, 2005, the private
placement's second and final closing, we issued and sold an additional
17,389,030 shares of Common Stock. A total of 206,249,997 shares of Common Stock
were issued through the August 2005 private placement, the Private Placement. We
received aggregate proceeds of approximately $6,600,000 before expenses and
commissions. In connection with the Private Placement, the holders of a majority
of our Series D Preferred Stock agreed to convert all of the outstanding shares
of Series D Preferred Stock into shares of Common Stock. As a result,
649,016,089 shares of Series D Preferred Stock were converted into 649,016,089
shares of Common Stock, and 1,902,857 shares of Common Stock were issued in lieu
of paying cash dividends on the Series D Preferred Stock from July 1, 2005 to
August 11, 2005. As of August 31, 2005, taking into consideration the Private
Placement, we had 936,277,855 shares of Common Stock issued and outstanding. No
shares of Series D Preferred Stock remain outstanding. Further, the holders of a
majority of our Series D Preferred Stock agreed to amend and restate all of our
outstanding warrants to purchase shares of Series D Preferred Stock into
warrants to purchase shares of Common Stock. In addition, certain holders of
Series D Preferred Stock waived their right to receive options to purchase up to
18,666,667 shares of our Common Stock as a result of delays in registering
shares issued under the 2003 and 2004 sales of Series D Preferred
Stock.
 
 We intend
to use the proceeds from the Private Placement to fund increased research and
development activities during fiscal years 2006 and 2007, as well as support the
expansion of our sales and marketing channels. We plan to add significant
personnel in these areas in advance of offsetting revenues. We also plan a large
increase in capital expenditures from prior years to meet our growing personnel
needs for office space, computers and phones, and to upgrade our existing
information technology, along with marketing related items like trade show
booths. Additionally, we contemplate changing our supplier(s) for our model 410
and new technologies. There may be additional costs involved with any transition
related to our suppliers.
 
 We
believe that adequate capital resources will be available to fund our operations
for the year ending June 30, 2006. Our business plans for the current year show
continuing increases in revenue with improved operating efficiency due to
increased scale covering overhead costs. Our customer base continues to expand
with existing customers rolling out multiple sites as they have proven results.
We expect the majority of 2006 revenue will come from existing customers. Our
working capital line of credit with Silicon Valley Bank was fully utilized as of
June 30, 2005, but was subsequently paid off in full. Since the line of credit
is guaranteed by two of our key investors, we have the ability to arrange
additional asset-based financing above and beyond the current line. Our business
plans do not include using this working capital credit line for long-term
capital needs. Furthermore, the private placement of Common Stock during August
2005 provided cash proceeds of approximately $6,200,000, net of commissions and
other related costs.


**Effect
of Recent Accounting Pronouncements**





In
December 2004, FASB issued SFAS No. 123R, “Share Based Payment" ("FAS 123R"),
requiring all share-based payments to employees, including grants of employee
stock options, to be recognized as compensation expense in the consolidated
financial statements based upon their fair values. As amended by the Securities
and Exchange Commission (“SEC”) on April 14, 2005, this standard is effective
for the quarter beginning January 1, 2006 for small business public filers. On
March 29, 2005 the SEC issued Staff Accounting Bulletin No. 107(SAB 107), which
provides the Staff’s views regarding interactions between FAS 123R and certain
SEC rules and regulations and provides interpretations of the valuation of
share-based payments for public companies. We are currently evaluating FAS 123R
and SAB 107 to determine the fair value method to measure compensation expense,
the appropriate assumptions to include in the fair value model and the
transition method to use upon adoption. The impact of the adoption is not known
at this time due to these factors. The effect on our results of operations of
expensing stock options using the Black-Scholes method is presented in the
accompanying Notes to Consolidated Financial Statements.





**Quantitative
and Qualitative Disclosure About Market Risk**





Interest
Rate Sensitivity





We
currently maintain an investment portfolio consisting mainly of cash
equivalents. The primary objective of our investment activities is to maintain
the safety of principal and preserve liquidity while maximizing yields without
significantly increasing risk. This is accomplished by investing in highly
liquid short-term instruments with maturities of 90 days or less from the date
of purchase. We would not expect our operating results or cash flows to be
affected to any significant degree by a sudden change in market interest rates.





Foreign
Currency Exchange Rate





We
frequently denominate our sales to certain European customers in Euros and Pound
Sterling. Although we do not currently hedge certain balance sheet exposures and
inter-company balances against future movements in foreign currency exchange
rates, we do anticipate exploring using foreign exchange contracts in the
future. We did not hold derivative financial instruments for trading purposes
during fiscal years 2005 and 2004 and we do not intend to utilize derivative
financial instruments for trading purposes in the future.




**ITEM 7.** **FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA** **.**





The
financial statements and supplementary data required by this Item are included
in this Annual Report on Form 10-KSB beginning on page F-1.








- 21
-






**ITEM 8.** **CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE** **.**





On April
23, 2004, our Board of Directors and our Audit Committee decided to no longer
engage WithumSmith+Brown, P.C. as our independent registered public accounting
firm, and engaged BDO Seidman, LLP to serve as our independent registered public
accounting firm for the fiscal year 2004.





WithumSmith+Brown,
P.C.’s report on our consolidated financial statements as of June 30, 2003, and
for each of the two years in the period ended June 30, 2003, did not contain an
adverse opinion or disclaimer of opinion, nor was it qualified or modified as to
audit scope or accounting principles.





During
the fiscal years ended June 30, 2003 and 2002 and through April 23, 2004, there
were no disagreements with WithumSmith+Brown, P.C. on any matter of accounting
principle or practice, financial statement disclosure, or auditing scope or
procedure which, if not resolved to the satisfaction of WithumSmith+Brown, P.C.,
would have caused them to make reference to the subject matter in connection
with their report on our consolidated financial statements for such fiscal year,
and there were no reportable events, as listed in Item 304(a)(1)(v) of SEC
Regulation S-K.




**ITEM 8A.** **CONTROLS
AND PROCEDURES** **.**




**Disclosure
Controls and Procedures**





We
maintain disclosure controls and procedures designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms, and that such information is accumulated and communicated to our
management, including our chief executive officer and our chief financial
officer/principal accounting officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating our disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving their objectives.





Our
management, with the participation of our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)
as of June 30, 2005. Based on this evaluation, our chief executive officer and
chief financial officer concluded that, as of June 30, 2005, our disclosure
controls and procedures were (1) effective in that they were designed to
ensure that material information relating to us, including our consolidated
subsidiaries, is made known to our chief executive officer and chief financial
officer by others within those entities, as appropriate to allow timely
decisions regarding required disclosures, and (2) effective in that
they ensure that information required to be disclosed by us in our reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the SEC’s rules and
forms.





Changes in Internal
Controls





During
the year ended June 30, 2005, we actively worked to remedy the deficiencies
noted in our prior year’s audit. We consolidated our financial reporting in our
Lawrenceville, New Jersey facility, allowing us to roll-up financial information
on a real-time basis. The implementation of this process began during the fourth
quarter of fiscal 2004 and was completed during the fourth quarter of fiscal
2005. We believe this consolidation provides more timely operating information,
a more efficient system of checks and balances to assure accurate reporting of
detailed transactions, and more efficient month-end closing procedures to
provide a comprehensive internal review before financial information is
considered final.






- 22
-





To
facilitate the consolidation of the reporting process, we hired a new Controller
in December 2004. The Controller, who reports to the Chief Financial Officer,
oversees and controls the timely and accurate capture of monthly data. In
addition to the Controller, a new Accounting Manager was hired in January 2005
and one additional accounting support staff was hired in May 2005 to augment the
existing team. Costs associated with consolidating the reporting process did not
have a material adverse affect on our financial condition.





Other
than for the matters discussed above, there were no changes during
the quarter ended June 30, 2005 in our internal control over financial
reporting or in other factors that materially affected, or are reasonably likely
to materially affect, our internal controls over financial
reporting.




**ITEM
8B.** **OTHER
INFORMATION** **.**







None.









- 23
-







**PART
III** ****






**ITEM 9.** **DIRECTORS,
EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a)
OF THE EXCHANGE ACT** **.**




The
information relating to our directors, nominees for election as directors and
executive officers under the headings “Election of Directors” and “Executive
Officers” in our definitive proxy statement for the 2005 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.




**ITEM 10.** **EXECUTIVE
COMPENSATION** **.**




The
discussion under the heading “Executive Compensation” in our definitive proxy
statement for the 2005 Annual Meeting of Stockholders is incorporated herein by
reference to such proxy statement.




**ITEM 11.** **SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS** **.**




The
discussion under the heading “Security Ownership of Certain Beneficial Owners
and Management” in our definitive proxy statement for the 2005 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.




**ITEM 12.****CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS** **.**





The
discussion under the heading “Certain Relationships and Related Transactions” in
our definitive proxy statement for the 2005 Annual Meeting of Stockholders is
incorporated herein by reference to such proxy statement.




**ITEM 13.****EXHIBITS
AND FINANCIAL STATEMENTS** **.**




List of
documents filed as part of this Annual Report on Form 10-KSB.





1.
FINANCIAL STATEMENTS. The financial statements listed in the accompanying Index
to Financial Statements appearing on page F-1 are filed as part of this Annual
Report on Form 10-KSB.





2.
EXHIBITS. The following is a list of Exhibits filed as part of this Annual
Report on Form 10-KSB. Where so indicated by footnote, Exhibits that were
previously filed are incorporated by reference. For Exhibits incorporated by
reference, the location of the Exhibit in the previous filing is indicated in
parentheses.





(a)
Exhibit No.





