USA Technologies, Inc.

Notes to Consolidated Financial Statements

9. INCOME TAXES

At June 30, 2006 and 2005, the Company had net operating loss carryforwards of approximately $111,024,000 and $98,428,000, respectively, to offset future taxable income expiring through approximately 2026. In addition, the Company had a capital loss carryforward of approximately $1,360,000 and $1,264,000 as of June 30, 2006 and 2005, respectively, that expires in 2011. At June 30, 2006 and 2005, the Company recorded net deferred tax assets of approximately $43,882,000 and $39,143,000, respectively, which was reduced by a valuation allowance of the same amount as the realization of the deferred tax asset is not likely, principally due to the lack of earnings history.

The timing and extent to which the Company can utilize future tax deductions in any year may be limited by provisions of the Internal Revenue Code regarding changes in ownership of corporations. Stitch had net operating loss carryforwards of approximately $11,800,000 at the acquisition date. Such net operating loss carryforwards are limited under the same provisions as to the amount available to offset future taxable income and to the extent used in any given year, will result in decreases to goodwill as opposed to income tax expense.

The deferred tax assets arose primarily from the use of different accounting methods for financial statement and income tax reporting purposes as follows:

		JUNE 30
		2006			2005
Deferred tax assets:
Net operating loss and capital loss carryforwards		$	41,833,000		$	37,508,000
Deferred research and development costs			234,000			373,000
Software development costs			1,081,000			1,297,000
Other			1,430,000			780,000
			44,578,000			39,958,000
Deferred tax liabilities:
Intangibles			(696,000	)		(815,000	)
			43,882,000			39,143,000
Valuation allowance			(43,882,000	)		(39,143,000	)
Deferred tax assets, net		$	—		$	—

 

F-21

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES

The Company has issued six series of Senior Notes each with an annual interest rate of 12% and are convertible into shares of the Company's Common Stock for which there were outstanding obligations as of June 30, 2006, 2005 or 2004. These Senior Notes were scheduled to mature on December 31, 2004 ("2004 Senior Notes"), December 31, 2005 ("2005 Senior Notes"), December 31, 2006, December 31, 2007, December 31, 2008, and December 31, 2009. The Company has also issued three series of Senior Notes each with an annual interest rate of 10% and are convertible into shares of the Company's Common Stock for which there were outstanding obligations as of June 30, 2006 or June 30, 2005. These Senior Notes were scheduled to mature on June 30, 2007, December 31, 2008, and December 31, 2010.

The 2004 Senior Notes were issued pursuant to a private placement offering authorized during the year ended June 30, 2002. The 2004 Senior Notes were convertible into shares of Common Stock at $40 per share at any time through December 31, 2004. Certain shareholders of the Company who held warrants to purchase shares of Common Stock exercisable at $50 per share were offered the opportunity to cancel those warrants and receive an equivalent number of new warrants exercisable at $10 per share if they invested in the 2004 Senior Note offering. The fair value of the new warrants issued and the intrinsic value of the beneficial conversion feature associated with the 2004 Senior Notes created debt discount that was allocated to equity and was amortized to interest expense through December 31, 2004. During January 2005, the Company repaid $131,152 of these Senior Notes and agreed with the holders of the remaining $320,000 of these notes to extend the maturity date to March 31, 2005. In exchange for extending the maturity date, the Company authorized a reduction of the conversion price to $10 resulting in the recording of $32,000 as debt discount related to the intrinsic value of this beneficial conversion feature, which was amortized through March 31, 2005. The maturity date of these notes was further extended to June 30, 2009 in March 2006, with no other terms being modified.