2.1
    Asset
      Purchase Agreement, dated as of February 4, 1999, by and between Ascend
      Communications, Inc. and Voxware, Inc.**(1)3.1(a)
      
      3.1(b)
      
      3.1(c)
      
      3.1(d)
    Amended
      and Restated Certificate of Incorporation**(11)
      
      Certificate
      of Amendment to the Amended and Restated Certificate of
      Incorporation.**(12)
      
      Certificate
      of Amendment to the Amended and Restated Certificate of Incorporation
      **(13)
      
      Certificate
      of Amendment to the Amended and Restated Certificate of Incorporation,
      filed with the Secretary of State of the State of Delaware on December 29,
      2004.*3.2
    Amended
      and Restated Bylaws.**(11)4.1
    Stock
      Restriction and Registration Rights Agreement, dated April 4, 2000, by and
      among Voxware, Inc., Verbex Acquisition Corporation, InRoad, Inc. and
      Stratos Product Development LLC.**(3)4.2
    Form
      of Warrant issued to InRoad, Inc., dated April 4,
    2000.**(3)4.3
      
      4.4
    Warrant
      issued to Stratos Product Development, LLC, dated April 4,
      2000.**(3)
      
      Amendment
      to Warrants, dated as of July 7, 2003, by and among Voxware, Inc. and
      Stratos Product Development, LLC and InRoad,
Inc.*
   - 24
-
  4.5
    Form
      of Common Stock Purchase Warrant.**(10)4.6
    Form
      of Common Stock Purchase Warrant issued to Ridgecrest Capital
      Partners.**(10)4.7
    Form
      of Series D Convertible Preferred Stock Purchase
      Warrant.**(10)4.8
    Form
      of Series D Convertible Preferred Stock Purchase Warrant to be issued to
      Edison Venture Fund V, L.P., dated December 30,
  2003.**(12)4.9
    Form
      of Series D Convertible Preferred Stock Purchase Warrant to be issued to
      Cross Atlantic Technology Fund II, L.P., dated December 30,
      2003.**(12)4.10
    Form
      of Common Stock Purchase Warrant issued to former holders of Series D
      Convertible Preferred Stock Purchase Warrants (see Exhibits 4.7, 4.8 and
      4.9).*4.11
    Form
      of Common Stock Purchase Warrant issued toMufson
      Howe Hunter & Company LLC, dated August 11, 2005.*4.12
    Form
      of Common Stock Purchase Warrant issued toAlan
      A. Nash, dated August 11, 2005.*4.13
    Form
      of Common Stock Purchase Warrant issued toDuncan
      J. L. Fitzwilliams, dated August 11, 2005.*4.14
    Form
      of Common Stock Purchase Warrant issued toEmma
      Smith, dated August 11, 2005.*10.1
    Voxware,
      Inc. 1994 Stock Option Plan.**(2)10.2
    Form
      of Voxware, Inc. Stock Option Agreement.**(2)10.3
    Form
      of Indemnification Agreement.**(2)10.4
    Securities
      Purchase Agreement, dated as of August 10, 2000, by and between Voxware,
      Inc. and Castle Creek Technology Partners, LLC.**(4)10.5
    Registration
      Rights Agreement, dated as of August 15, 2000, by and between Voxware,
      Inc. and Castle Creek Technology Partners, LLC.**(4)10.6
    Securities
      Purchase Agreement, dated as of April 19, 2001, by and between Voxware,
      Inc. and Castle Creek Technology Partners, LLC, together with the form of
      Additional Share Warrant attached as an exhibit
    thereto.**(7)


10.7
    Registration
      Rights Agreement, dated as of April 19, 2001, by and between Voxware, Inc.
      and Castle Creek Technology Partners, LLC, together with the form of
      Remedy Warrant attached as an exhibit thereto.**(7)10.8
    Voxware,
      Inc. 1998 Stock Option Plan for Outside Directors.**(8)10.9
    Voxware,
      Inc. Plan to Pay Non-Employee Directors an Annual
      Retainer.**(8)10.10
    Series
      D Convertible Preferred Stock Purchase Agreement, dated as of April 16,
      2003, by and among Voxware, Inc. and the Purchasers
      thereto.**(10)10.11
    Exchange
      Agreement, dated as of April 16, 2003, by and between Voxware, Inc. and
      Castle Creek Technology Partners, LLC.**(10)10.12
    Exchange
      Agreement, dated as of April 16, 2003, by and among Voxware, Inc. and
      certain holders of its Series C Convertible Preferred
      Stock.**(10)10.13
    Exchange
      Agreement, dated as of April 16, 2003, by and among Voxware, Inc.,
      Creafund n.v., Avvision BVBA, BVBA Com2Wizards, Eurl Val D Auso and Wim
      Deneweth.** (10)10.14
    Settlement
      Agreement, dated as of April 16, 2003, by and between Voxware, Inc. and
      Castle Creek Technology Partners, LLC.**(10)10.15
    Investor
      Rights Agreement, dated as of June 27, 2003, by and between Voxware, Inc.
   - 25
-
   and the Investors thereto.**(11)10.16
    Stockholders
      Agreement, dated as of June 27, 2003, by and between Voxware, Inc. and the
      Holders and Investors listed on Schedule 1
  thereto.**(11)10.17
    Voxware,
      Inc. 2003 Stock Option Plan.**(11)10.18
    Form
      of Voxware, Inc. Stock Option Agreement.**(11)10.19
    Loan
      and Security Agreement, dated as of December 29, 2003, by and between
      Voxware, Inc. and Silicon Valley Bank.**(12)10.20
    Intellectual
      Property Security Agreement, dated as of December 29, 2003, by and between
      Voxware, Inc. and Silicon Valley Bank.**(12)10.21
    Unconditional
      Guaranty of Edison Venture Fund V, L.P., as guarantor, dated as of
      December 29, 2003.**(12)10.22
    Unconditional
      Guaranty of Cross Atlantic Technology Fund II, L.P., as guarantor, dated
      as of December 29, 2003.**(12)10.23
    Executive
      Employment Agreement, dated March 3, 2004, by and between Voxware,
      Inc. and Thomas J. Drury, Jr.**(12)10.24
    Indemnification
      Agreement, dated February 2004, by and between Voxware, Inc. and
      Thomas J. Drury, Jr.*10.25
    Executive
      Employment Agreement, dated June 21, 2004, by and between Voxware,
      Inc. and Paul Commons**(12)10.26
    Indemnification
      Agreement, dated June 21, 2004, by and between Voxware, Inc. and Paul
      Commons.*10.27
    First
      Loan Modification Agreement dated May 28, 2004 between Voxware, Inc.
      and Silicon Valley Bank**(12)10.28
    Software
      License, Hardware, Services and Maintenance Agreement, dated as of August
      23, 2001, by and between Voxware, Inc. and US Food Service,
      Inc.***10.29
    Waiver
      Letter, dated October 8, 2004, from Silicon Valley Bank to the
      Company**(12)10.30
    Second
      Loan Modification Agreement, dated December 8, 2004, between Voxware, Inc.
      and Silicon Valley Bank**(16)10.31
    Form
      of Common Stock Purchase Agreement, date as of August 11, 2005 by and
      between Voxware, Inc. and certain accredited
      investors.**(20)10.32
    Form
      of Amendment No. 2 to Stockholders Agreement, dated as of August 11, 2005
      by and between Voxware, Inc. and certain accredited
      investors.**(20)10.33
    Form
      of Amended and Restated Investor Rights Agreement, dated as of August 11,
      2005 by and between Voxware, Inc. and certain accredited
      investors**(20)21.1
    Subsidiaries
      of Voxware, Inc.**(11)23.1
    Consent
      of BDO Seidman, LLP*23.2
    Consent
      of Hempstead & Co.*31.1
    Certification
      of principal executive officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.*31.2
    Certification
      of the principal financial officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.*32.1
    Certification
      of the principal executive officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*32.2
    Certification
      of the principal financial officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*99.1
    Hempstead
      & Co. valuation report dated February 16,
  2004.**(14)







- 26
-









*
    Filed herewith.





**
    Previously
      filed with the Commission as Exhibits to, and incorporated by reference
      from, the following documents:





***
    The attachments to this document have not been filed because the Company
      believes that the information contained therein is not deemed material.








(1)
    Filed
      in connection with the Company’s Quarterly Report on Form 10-Q for the
      fiscal quarter ended December 31, 1998.





(2)
    Filed in connection
      with the Company’s Registration Statement on Form S-1 (File Number
      33-08393).





(3)
    Filed in connection with
      the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended
      March 31, 2000.





(4)
    Filed in connection
      with the Company’s Current Report on Form 8-K that was filed on August 16,
      2000.





(5)
    Filed in connection
      with the Company’s Annual Report on Form 10-K for the fiscal year ended
      June 30, 1998.





(6)
    Filed in connection
      with the Company’s Registration Statement on Form S-2 (File Number
      33-68646).





(7)
    Filed in connection
      with the Company’s Current Report on Form 8-K that was filed on April 20,
      2001.





(8)
    Filed in connection
      with the Company’s Registration Statement on Form S-8 (File Number
      33-33342).





(9)
    Filed in connection with
      the Company’s Annual Report on Form 10-K for the fiscal year ended June
      30, 2002.





(10)
    Filed
      in connection with the Company’s Current Report on Form 8-K that was filed
      on April 17, 2003.





(11)
    Filed
      in connection with the Company’s Annual Report on Form 10-K for the fiscal
      year ended June 30, 2003.





(12)
    Filed in connection with the Company’s Current Report on Form 8-K that was
      filed on January 6, 2004.





(13)
    Filed in connection with the Company’s Current Report on Form 8-K that was
      filed on May 7, 2004.




(14)
    Filed
      in connection with the Company's Annual Report on Form 10-K for the fiscal
      year ended June 30, 2004.




(15)
    Filed in connection with the Company’s Current Report on Form 8-K that was
      filed on November 12, 2004.




(16)
    Filed
      in connection with the Company’s Current Report on Form 8-K that was filed
      on December 10, 2004.




(17)
    Filed in connection with the Company’s Current Report on Form 8-K that was
      filed on December 15, 2004.




(18)
    Filed in connection with the Company's Quarterly Report on Form 10-QSB for
      the fiscal quarter ended December 31, 2004.




(19)
    Filed in connection with the Company’s Current Report on Form 8-K that was
      filed on February 9, 2005.




(20)
    Filed
      in connection with the Company’s Current Report on Form 8-K that was filed
      on August 11, 2005.






**ITEM 14.** **PRINCIPAL
ACCOUNTANT FEES AND SERVICES** **.**





The
discussion under the heading “Independent Auditors Fees and Other Matters” in
our definitive proxy statement for the 2005 Annual Meeting of Stockholders is
incorporated herein by reference to such proxy statement.





- 27
-





**SIGNATURES**





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





Date:
September 26, 2005





**VOXWARE, INC.**(Registrant)By: /s/ Thomas J. Drury,
      Jr.Thomas
      J. Drury, Jr., PresidentChief
      Executive Officer and Director(Principal Executive Officer)By: /s/ Paul CommonsPaul
      Commons, Chief Financial Officer(Principal
      Financial Officer andPrincipal Accounting Officer)


By: /s/ James
    L.AlexandreJames
      L. Alexandre, DirectorBy:
      /s/ Joseph A. AllegraJoseph
      A. Allegra, DirectorBy: /s/ Donald R.
    CaldwellDonald
      R. Caldwell, DirectorBy: /s/ Michael
JanisMichael
      Janis, DirectorBy: /s/ David B.
LeviDavid
      B. Levi, DirectorBy: /s/ Ross T.
    MartinsonRoss
      T. Martinson, Director













**VOXWARE,
INC. AND SUBSIDIARIES**







**INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS** ****







Consolidated
      Financial Statements:Report
      of Independent Registered Public Accounting Firm
    F-2Consolidated
      Balance Sheets as of June 30, 2005 and 2004
    F-3Consolidated
      Statements of Operations for the years ended June 30, 2005 and
      2004
    F-4Consolidated
      Statements of Stockholders’ Equity (Deficit) for the years ended June 30,
      2005 and 2004
    F-5Consolidated
      Statements of Cash Flows for the years ended June 30, 2005 and
      2004
    F-7Summary
      of Accounting Policies and Notes to Consolidated Financial
      Statements
    F-8










F-1







**Report
of Independent Registered Public Accounting Firm**









Board of
Directors and Stockholders


Voxware,
Inc.


Lawrenceville,
NJ




We have
audited the accompanying consolidated balance sheets of Voxware, Inc. and
subsidiaries as of June 30, 2005 and 2004, and the related consolidated
statements of operations, stockholders’ equity (deficit), and cash flows
for the years then ended. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our a udits
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Voxware, Inc. and
subsidiaires at June 30, 2005 and 2004, and the results of their operations
and their cash flows for the years then ended **,** in
conformity with accounting principles generally accepted in the United States of
America.







BDO
Seidman, LLP


Philadelphia,
Pennsylvania


September
14, 2005











F-2









**Voxware,
      Inc. and Subsidiaries****Consolidated
      Balance Sheets****(in
      thousands, except share data)****June
      30, 2005**
    
    **June
      30, 2004****ASSETS****CURRENT
      ASSETS**Cash
      and cash equivalents
    
    
    
    
    $
    3,639
    
    $
    1,124Accounts
      receivable, net of allowance for doubtful accounts of $116
      and$114
      at June 30, 2005 and June 30, 2004, respectively
    
    
    
    
    
    2,408
    
    
    2,854Inventory,
      net
    
    
    
    
    
    616
    
    
    324Deferred
      project costs
    
    
    
    
    
    150
    
    
    31Prepaids
      and other current assets
    
    
    
    
    
    61
    
    
    397**Total
      current assets**
    
    
    
    
    
    6,874
    
    
    4,730**PROPERTY
      AND EQUIPMENT, NET**
    
    
    
    
    
    238
    
    
    247**OTHER
      ASSETS**Deferred
      financing costs, net
    
    
    
    
    
    266
    
    
    438Other
      assets, net
    
    
    
    
    
    36
    
    
    29**Total
      other assets**
    
    
    
    
    
    302
    
    
    467**TOTAL
      ASSETS**
    
    
    
    
    $
    7,414
    
    $
    5,444**LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)****CURRENT
      LIABILITIES**Current
      portion of long-term debt
    
    
    
    
    $
    666
    
    $
    363Working
      capital line of credit
    
    
    
    
    
    1,000
    
    
    -Accounts
      payable and accrued expenses
    
    
    
    
    
    3,103
    
    
    3,515Preferred
      stock rescission liability
    
    
    
    
    
    -
    
    
    2,051Deferred
      revenues
    
    
    
    
    
    1,501
    
    
    743**Total
      current liabilities**
    
    
    
    
    
    6,270
    
    
    6,672Long-term
      debt, net of current maturities
    
    
    
    
    
    334
    
    
    1,013**Total
      liabilities**
    
    
    
    
    
    6,604
    
    
    7,685**STOCKHOLDERS'
      EQUITY (DEFICIT)**7%
      cumulative Series D convertible preferred stock, $.001 par value,
      ($9,744and
      $9,891 aggregate liquidation preference at June 30, 2005 andJune
      30, 2004, respectively); 649,621,940 and 659,424,187 shares issuedand
      outstanding at June 30, 2005 and June 30, 2004,
      respectively
    
    
    
    
    
    650
    
    
    660Common
      stock, $.001 par value, 1,500,000,000 and 1,035,000,000 sharesauthorized
      as of June 30, 2005 and June 30, 2004, respectively;78,203,061
      and 46,043,621 shares issued and outstanding atJune
      30, 2005 and June 30, 2004, respectively
    
    
    
    
    
    78
    
    
    46Additional
      paid-in capital
    
    
    
    
    
    70,718
    
    
    67,856Accumulated
      deficit
    
    
    
    
    
    (66,626
    )
    
    (65,866
    )Deferred
      compensation
    
    
    
    
    
    (4,022
    )
    
    (4,937
    )Accumulated
      other comprehensive gain
    
    
    
    
    
    12
    
    
    -**Total
      stockholders' equity (deficit)**
    
    
    
    
    
    810
    
    
    (2,241
    )**TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)**
    
    
    
    
    $
    7,414
    
    $
    5,444


See
accompanying summary of accounting policies and notes to consolidated financial
statements.





F-3




**Voxware,
      Inc. and Subsidiaries****Consolidated
      Statements of Operations****(in
      thousands, except per share data)****Year
      Ended June 30,****2005**
    
    **2004****REVENUES**Product
      revenues
    
    $
    13,859
    
    $
    8,190Services
      revenues
    
    
    3,643
    
    
    3,460**Total
      revenues**
    
    
    17,502
    
    
    11,650**COST
      OF REVENUES**Cost
      of product revenues
    
    
    4,380
    
    
    4,460Cost
      of service revenues
    
    
    3,685
    
    
    3,174**Total
      Cost of Revenues**
    
    
    8,065
    
    
    7,634**GROSS
      PROFIT**
    
    
    9,437
    
    
    4,016**OPERATING
      EXPENSES**Research
      and development
    
    
    2,274
    
    
    1,974Sales
      and marketing
    
    
    2,985
    
    
    3,554General
      and administrative
    
    
    2,992
    
    
    3,791Amortization
      of deferred employee compensation
    
    
    1,630
    
    
    1,149Impairment
      of purchased intangibles
    
    
    -
    
    
    1,039**Total
      operating expenses**
    
    
    9,881
    
    
    11,507**OPERATING
      LOSS**
    
    
    (444
    )
    
    (7,491
    )**OTHER
      EXPENSES**Interest
      expense
    
    
    (247
    )
    
    (115
    )Other
      expenses, net
    
    
    (69
    )
    
    (97
    )**NET
      LOSS**
    
    
    (760
    )
    
    (7,703
    )Beneficial
      conversion feature - Series D convertible preferred
    
    
    -
    
    
    (2,051
    )Dividends-Series
      D convertible preferred stock
    
    
    (696
    )
    
    (572
    )**NET
      LOSS APPLICABLE TO COMMON STOCKHOLDERS**
    
    $
    (1,456
    )
    $
    (10,326
    )**NET
      LOSS PER SHARE APPLICABLE TO COMMON STOCKHOLDERS**Basic
      and diluted
    
    $
    (0.03
    )
    $
    (0.29
    )**WEIGHTED
      AVERAGE NUMBER OF SHARES USED IN COMPUTING NET LOSS PER COMMON
      SHARE**Basic
      and diluted
    
    
    57,854
    
    
    35,312


See
accompanying summary of accounting policies and notes to consolidated financial
statements.





F-4




Voxware, Inc. and
Subsidiaries


**Consolidated
Statements of Stockholders' Equity (Deficit)**
 **(in
thousands, except share data)**


Series
      D Preferred
    
    Series
      B PreferredNumber
      of
      Shares
    
    Stated
      Value
      Amout
    
    Number of
      Shares
    
    
    **Stated**
      **Value**
      **Amount**
    
    Common
      Stock Number of Shares
    
    Par
      Value $.001 Amount
    
    Additional
      Paid-inCapital
    
    Deferred
      Employee Compensation
    
    Accumulated
      Other Comprehensive Gain
    
    Accumulated
      Deficit
    
    TotalBalance,
      June 30, 2003
    
    485,267,267
    
    $
    485
    
    1,767
    
    
    $
    -
    
    28,210,919
    
    $
    28
    
    $
    64,644
    
    $
    
    (3,220
    )
    $
    
    (2)
    
    $
    
    (58,163)
    
    $
    3,772Conversion
      of Series B preferredstock
      into common stock
    
    -
    
    
    -
    
    (1,767
    )
    
    
    -
    
    8,250,000
    
    
    8
    
    
    (8
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Amortization
      of deferred compensation
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    1,149
    
    
    
    -
    
    
    
    -
    
    
    1,149Conversion
      of Series D warrantsinto
      Series D preferred stock
    
    37,210,420
    
    
    38
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    38Issuance
      of warrants to guarantorsof
      Silicon Valley Bank Loan
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    500
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    500Issuance
      of Series D April 30, 2004 for cash
    
    137,446,500
    
    
    138
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    (138
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Beneficial
      conversion featureembedded
      in preferred stock
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    2,051
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    2,051Deemed
      dividend on preferred stock
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    (2,051
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    (2,051
    )Conversion
      of Series D preferredstock
      into common stock
    
    (500,000
    )
    
    (1
    )
    -
    
    
    
    -
    
    500,000
    
    
    1
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Issuance
      of common stock insettlement
      of accrued divdendsto
      Series D preferred stock
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    8,150,499
    
    
    8
    
    
    (8
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Issuance
      of stock options
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    4,715
    
    
    
    (4,715
    )
    
    
    -
    
    
    
    -
    
    
    -Forfeited
      stock options
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    (1,849
    )
    
    
    1,849
    
    
    
    -
    
    
    
    -
    
    
    -Exercise
      of stock options
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    932,203
    
    
    1
    
    
    (1
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Comprehensive
      income (loss):Net
      loss
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (7,703)
    
    
    (7,703
    )Foreign
      currency translation adjustment
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    -
    
    
    
    2
    
    
    
    -
    
    
    2Total
      Comprehensive income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,701
    )Balance,
      June 30, 2004
    
    659,424,187
    
    
    
    
    -
    
    
    $
    -
    
    46,043,621
    
    $
    46
    
    $
    67,856
    
    $
    
    (4,937
    )
    $
    
    -
    
    $
    
    (65,866)
    
    $
    (2,241
    )


See
accompanying summary of accounting policies and notes to consolidated financial
statements.