The 2005 Senior Notes were issued pursuant to a private placement offering authorized during the year ended June 30, 2002 that included the issuance of 200 shares of Common Stock for each $10,000 of face amount of notes issued. The 2005 Senior Notes were convertible into shares of Common Stock at $20 per share at any time through December 31, 2005. The fair value of the Common Stock issued and the intrinsic value of beneficial conversion feature associated with the 2005 Senior Notes created debt discount that was allocated to equity and was amortized to interest expense through December 31, 2005. During the years ended June 30, 2006, 2005 and 2004, $130,000, $21,000, and $514,359, respectively, of the 2005 Senior Notes were converted into 6,500, 1,050, and 25,717, shares of Common Stock, respectively. On January 1, 2006, the Company repaid all of the outstanding 2005 Senior Notes for a total repayment of $910,262.

In March 2003, the Company granted to the holders of Senior Notes due December 31, 2003 (“2003 Senior Notes”) and the 2004 Senior Notes the right to extend the maturity date of these Senior Notes to December 31, 2006 (“2006 Senior Notes”) and December 31, 2007 (“2007 Senior Notes”), respectively, in exchange for reducing the conversion rates from $125 to $20 per share for the 2003 Senior Notes and from $40 to $20 per share for the 2004 Senior Notes. This offer expired on December 31, 2003. During the years ended June 30, 2004 and 2003, Senior Note holders agreed to exchange an aggregate of $2,303,953 and $6,911,397, respectively, of 2003 Senior Notes and 2004 Senior Notes for new notes maturing in 2006 and 2007. The exchange of the 2003 Senior Notes and 2004 Senior Notes to the 2006 Senior Notes and 2007 Senior Notes was deemed a significant modification of the terms of the Senior Notes and, accordingly, the exchanged 2003 Senior Notes and 2004 Senior Notes have been extinguished. The unamortized debt discount and other issuance costs remaining on the 2003 Senior Notes and 2004 Senior Notes exchanged and extinguished were expensed ($318,915 for the year ended June 30, 2004) and have been reported as a loss on debt modification in the Consolidated Statements of Operations. Included in the loss on debt modification for the year ended June 30, 2004 is $277,279 that occurred during the three months ended September 30, 2003. During fiscal year 2003 and 2004, the Company's share price was often greater than the conversion price at times when Senior Note holders exchanged their 2003 and 2004 Senior Notes for 2006 and 2007 Senior Notes. The intrinsic value of this beneficial conversion feature created debt discount that was allocated to equity and is being amortized to interest expense through December 31, 2006 and 2007, respectively.

F-22

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES (CONTINUED)

During the year ended June 30, 2006 and 2004, $10,000 and $1,478,000, respectively, of the 2006 Senior Notes were converted into 500 and 73,900 shares of Common Stock, respectively. During the years ended June 30, 2006, 2005 and 2004, $10,000, $34,381, and $848,619, respectively, of the 2007 Senior Notes were converted into 500, 1,719 and 42,430 shares of Common Stock, respectively. During May 2006, the Company repaid all of the 2006 Senior Notes for a total principal repayment of $1,683,500.

On November 3, 2004, the Company authorized the issuance of up to $2,500,000 of Senior Notes convertible into shares of Common Stock at $10 per share and maturing on June 30, 2007 (2007-B Senior Notes”). Interest is payable quarterly at a rate of 10% per annum. Participation in the Senior Note offering was offered to the holders of certain warrants issued in conjunction with the payment of interest on Senior Notes (see “Additional Interest Warrants” in Note 13), holders of the warrants issued in conjunction with the 2004-A Private Placement Offering, and to an accredited investor and current warrant holder. Due to the limited number of authorized shares available for issuance, the terms of the offering provided that all of such warrant holder’s warrants would be cancelled if they participated in the offering. Through the last day of the offering, the Company received $1,550,789 in gross proceeds from sales of the 2007-B Senior Notes and 56,370 shares underlying the warrants were cancelled. As the Company’s share price on the day of issuance of each of these Senior Notes was greater than the conversion price of $10, the Company recorded the intrinsic value of this beneficial conversion feature totaling $518,645 as additional debt discount, which is being amortized to interest expense through the maturity date of these Senior Notes. During the years ended June 30, 2006 and 2005, $56,136 and $460,827, respectively, of the 2007-B Senior Notes were converted into 5,613 and 46,082, respectively, shares of Common Stock.