F-5








Voxware, Inc. and
Subsidiaries
 **Consolidated
Statements of Stockholders' Equity (Deficit) (Continued)**
 **(in
thousands, except share data)**
 Series
      D Preferred
    
    Series
      B PreferredNumber
      of
      Shares
    
    Stated
      Value
      Amout
    
    Number of
      Shares
    
    
    **Stated**
      **Value**
      **Amount**
    
    Common
      Stock Number of Shares
    
    Par
      Value $.001 Amount
    
    Additional
      Paid-inCapital
    
    Deferred
      Employee Compensation
    
    Accumulated
      Other Comprehensive Gain
    
    Accumulated
      Deficit
    
    TotalBalance,
      June 30, 2004
    
    659,424,187
    
    $
    660
    
    -
    
    
    $
    -
    
    46,043,621
    
    $
    46
    
    $
    67,6856
    
    $
    
    (4,937
    )
    $
    
    -
    
    $
    
    (65,866)
    
    $
    (2,241
    )Amortization
      of deferred compensation
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    1,630
    
    
    
    -
    
    
    
    -
    
    
    1,630Reclass
      of preferred stockrescission
      liability to equity
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    2,051
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    2,051Conversion
      of Series D warrantsinto
      Series D preferred stock
    
    132,476
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Conversion
      of Series D preferredstock
      into common stock
    
    (9,934,723
    )
    
    (10
    )
    -
    
    
    
    -
    
    9,934,723
    
    
    10
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Issuance
      of common stock insettlement
      of accrued divdendsto
      Series D preferred stock
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    14,952,957
    
    
    15
    
    
    (15
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    -Issuance
      of stock options
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    1,024
    
    
    
    (1,024
    )
    
    
    -
    
    
    
    -
    
    
    -Forfeited
      stock options
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    (309
    )
    
    
    309
    
    
    
    -
    
    
    
    -
    
    
    -Exercise
      of stock options
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    7,271,760
    
    
    7
    
    
    111
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    118Comprehensive
      income (loss):Net
      loss
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (760)
    
    
    (760
    )Foreign
      currency translation adjustment
    
    -
    
    
    -
    
    -
    
    
    
    -
    
    -
    
    
    -
    
    
    -
    
    
    
    -
    
    
    
    12
    
    
    
    -
    
    
    12Total
      Comprehensive income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (748
    )Balance,
      June 30, 2005
    
    649,621,940
    
    $
    650
    
    -
    
    
    $
    -
    
    78,203,061
    
    $
    78
    
    $
    70,718
    
    $
    
    (4,022
    )
    $
    
    12
    
    $
    
    (66,626)
    
    $
    810


See
accompanying summary of accounting policies and notes to consolidated financial
statements.









F-6




**Voxware,
      Inc. and Subsidiaries****Consolidated
      Statements of Cash Flows****(in
      thousands)****Year
      Ended June 30,****2005**
    
    **2004****CASH
      FLOWS FROM OPERATING ACTIVITIES:**Net
      Loss
    
    $
    (760
    )
    $
    (7,703
    )**Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:**Depreciation
      and amortization
    
    
    94
    
    
    198Impairment
      of goodwill
    
    
    -
    
    
    1,039Loss
      on disposal of equipment
    
    
    23
    
    
    26Provision
      for doubtful accounts
    
    
    2
    
    
    41Amortization
      of deferred employee compensation
    
    
    1,630
    
    
    1,149Amortization
      of deferred financing costs
    
    
    172
    
    
    64**Changes
      in assets and liabilities:**Accounts
      receivable
    
    
    444
    
    
    (637
    )Inventory
    
    
    (292
    )
    
    491Deferred
      project costs
    
    
    (119
    )
    
    (31
    )Prepaid
      expenses and other current assets
    
    
    336
    
    
    (130
    )Other
      assets, net
    
    
    (7
    )
    
    5Accounts
      payable and accrued expenses
    
    
    (412
    )
    
    (946
    )Deferred
      revenues
    
    
    758
    
    
    195**Net
      cash provided by (used in) operating activities**
    
    
    1,869
    
    
    (6,239
    )**CASH
      FLOWS FROM INVESTING ACTIVITIES:**Cash
      released in attorney's escrow account
    
    
    -
    
    
    3,891Purchase
      of property and equipment
    
    
    (161
    )
    
    (285
    )Proceeds
      from disposal of fixed assets
    
    
    53
    
    
    1**Net
      cash (used in) provided by investing activities**
    
    
    (108
    )
    
    3,607**CASH
      FLOWS FROM FINANCING ACTIVITIES:**Proceeds
      from long term debt
    
    
    -
    
    
    1,309Proceeds
      from short-term borrowings
    
    
    1,300
    
    
    -Proceeds
      from exercise of warrants
    
    
    -
    
    
    38Repayment
      of long-term debt
    
    
    (376
    )
    
    -Repayment
      of short-term borrowings
    
    
    (300
    )
    
    -Proceeds
      from issuance of Series D preferred stock
    
    
    -
    
    
    2,051Proceeds
      from exercise of stock options
    
    
    118
    
    
    -**Net
      cash provided by financing activities**
    
    
    742
    
    
    3,398Effect
      of foreign currency exchange rate on cash and cash
      equivalents
    
    
    12
    
    
    2**NET
      INCREASE IN CASH AND CASH EQUIVALENTS**
    
    
    2,515
    
    
    768**CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD**
    
    
    1,124
    
    
    356**CASH
      AND CASH EQUIVALENTS, END OF PERIOD**
    
    $
    3,639
    
    $
    1,124**SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:**Cash
      paid for interest
    
    $
    71
    
    $
    26Beneficial
      conversion feature on Series D preferred stock treated as a
      dividend
    
    $
    -
    
    $
    2,051Issuance
      of common stock in payment of Series D preferred stock
      dividends
    
    $
    696
    
    $
    572Reclass
      of preferred stock rescission liability to equity
    
    $
    2,051
    
    $
    -Issuance
      of warrants related to guarantee of bank credit facility
    
    $
    -
    
    $
    500
 See
accompanying summary of accounting policies and notes to consolidated financial
statements.
  F-7
  **SUMMARY
OF ACCOUNTING POLICIES AND NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.**
 
 **1.** **THE
COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:**
 
 *Nature
of Business Operations*
 
 Voxware,
Inc. and subsidiaries (or the “Company”) is a leading provider of voice-based
technology that optimizes the front line logistics and distribution center
workforce. The Company’s primary product, VoiceLogistics®, enables warehouse
workers to perform a wide array of logistics tasks-such as picking, receiving,
put away, replenishment, loading, returns processing, cycle counting,
cross-docking and order entry-more efficiently and effectively. VoiceLogistics
also gives distribution center management an effective tool for reducing
logistics costs and optimizing complex materials handling processes.
 
 The
VoiceLogistics solution is a combination of software, hardware and professional
services. Enabled by the Company’s patented speech recognition and
patent-pending VoiceXML TM web
browser technologies, it creates a dynamic, real-time link between highly mobile
workers, the warehouse management system ( WMS ), and supervisory personnel. The
Company believes that its solution is unique in the industry because it is the
first web-based, people-centric, interactive speech recognition application
engineered specifically to operate in highly demanding industrial environments.
 
 VoiceLogistics
is sold primarily to large companies that operate warehouses and distribution
centers. The Company has customers from a variety of industry sectors, including
food service, grocery, retail, consumer packaged goods, third party logistics
providers and wholesale distribution. The Company’s technology has the ability
to integrate easily (generally in less than 90 days) with an external WMS.
VoiceLogistics revenues are generated from product sales, license fees,
professional services, and maintenance fees.
 
 The
United Kingdom accounted for 9% and 30% of the Company’s total revenue for
fiscal years 2005 and 2004, respectively.
 
 In
addition to the industrial voice-based solutions business, the Company also
licenses its digital speech coding technologies and products on a limited basis
to customers in the multimedia applications and consumer devices markets.
Although the assets relating to the speech and audio coding business were sold
to Ascend Communications, Inc. (Ascend) (a wholly-owned subsidiary of Lucent
Technologies, Inc.), the sale did not include the Company’s rights and
obligations under its then existing license agreements. While the Company may
continue to take advantage of favorable opportunities to license its speech
coding technologies, the Company does not anticipate dedicating resources to the
development, marketing or licensing of speech coding technologies to potential
new licensees.
 
 The
Company’s operating results may fluctuate significantly in the future as a
result of a variety of factors, including the Company’s ability to compete in
the voice-based logistics market, the budgeting cycles of potential customers,
the lengthy sales cycle of the Company’s solutions, the volume of and revenues
derived from sales of products utilizing our third-party partners network, the
introduction of new products or services by the Company or its competitors,
pricing changes in the industry, the degree of success of the Company’s efforts
to penetrate its target markets, technical difficulties with respect to the use
of products developed by the Company or its licensees, and general economic
conditions.
 
 *Summary
of Significant Accounting Policies*
 **
 **Use
of Estimates**
 
 The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States of America
requires management to make judgments, assumptions and estimates that affect the
amounts reported in the Company’s consolidated financial statements and
accompanying notes. The Company bases its estimates and judgments on historical
experience and on various other assumptions that it believes are reasonable
under the circumstances. However, future events are subject to change and the
best estimates and judgments routinely require adjustment. The amounts of assets
and liabilities reported in the Company’s balance sheets and the amounts of
revenues and expenses reported for each of its fiscal periods are affected by
estimates and assumptions which are used for, but not limited to, the accounting
for allowance for doubtful accounts, warranty costs, impairments, inventory and
income taxes. Actual results could differ from these estimates.
 
 **Principles
of Consolidation**
 
 The
accompanying consolidated financial statements include the financial statements
of Voxware, Inc. and its wholly-owned subsidiaries, Verbex Acquisition
Corporation and Voxware n.v. All significant inter-company balances and
transactions have been eliminated in consolidation.
   F-8
 
 **Revenue
Recognition**
 
  Revenue
is recognized when earned in accordance with applicable accounting standards,
including AICPA Statement of Position (SOP) No. 97-2, “Software Revenue
Recognition,” as amended. SOP No. 81-1, “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts,” applies to the initial
site implementation for certain customers requiring significant customization to
our software. Revenues from product sales and license fees generally are
recognized upon shipment of hardware and applicable software, provided
collection is determined to be probable and there are no significant
post-delivery obligations. Revenues for implementation services are generally
recognized upon completion of the implementation. If an acceptance period is
required to ensure satisfactory delivery of customized software development or
implementation services, as typically occurs for the initial site implementation
for new customers, revenues are recognized upon customer acceptance.
Vendor-specific objective evidence of the fair value of hardware, services, and
most software is determined based upon the price of those elements when sold
separately. Vendor-specific objective evidence of the fair value of certain
software elements that are not sold separately is determined using the residual
method.

Deferred revenue consists of unearned customer deposits and
postcontract customer support (“PCS”) arrangements. Customer deposits are
recognized as revenue upon customer acceptance of the underlying product and
services in conjunction with the recognition of deferred project costs. PCS
arrangements include extended hardware warranty, software maintenance revenues
and depot management service fees. These arrangements, which sometimes include
amounts bundled with initial revenues, are deferred upon invoicing and
recognized as revenue over the term of the warranty or service period, which is
typically one year. Maintenance revenue, including the amounts bundled with
initial or recurring revenues, are recognized over the term of the maintenance
support period, which is typically one year.
 
 The
Company continues to generate royalty revenues from its speech coding
technologies in the form of royalties, periodic license renewal fees, and
maintenance fees. Royalty revenues are recognized at the time of the customer’s
shipment of products incorporating the Company’s technology. Periodic license
fees generally are recognized at the inception of the renewal period, provided
that persuasive evidence of an arrangement exists, pricing is fixed or
determinable, the payment is due within one year, and collection of the
resulting receivable is deemed probable. Maintenance revenue, including the
amounts bundled with initial or recurring revenues, are recognized over the term
of the maintenance support period, which is typically one year.
 
 **Research
and Development**
 
 Research
and development expenditures are charged to operations as incurred. Pursuant to
Statement of Financial Accounting Standards (SFAS) No. 86, “Accounting for the
Cost of Computer Software to be Sold, Leased or Otherwise Marketed,” development
costs incurred in connection with the research and development of software
products and enhancements to existing software products are charged to expense
as incurred until technological feasibility has been established, at which time
such costs are capitalized until the product is available for general release to
customers. To date, the establishment of the technological feasibility of the
Company’s products and general release substantially coincided. As a result,
costs incurred by the Company between completion of the working model and the
point at which the product is ready for general release have been insignificant
and, therefore, the Company has not capitalized any such costs.
 
 **Net
Loss Per Share**
 
 Basic net
loss per share was computed by dividing the net loss available to common
shareholders by the weighted average number of common shares outstanding for the
fiscal years ended June 30, 2005 and 2004. Due to the Company’s net losses for
the fiscal years ended June 30, 2005 and 2004, the effect of including Common
Stock equivalents in the calculation of net loss per share would be
anti-dilutive. Therefore, outstanding Common Stock equivalents of 941,313,679
and 879,972,233 in the fiscal years ended June 30, 2005 and 2004, respectively,
have not been included in the calculation of net loss per share. As a result,
basic net loss per share is the same as diluted net loss per share for the
fiscal years ended June 30, 2005 and 2004.
 
 Basic and
diluted net loss per share was reported as $0.25 in the Form 10-K for the fiscal
year ended June 30, 2004. This was calculated using the weighted number of
shares for the fourth quarter of fiscal 2004. The proper calculation uses the
full year average resulting in basic and diluted net loss per share of
$0.29.
 
 **Cash
and Cash Equivalents**
 
 The
Company currently maintains an investment portfolio consisting mainly of cash
equivalents. Cash and cash equivalents consist of investments in highly liquid
short-term instruments (short-term bank deposits) with maturities of 90 days or
less from the date of purchase.
   F-9
 
 **Accounts
Receivable and Credit Policies**
 
 Accounts
receivable are uncollateralized customer obligations due under normal trade
terms requiring payment within 30 days, depending on contractual terms. Unpaid
accounts do not bear interest. Accounts receivable are stated at the amount
billed to the customer. Payments of accounts receivable are allocated to the
specific invoices identified on the customer’s remittance advice or if
unspecified, are applied to the earliest unpaid invoice.
 
 The
carrying amount of accounts receivable is reduced by a valuation allowance that
reflects management’s best estimate of the amounts that will not be collected.
Customer account balances with invoices dated over 90 days old are considered
delinquent and are reserved for in the valuation allowance. In addition,
management reviews all other accounts receivable balances and based on an
assessment of current creditworthiness estimates the portion, if any, of the
balance that will not be collected.
 
 **Inventory**
 
 We value
our inventory at the lower of average cost (which approximates first-in,
first-out cost) or market. If we believe that demand no longer allows us to sell
our inventory above cost or at all, then we write down that inventory to market
or write-off excess inventory levels.
 
 **Property
and Equipment**
 
 Property
and equipment are stated at cost. Depreciation is computed on a straight-line
basis over the useful lives of the assets, ranging from three to seven years.
Maintenance, repairs and minor replacements are charged to expense as incurred.
 
 **Goodwill
and Intangible Assets**
 
 The
Company evaluates the recoverability of goodwill on an annual basis or in
certain circumstances more often, as required under SFAS 142, “Goodwill and
Other Intangible Assets.” Goodwill is reviewed for impairment by applying a
fair-value based test at the business segment level. A goodwill impairment loss
is recorded for any goodwill that is determined to be impaired. Under SFAS No.
144, “Accounting for the Disposal of Long-Lived Assets,” intangible assets are
evaluated whenever events or changes in circumstances indicate that the carrying
value of the asset may be impaired. An impairment loss is recognized when the
fair value or the estimated future cash flows expected to result from the use of
the asset, including disposition, is less than the carrying value of the asset.
Cash flow estimates in evaluating for impairment represent management’s best
estimates using appropriate assumptions and projections at the time. The Company
in the year ended June 30, 2004, determined that the $1,039,000 of goodwill
recognized in the Voxware n.v. acquisition was completely impaired and, as such,
reflected this amount as impairment in the Statements of Operations for the year
ended June 30, 2004.
 
 **Impairment
of Long-Lived Assets**
 
 The
Company reviews its long-lived assets, including property and equipment, and
intangible assets subject to amortization for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be fully recoverable. To determine the recoverability of its long-lived assets,
the Company evaluates the estimated future undiscounted cash flows that are
directly associated with and that are expected to arise as a direct result of
the use and eventual disposition of the long-lived asset. If the estimated
future undiscounted cash flows demonstrate that recoverability is not probable,
an impairment loss would be recognized. An impairment loss would be calculated
based on the excess carrying amount of the long-lived asset over the long-lived
asset’s fair value.
 
 **Warranty**
 ****
 The
Company warrants all manufacturer defects on its voice-based solutions generally
commencing upon shipment extending for a minimum of three months up to twelve.
The Company accrues warranty costs based on historical experience and
management’s estimates. Accrued warranty costs were $74,000 and $186,000, as of
June 30, 2005 and 2004, respectively.
 
 **Concentration
of Credit Risk**
 
 Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash balances and trade receivables. The Company invests
its excess cash in highly liquid investments (short-term bank deposits). The
Company’s customer base principally comprises distribution and logistics
companies in food service, grocery, retail, consumer packaged goods, third party
logistics providers, wholesale distributors, as well as value-added resellers.
The Company does not typically require collateral from its customers.
   F-10
 
 One
customer accounted for 36% of total revenue for the fiscal year ended June 30,
2005 and 21% of total receivables at that date. Two customers accounted for 26%,
and 16% of revenues for the fiscal year ended June 30, 2004. Accounts receivable
due from these customers as of June 30, 2004 approximated 35%, and 8% of total
receivables, respectively.
 
 **Income
Taxes**
 
 Deferred
income tax assets and liabilities are determined based on differences between
the financial statement reporting and tax basis of assets and liabilities and
are measured using the enacted tax rates and laws that will be in effect when
the differences are expected to reverse. The measurement of deferred income tax
assets is reduced, if necessary, by a valuation allowance for any tax benefits
that are not expected to be realized. The effect on deferred income tax assets
and liabilities of a change in tax rates is recognized in the period that such
tax rate changes are enacted.
 
 **Foreign
Currency Translation**
 
 The
Company’s wholly-owned subsidiary, Voxware n.v., utilizes their local currency
(Euro dollar) as their functional currency. Their assets and liabilities are
translated into U.S. dollars monthly, at exchange rates as of the balance sheet
date. Revenues, expenses, gains and losses are translated monthly, at average
exchange rates during the period. Resulting foreign currency translation
adjustments are included as a component of other comprehensive income (loss).
 
 **Stock-Based
Compensation**
 
 The
Company accounts for employee stock-based compensation in accordance with
Accounting Principals Board (APB) Opinion No. 25, “Accounting for Stock Issued
to Employees,” using an intrinsic value approach to measure compensation
expenses, if any. Under this method, compensation expense is recorded on the
date of the grant only if the current market price of the underlying stock
exceeds the exercise price. Options issued to non-employees are accounted for in
accordance with SFAS No. 123. “Accounting for Stock-Based Compensation”, and
Emerging Issues Task Force ( EITF ) Issue No. 96-18. “Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods and Services,” using a fair value approach.
 SFAS 123
established accounting and disclosure requirements using a fair value-basis
method of accounting for stock-based employee compensation plans. As allowed by
SFAS 123, the Company has elected to continue to follow the intrinsic value
method of accounting as prescribed by APB 25 to account for employee stock
options. Compensation expense was charged to operations in fiscal years 2005 and
2004 respectively as follows:
  **June 30,****2005**
    
    **2004****(in
      thousands)**Cost
      of Product Revenues
    
    $
    5
    
    $
    2Cost
      of Service Revenues
    
    
    44
    
    
    33Research
      and development
    
    
    174
    
    
    118Sales
      and marketing
    
    
    118
    
    
    99General
      and administrative
    
    
    1,289
    
    
    897$
    1,630
    
    $
    1,149
   Deferred
employee compensation of $4,022,000 and $4,937,000 as of June 30, 2005 and 2004,
respectively, is included in the accompanying consolidated financial statements.
In accordance with SFAS 123, the fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following assumptions used for grants in fiscal 2005 and 2004: risk-free
interest rates ranging from 3.66% to 5.00% based on the rate in effect on the
date of grant; no expected dividend yield; expected lives of 8 years for the
options; and expected volatility of 100%. The following table illustrates the
effects on net loss applicable to Common Stockholders and net loss per share
applicable to Common Stockholders if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation:
   F-11
   **Year
      Ended June 30,****2005**
    
    **2004****(in
      thousands, except share data)******Net
      loss applicable to common stockholders:As
      reported
    
    $
    (1,456
    )
    $
    (10,326
    )Add:Stock-based
      employee compensation included in net loss
    
    
    1,630
    
    
    1,149Less:Stock-based
      compensation expense determined underfair-value
      method for all awards
    
    
    (1,732
    )
    
    (3,082
    )Pro
      forma net loss applicable to common stockholders
    
    $
    (1,558
    )
    $
    (12,259
    )Net
      loss per share applicable to common stockholders - basic and
      dilutedAs
      reported
    
    $
    (0.03
    )
    $
    (0.29
    )Pro
      forma
    
    $
    (0.03
    )
    $
    (0.35
    )Weighted
      average number of shares outstanding for use in computingnet
      loss per share applicable to common stockholders
    
    
    57,854
    
    
    35,312
  The pro
forma results above are not intended to be indicative of or a projection of
future results.
 
 **Comprehensive
Income (Loss)**
 
 The
Company has adopted SFAS No. 130, “Reporting Comprehensive Income.”
Comprehensive income is a more inclusive financial reporting methodology that
includes disclosure of certain financial information that historically has not
been recognized in the calculation of net income (loss). SFAS 130 requires that
all items defined as comprehensive income, including changes in the amounts of
unrealized gains and losses on available-for-sale securities, be shown as a
component of comprehensive income (loss). The only items of other comprehensive
income of the Company in the years ended June 30, 2005 and 2004 are foreign
currency translation adjustments.
 
 **Reclassifications**
 
 Certain
amounts contained in the accompanying 2004 Consolidated Financial Statements
have been reclassified to conform to the 2005 presentation.
 
 **Recent
Accounting Pronouncements**
 
 In
December 2004, FASB issued SFAS No. 123R, “Share Based Payment" (“FAS
123R”), requiring
all share-based payments to employees, including grants of employee stock
options, to be recognized as compensation expense in the consolidated financial
statements based upon their fair values. As amended by the Securities and
Exchange Commission (“SEC”) on April 14, 2005, this standard is effective for
the quarter beginning January 1, 2006 for small business public filers. On March
29, 2005 the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107"), which
provides the Staff’s views regarding interactions between FAS 123R and certain
SEC rules and regulations and provides interpretations of the valuation of
share-based payments for public companies. The Company is currently evaluating
FAS 123R and SAB 107 to determine the fair value method to measure compensation
expense, the appropriate assumptions to include in the fair value model and the
transition method to use upon adoption. The impact of the adoption is not known
at this time due to these factors. The effect on the Company’s results of
operations of expensing stock options using the Black-Scholes method is
presented in the accompanying Notes to Consolidated Financial
Statements.
 
 F-12
   
 **2.** **INVENTORY:**
   **June 30,****2005**
    
    **2004****(in
      thousands)**Raw
      materials
    
    $
    181
    
    $
    191Work
      in process
    
    
    338
    
    
    182Finished
      goods
    
    
    231
    
    
    116Less:
      inventory reserve
    
    
    (134)
    
    
    (165)Inventory
      - net
    
    $
    616
    
    $
    324
 **3.** **GOODWILL:**
 
 During
the fiscal year ended June 30, 2003, the Company recorded goodwill of $1,039,000
as a result of its purchase of Voxware, n.v. During the fiscal year ended June
30, 2004, the Company determined the entire $1,039,000 was impaired due to the
Company’s losing key personnel and contacts in continental Europe and
transferring its operations to the United Kingdom. This impairment was reflected
in the consolidated statements of operations for the fiscal year ended June 30,
2004, as an impairment charge. The office was subsequently closed on June 30,
2004.
 
 There was
no goodwill recorded on the Company’s balance sheet during the year ended June
30, 2005.
  **4.** **PROPERTY
AND EQUIPMENT:**
  **June
      30,****2005**
    
    **2004****(In
      thousands)**Equipment
    
    $
    1,338
    
    $
    1,157Leasehold
      improvements
    
    
    91
    
    
    91Furniture
      and fixtures
    
    
    453
    
    
    5551,882
    
    
    1,803Less:
      Accumulated depreciation
    
    
    (1,644
    )
    
    (1,556
    )Property
      and equipment, net
    
    $
    238
    
    $
    247
  Depreciation
expense was approximately $94,000 and $198,000 for the fiscal years ended June
30, 2005 and 2004, respectively. During the fiscal year ended June 30,
2005, assets with a value of $103,000, with $27,000 in related accumulated
depreciation, were sold for $53,000, resulting in a loss on sale of assets of
$23,000. During the fiscal year ended June 30, 2004, assets with a value of
$118,000, with $91,000 in related accumulated depreciation, were sold for
$1,000, resulting in a loss on sale of assets of $26,000.
 
  F-13
  **5.** **ACCOUNTS
PAYABLE AND ACCRUED EXPENSES:**
  **June 30,****2005**
    
    
    **2004****(In
      thousands)**Accounts
      payable - trade
    
    $
    928
    
    $
    1,236Accrued
      compensation and benefits
    
    
    883
    
    
    312Accrued
      professional fees
    
    
    290
    
    
    286Accrued
      royalties
    
    
    45
    
    
    93Accrued
      inventory
    
    
    123
    
    
    126Warranty
      reserves
    
    
    74
    
    
    186Other
      accrued expenses
    
    
    760
    
    
    1,276Accounts
      payable and accrued expenses
    
    $
    3,103
    
    $
    3,515
 ****
 **6.** **DEBT:**
 
 On
December 30, 2003, the Company entered into a credit facility (the “SVB
facility”) with Silicon Valley Bank. The SVB facility initially provided the
Company with $2,000,000 in financing, comprised of a $1,500,000 term loan and
$500,000 working capital facility. The term loan is payable in monthly
installments over a 36-month period commencing February 1, 2004. The SVB
facility bears interest at a rate of prime (6% as of June 30, 2005) plus 1⁄2
percent per annum and is secured by all of the Company’s assets, including its
intellectual property and a guarantee of the Company’s two largest shareholders.
In exchange for the SVB facility guarantee, the shareholders were granted
133,333,333 Series D warrants to purchase shares of the Company’s Series D
Preferred Stock. The warrants are exercisable into shares of the Company’s
Series D Preferred Stock at an exercise price of $0.015 per share.
 
 The
Company engaged Hempstead & Co. as its valuation expert to assist in
determining the fair value of the guarantee for which the warrants were issued.
Based on the work performed by Hempstead & Co., as its valuation expert, the
Company recorded a deferred financing asset of $500,000 on its balance sheet as
of December 31, 2003. This deferred asset is being amortized over 36 months
commencing on January 1, 2004 and has a remaining balance of $250,000 as of June
30, 2005.
 
 On May
28, 2004, the Company entered into a modification agreement to the term loan
deferring the seven monthly principal payments originally scheduled to occur
from June 1, 2004 through December 1, 2004. Commencing on January 1, 2005, and
over the remaining twenty-four (24) payments, the deferred principal payments
will be amortized and added to the original principal payment amount. The
initial term of the loan has not been extended and the final term loan payment,
due on December 1, 2006, shall include all outstanding term loan principal and
accrued interest.
 
 On
December 8, 2004, the Company entered into a second loan modification agreement
with Silicon Valley Bank wherein, among other factors, the working capital line
of credit was renewed to December 27, 2005 and increased from $500,000 to
$2,000,000. The terms of the modification agreement allowed for immediate
availability of $666,667 under this working capital line of credit. The amount
of availability is determined by subtracting from $2,000,000 the amount
outstanding under the term loan. The principal amount due under the term loan
was $1,000,000 as of June 30, 2005, leaving $1,000,000 available under the
working capital line of credit at that date. Effective January 1, 2005, the
monthly principal payment under the term loan is approximately $56,000. These
monthly principal payments under the term loan have the effect of increasing the
available working capital line of credit by an equal amount. The renewal
interest rate is at prime plus one-half percent with a floor rate of prime of
4.5%.
 
 Proceeds
from the $1,500,000 term loan were used to satisfy $1,310,000 of outstanding
Federal and State payroll tax liabilities including related interest of $59,000.
The remaining $190,000 was used for operating activities. As of June 30, 2005,
the Company has borrowed the full $1,000,000 of the available working capital
line of credit.
 
 SVB
granted the Company an extension to deliver its audited financial statements for
June 2004, and its interim financial statements for July 2004 and August 2004,
until October 15, 2004. Due to the Company’s restatements during the previous
year combined with the installation of new management, federal and state income
tax filings were filed late. Silicon Valley Bank waived the requirement for
current reporting and payment of taxes, and allowed the Company until October
13, 2004 to file the required tax returns. All required past due reports and
filings were made as of October 12, 2004 and the Company is in compliance as of
this filing date.
 
 Our
wholly-owned subsidiary, Voxware n.v., had an equipment loan with KBC Bank
Roeselare. The original amount of this loan was €70,000. This equipment loan was
due November 13, 2005, and was payable in 36 equal installments of €2,136.
Interest on the facility was charged at 6.12% per annum, and was secured by a
blanket lien on equipment. This loan was paid in full and closed in December
2004.
   F-14
  
 Future
minimum payments for these Notes are as follows as of June 30, 2005 (in
thousands):
  **Silicon
      Valley Bank****Term
      Loan**
    
    
    **Working**
      **Line**
      **of
      Credit**
    
    
    **Total**Short
      Term
    
    $
    666
    
    $
    1,000
    
    $
    1,666Long
      Term (fiscal year 2007)
    
    
    334
    
    
    
    
    
    334Total
      Debt
    
    $
    1,000
    
    $
    1,000
    
    $
    2,000
 ****
 ****
 **7.** **STOCKHOLDERS’
EQUITY (DEFICIT):**
 **Authorized
Number of Shares**
 During
the year ended June 30, 2005, the Company’s stockholders approved an increase in
the number of authorized shares of Common Stock from 1,035,000,000 up to
1,500,000,000 shares.
 **Private
Placement of Series D Preferred Stock, Series D Preferred Stock**
 **Warrants,
and Common Stock Warrants**
 
 On April
30, 2004, the Company completed a private placement of Series D Preferred Stock
to purchase up to 137,446,500 shares of Series D Preferred Stock, which provided
proceeds of $2,051,000 to the Company.
 
 The
Company’s issuance of 137,446,500 shares of Series D Preferred Stock was valued
at $2,051,000 in the accompanying consolidated financial statements using the
fair value of $0.015 per share. The Company determined that a Beneficial
Conversion Feature (BCF) existed with regards to the Series D private placement
since there was a difference between the Common Stock closing price as quoted on
the Nasdaq Stock Market on the NASDAQ OTC Bulletin Board and the conversion
price available to the holders of the Series D Preferred Stock. The BCF was
limited to the carrying value of the Series D Preferred Stock, which was
determined to be $2,051,000 for the year ended June 30, 2004. The Company
recorded this BCF as a preferred dividend during the year ended June 30,
2004.
 
 Additionally
in 2004, the Company converted 37,011,706 and 198,714 Series D Preferred Stock
warrants into Series D Preferred Stock of the June 27, 2003 and April 30, 2004
issuances, respectively, and exercised 1,000,000 shares of Series D Preferred
Stock into 1,000,000 shares of Common Stock. During the year ended June 30,
2005, 132,476 Series D Preferred Stock warrants were exercised while 9,934,723
shares of Series D Preferred Stock were converted into common stares. The total
issued and outstanding shares of Series D Preferred Stock at June 30, 2005 were
649,621,940 shares.
 
 The
Series D Preferred Stock has a 7% dividend payable in cash or equity, at the
election of Voxware, and each preferred share is convertible into one share of
Voxware Common Stock at an initial conversion price of $0.015 per share. The
Company paid in-kind dividends to holders of the Series D Preferred Stock
through the issuance of 14,952,957 shares and 8,150,499 shares respectively, of
the Company’s Common Stock for the years ended June 30, 2005 and
2004.
 
 If the
Company failed to complete filing of registration statements, as defined in the
Series D Preferred Stock transaction agreements, certain purchasers can receive
additional Common Stock warrants to purchase up to 18,666,667 shares of Common
Stock at an exercise price of $0.015 per share. Such warrants, if issued, would
expire on June 27, 2013. The Company has filed a registration statement in a
timely manner, as required. However, the effective date of the registration
statement was delayed until April 2005 because of comments from the Securities
and Exchange Commission requesting additional information related to the filing
of the registration statement. In August 2005, the holders of the Series D
Preferred Stock waived their rights to receive these warrants in conjunction
with a private placement of Common Stock.
 
 Pursuant
to the transaction documents relating to our Series D Private Placements
consummated in June 2003 and April 2004, and our private placement of Series D
Preferred Stock and Series D Preferred Stock Warrants in December 2003 to two of
our stockholders as consideration for acting as guarantors of our credit
facility, we agreed to provide certain registration rights to the purchasers.
Accordingly, the Company filed a registration statement in a timely manner as
required by the transaction documents. On September 9, 2004, the Securities and
Exchange Commission asserted, among other things, a violation of Section 5 of
the Securities Act in
 
 
 F-15
 
 
 connection
with these transactions. As such, the purchasers of the Preferred Stock related
to the April 2004 offering obtained the right to require the Company to
repurchase the shares sold to the purchasers in the Series D Private Placement
at the original purchase price, plus statutory interest from the date of
purchase for a period of one year following the date of violation. Upon learning
of the SEC’s position in September 2004 the Company sought and obtained waivers
of any right of rescission from the affected shareholders for 100% of the
shares. However, since the waivers were not obtained until after year-end, a
current liability in the amount of $2,051,000 was recorded at June 30, 2004. As
100% of the affected shareholders have since waived their rescission right, this
amount was reclassed from a current liability to Additional Paid in Capital in
September 2004.
 
 In
connection with the Series D Preferred Stock private placement, each respective
Purchaser agreed not to sell any shares of the Company’s Common Stock issued
upon the conversion of the Series D Preferred Stock for a period of one (1) year
from the date of the closing. In addition, each respective Purchaser agreed for
a period of two (2) years from the date of the closing that it shall limit its
sale of any shares of Common Stock issued upon conversion of Series D Preferred
Stock to no more than ten percent (10%) of the previous month’s trading volume
on the principal securities exchange, automated quotation service or
consolidated reporting system upon which the Company’s common Stock is then
listed and not to short sell any shares of Common Stock issued upon conversion
of Series D Preferred Stock. All shares of Series D Preferred Stock rank senior
in liquidation preference to all other securities issued by the Company, and
such shares have similar voting rights as common shares.
 
 As of
June 30, 2005, the Company also has warrants outstanding to purchase 29,662,846
shares of the Company’s Common Stock at exercise prices ranging from $0.015 to
$0.320, the last of which expire June 2013.
 
 As of
June 30, 2005, the Company also has Series D warrants outstanding to purchase
156,879,326 shares of the Company’s Series D Stock at exercise prices ranging
from $0.001 to $0.015, the last of which expire April 2014.
 
 In August
2005, all of the shares of Series D Preferred Stock were converted to Common
Stock and all warrants to purchase Series D Preferred Stock were converted to
warrants to purchase Common Stock. (See Note 11, Subsequent Events for further
discussion.)
 
 **Stock
Option Plans**
 
 Pursuant
to the 1994 Stock Option Plan as amended (1994 Plan), the Company may grant to
eligible individuals incentive stock options (as defined in the Internal Revenue
Code) and nonqualified stock options. As of June 30, 2005, options to purchase
561,125 shares of Common Stock were outstanding under the 1994 Plan, and there
are no additional shares available for future option grants. The period which an
option may be exercised is fixed by the Board of Directors, up to a maximum of
ten years (five years in cases of incentive stock options granted to holders of
10% or more of the combined voting power of all classes of stock of the
Company), and options typically vest over a four-year period.
 
 Additionally,
pursuant to the 1998 Stock Option Plan for Outside Directors (1998 Plan), which
was approved by the Company’s stockholders in January 1998, the Company has
granted a total of 135,000 options at exercise prices of $0.40 to $3.75 per
share. As of June 30, 2005, options to purchase 62,500 shares of Common Stock
were outstanding under the 1998 Plan. Pursuant to the Outside Directors Plan,
each non-employee director of the Company shall receive an option to purchase
30,000 shares of the Company’s Common Stock (Initial Option) on the date of his
or her election or appointment to the Board of Directors, at an exercise price
equal to the Company’s stock price at the end of the day of his or her election
or appointment to the Board of Directors (Initial Grant Date). In addition, on
the date of his or her re-election to the Board of Directors, if he or she is
still a non-employee director on such date and has met certain other
requirements defined in the Outside Directors Plan, he or she shall receive an
option to purchase 10,000 shares of the Company’s Common Stock (Additional
Option) on the date of his or her re-election or appointment to the Board of
Directors, at an exercise price equal to the Company’s stock price at the end of
the day of his or her re-election or appointment to the Board of Directors
(Additional Grant Date). All options granted under the Outside Directors Plan
shall be exercisable as to one-twelfth of the shares issued under each option on
the last day of each of the 12 three-month periods immediately following the
applicable grant date.
 
 In June
2003, the Company’s stockholders approved the 2003 Stock Option Plan (2003
Plan). Pursuant to the 2003 Plan, the Company may grant to eligible individuals
incentive stock options (as defined in the Internal Revenue Code) and
nonqualified stock options. As of June 30, 2005, options to purchase 104,769,692
shares of Common Stock were outstanding under the 2003 Plan. Of such options,
5,000,000 shares were granted to non-employee directors of the Company. The
period during which an option may be exercised is fixed by the Board of
Directors, up to a maximum of ten years (five years in cases of incentive stock
options granted to holders of 10% or more of the combined voting power of all
classes of stock of the Company), and options typically vest over a four-year
period.
 
 The
Company typically would issue stock options at a price equal to the fair market
value on the date of grant. In the event that options are granted at a price
below the trading value on the date of grant, the difference is recorded as
deferred compensation and amortized over the vesting period of the option.
 
 
 F-16
 
 
 Information
relative to the 1994 Plan, 1998 Plan and 2003 Plan are as follows:
 **Shares**
    
    **Range
      of Exercise Price**
      **per
      Share**
    
    ******Weighted
      Price**
      **Per
      Share**Outstanding
      at June 30, 2003 (2,023,229 exercisable)
    
    
    67,927,625
    
    $
    0.015
    
    $
    7.875
    
    $
    2.760Granted
    
    
    46,896,683
    
    
    0.015
    
    
    -
    
    
    0.015Exercised
    
    
    (932,203
    )
    
    0.015
    
    
    -
    
    
    0.015Canceled
    
    
    (34,650,297
    )
    
    0.015
    
    
    4.130
    
    
    0.064Outstanding
      at June 30, 2004 (19,905,593 exercisable)
    
    
    79,241,808
    
    $
    0.015
    
    $
    7.875
    
    $
    0.070Granted
    
    
    47,844,644
    
    
    0.015
    
    
    0.025
    
    
    0.020Exercised
    
    
    (7,271,760
    )
    
    0.015
    
    
    0.020
    
    
    0.016Canceled
    
    
    (14,421,375
    )
    
    0.015
    
    
    7.875
    
    
    0.233Outstanding
      at June 30, 2005 (28,495,373 exercisable)
    
    
    105,393,317
    
    $
    0.015
    
    $
    7.875
    
    $
    0.029
  Information
with respect to options outstanding at June 30, 2005 and 2004 is as follows:
 **Outstanding**
    
    **Exercisable****Exercise
      Price Per Share**
    
    **Number
      of**
      **Shares**
    
    ******Weighted**
      **Average**
      **Exercise**
      **Price**
    
    **Average**
      **Remaining
      Contractual**
      **Life**
    
    **Number
      of**
      **Shares**
    
    ******Weighted**
      **Average**
      **Exercise**
      **Price********(in
      Dollars)**
    
    **(in
      Years)**
    
    
    
    ******(in
      Dollars)**June
      30, 2004$0.015
      - $0.020
    
    
    77,490,558
    
    $
    0.015
    
    
    9.31
    
    
    18,237,937
    
    $
    0.015$0.021
      - $2.000
    
    
    937,375
    
    
    1.076
    
    
    5.23
    
    
    858,000
    
    
    1.154$2.001
      - $5.000
    
    
    727,875
    
    
    3.810
    
    
    4.73
    
    
    723,656
    
    
    3.815$5.001
      - $7.000
    
    
    1,000
    
    
    5.875
    
    
    2.67
    
    
    1,000
    
    
    5.875$7.001
      - $7.880
    
    
    85,000
    
    
    7.776
    
    
    3.40
    
    
    85,000
    
    
    7.776$0.015
      - $7.880
    
    
    79,241,808
    
    $
    0.071
    
    
    9.21
    
    
    19,905,593
    
    $
    0.236June
      30, 2005$0.015
      - $0.020
    
    
    102,394,692
    
    $
    0.017
    
    
    8.81
    
    
    27,903,435
    
    $
    0.016$0.021
      - $2.000
    
    
    2,770,250
    
    
    0.014
    
    
    9.00
    
    
    363,563
    
    
    0.891$2.001
      - $5.000
    
    
    202,375
    
    
    3.782
    
    
    4.55
    
    
    202,375
    
    
    3.782$5.001
      - $7.000
    
    
    1,000
    
    
    5.875
    
    
    1.67
    
    
    1,000
    
    
    5.875$7.001
      - $7.880
    
    
    25,000
    
    
    7.538
    
    
    4.75
    
    
    25,000
    
    
    7.538$0.015
      - $7.880
    
    
    105,393,317
    
    $
    0.071
    
    
    8.80
    
    
    28,495,373
    
    $
    0.060
  The
resulting pro forma compensation cost may not be representative of that expected
in future years. The weighted average fair value of options granted was $0.020
and $0.015 for the fiscal years ended June 30, 2005 and 2004,
respectively.
 
 **Annual
Stock Grant Retainer to Directors**
 
 In
January 1998 the Company’s Board of Directors and stockholders approved a plan,
which provides for the granting of common option shares to non-employee
directors. Each calendar year in which the Company holds an Annual Meeting of
Stockholders, each non-employee director will receive shares valued at $10,000
based on the market price of the Company’s Common Stock, as defined in the plan.
For the years ended June 30, 2005, and 2004, there were no shares of Common
Stock granted pursuant to this plan.
 
 Since
April 2001, all non-employee directors have volunteered to not be paid for
attending any regular or special meeting of any committee of the Board of
Directors until further notice. Accordingly, the Company has not
accrued any charges during the period pursuant to this plan for the grant
of Common Stock for attendance by members of the Board of Directors at any
regular or special meeting.
 
  F-17
 ****
 
 **8.** **401(k)
SAVINGS PLAN:**
 
 Effective
January 1997, the Company adopted a 401(k) Savings Plan (401(k) Plan) that is
available to all employees. The 401(k) Plan permits participants to contribute
up to 10% of their base salary to the 401(k) Plan, not to exceed the limits
established by the Internal Revenue Code. The Company previously matched 25% of
employee contributions on the initial 6% contributed by employees. Effective
January 1, 2002, the Company match was suspended.
 
 Employees
vest immediately in all employee contributions and Company match contributions.
The Company recorded no compensation expenses in connection with the 401(k) Plan
for the years ended June 30, 2005 and 2004.
 
 **9.** **INCOME
TAXES:**
 
 There was
no provision for (benefit from) income taxes reflected in the consolidated
financial statements for the years ended June 30, 2005 and 2004
because of losses which were generated during the years for which no future tax
benefit has been provided.
 
 Income
before income taxes for the years ended June 30, 2005 and 2004 includes foreign
subsidiary income of $0 and $99,000, respectively.
 
 Deferred
tax assets reflects the impact of temporary differences as follows:
 June
      30,(in
      thousands)
    
    2005
    
    2004Deferred
      tax assets:Net
      operating loss carryforwards
    
    $
    13,010
    
    $
    13,485Allowance
      for doubtful accounts
    
    
    42
    
    
    41Accrued
      expenses
    
    
    348
    
    
    238Research
      and development credit
    
    
    966
    
    
    966Total
      deferred tax assets
    
    
    14,366
    
    
    14,730Valuation
      Allowance
    
    
    (14,356
    )
    
    (14,689
    )Deferred
      tax liabilities:Depreciation
    
    
    (10
    )
    
    (41
    )Net
      deferred tax assets
    
    $
    -
    
    $
    -
  As of
June 30, 2005, the Company had approximately $38,000,000 of federal net
operating loss carry-forwards for tax reporting purposes available to offset
future taxable income; such carry-forwards begin to expire in 2009. Net
operating loss carry-forwards were $39,000,000 as of June 30, 2004. The Company
has established a full valuation allowance against their deferred tax assets.
The Company is not aware of any factors which would generate significant
differences between taxable income and pre-tax accounting income in future years
except for the reversal of current or future net deductible temporary
differences. A full valuation allowance has been provided on the net
deferred tax asset because of the uncertainty regarding realization of the
deferred asset as a result of the operating losses incurred to
date.
 
 The Tax
Reform Act of 1986 enacted a complex set of rules limiting the potential
utilization of net operating loss and tax credit carry-forwards in periods
following a corporate “ownership change.” In general, for federal income tax
purposes, an ownership change is deemed to occur if the percentage of stock of a
loss corporation owned (actually, constructively and, in some cases, deemed) by
one or more “5% shareholders” has increased by more than 50 percentage points
over the lowest percentage of such stock owned during a three-year testing
period. During 2003, such a change in ownership occurred. As a result of the
change, the Company’s ability to utilize certain of its net operating loss
carry-forwards will be limited.
 
 Research
and development credits expire in
accordance with provisions of applicable tax law and have remaining lives
ranging from 6 to 20 years. The
Company had no accumulated earnings in Europe.
 
 **10.** **COMMITMENTS
AND CONTINGENCIES:**
 
 The
Company leases its office facilities and certain equipment under operating
leases with remaining non-cancelable lease terms generally in excess of one
year. Rent expense, including escalations, was approximately $431,000 and
$382,000 for the years ended June 30, 2005 and 2004, respectively. Future
minimum rental payments for the Company’s office facilities and equipment under
operating leases as of June 30, 2005 are as follows:
   F-18
  Year
      Ending June 30,
    
    (in
      thousands)2006
    
    $
    4232007
    
    
    3132008
    
    
    162009
    
    
    1$
    753
  The
Company is subject to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. While the outcome of
these claims cannot be predicted with certainty, management does not believe
that the outcome of any of these legal matters will have a material adverse
effect on the Company’s business, operating results or financial condition.
 
 The
Company has a three-year employment agreement with two of its officers. The
agreement provides for minimum salary levels, adjusted annually at the
discretion of the Board of Directors, and a bonus based upon the Company’s
performance as measured against a business plan approved by the Company’s Board
of Directors.
  **11.** **SUBSEQUENT
EVENTS:**
 
 In August
2005, the Company executed transaction documents for a private placement of
206,249,997 shares of its Common Stock at $0.032 per share (the “Private
Placement”). Aggregate proceeds to the Company were approximately $6,200,000,
net of expenses and commissions. In connection with the Private Placement, the
holders of a majority of the Company’s Series D Preferred Stock agreed to
convert all of the Company’s outstanding shares of Series D Preferred Stock into
shares of Common Stock. As a result, 649,016,089 shares of Series D Preferred
Stock were converted into 649,016,089 shares of Common Stock and 1,902,857
shares of Common Stock was issued in lieu of paying cash dividends on the Series
D Preferred Stock from July 1, 2005 to August 11, 2005. As of August 31, 2005,
taking into consideration the August 2005 sales of Common Stock and conversion
of the Series D Preferred Stock, the Company has 936,277,855 shares of Common
Stock issued and outstanding. No shares of Series D Preferred Stock remain
outstanding. Further, the holders of a majority of the Company’s Series D
Preferred Stock agreed to amend and restate all of the Company’s outstanding
warrants to purchase shares of Series D Preferred Stock into warrants to
purchase shares of Common Stock of the Company. In addition, certain holders of
Series D Preferred Stock waived their right to receive options to purchase up to
18,666,667 shares of Common Stock as a result of delays in registering shares
issued under the 2003 and 2004 sales of Series D Preferred Stock. As of August
31, 2005, 167,875,505 warrants to purchase the Company’s Common Stock ranging in
price from $.001 to $.32 with a life no greater than April 2014 were
outstanding.
 
 In
connection with the private placement, and in accordance with the terms of the
Company’s by-laws, the Company’s Board of Directors has been expanded from six
members to seven members. Pursuant to the relevant terms of the Purchase
Agreement and the Amended and Restated Stockholders Agreement between the
Company and the investors named therein, certain investors obtained the right to
appoint a director to the Company’s Board of Directors to fill the vacancy
created by the Board’s expansion. As such, James Alexandre was elected to the
Board of Directors to fill the seat created in connection with the Private
Placement.
 
 F-19