 

On February 23, 2005, the Company authorized the issuance of up to $1,755,000 of Senior Notes, due April 30, 2005 to accredited investors (the “2005-B Senior Notes”) with interest payable at a rate of 10% per annum. In connection with this offering, the Company paid a due diligence fee of $27,000 to an accredited investor. The Company received $1,755,000 in gross proceeds from the 2005-B Senior Note offering. On March 22, 2005, the Company authorized an offer whereby the holders of the 2005-B Senior Notes had the right through April 30, 2005 to exchange their 2005-B Senior Notes for Senior Notes convertible into shares of Common Stock at $10 per share maturing on December 31, 2010 (“2010 Senior Notes”). Interest on the 2010 Senior Notes is payable quarterly at 10% per annum. During March 2005, all of the 2005-B Senior Notes were exchanged for 2010 Senior Notes. As the Company’s share price on the day of issuance of each of these Senior Notes was greater than the conversion price of $10, the Company recorded the intrinsic value of this beneficial conversion feature totaling $1,394,200 as additional debt discount, which is being amortized to interest expense through the maturity date of these Senior Notes. During the years ended June 30, 2006 and 2005, $98,000 and $415,000, respectively, of the 2010 Senior Notes were converted into 9,800 and 41,500 shares, respectively, of Common Stock.

On March 22, 2005, the Company authorized an offer to the holders of the Senior Notes whereby those holders could elect to extend the maturity date of their Senior Notes (the “Senior Note Extension Offer”). Holders of 2005 Senior Notes had the right to extend their maturity to December 31, 2008 (“2008 Senior Notes”) and holders of 2006 Senior Notes had the right to elect to extend their maturity to December 31, 2009 (“2009 Senior Notes”). Principal on the Senior Notes extended was not be prepaid prior to April 1, 2006. During the year ended June 30, 2005, these Senior Note holders agreed to exchange an aggregate of $1,920,651 and $1,520,000, respectively, of 2005 Senior Notes and 2006 Senior Notes for new notes maturing in 2008 and 2009. The exchange of the 2005 Senior Notes and 2006 Senior Notes to the 2008 Senior Notes and 2009 Senior Notes was not deemed a significant modification of the terms of the Senior Notes and, accordingly, the unamortized debt discount and other issuance costs remaining on the 2005 Senior Notes and 2006 Senior Notes exchanged will be amortized to interest expense through the maturity date of the new notes.

F-23

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES (CONTINUED)

During October 2005, the Company approved a non-dilutive private placement offering of up to $2,333,333 of principal amount 10% Convertible Senior Notes due December 31, 2008 (the “2008-C Senior Notes”) to the holders of the 2005-D Common Stock Warrants, which were received in connection with an offering that commenced on March 22, 2005 and ended on April 15, 2005 (“2005-D Private Placement Offering”) in which accredited investors purchased Common Stock at $15 per share. The 2008-C Senior Note offering terminated on November 30, 2005. The holders of the 2005-D Common Stock Warrants had the right to purchase the principal amount of the 2008-C Senior Notes equal to the number of 2005-D Common Stock Warrants multiplied by $10. Upon the investment in the offering, the corresponding 2005-D Common Stock Warrants were cancelled, resulting in a non-dilutive offering. Interest on the 2008-C Senior Notes shall be paid on a quarterly basis in arrears at the rate of 10% per annum with the outstanding principal amount of the 2008-C Senior Notes together with all accrued and unpaid interest thereon to be paid in full no later than December 31, 2008. The 2008-C Senior Notes are convertible at any time into Common Stock at the rate of $10 per share. As the Company’s share price on the day of issuance of each of these Senior Notes was greater than the conversion price of $10, the Company recorded the intrinsic value of this beneficial conversion feature totaling $230,864 as additional debt discount, which is being amortized to interest expense through the maturity date of these Senior Notes. For each $10,000 investment in the 2008-C Senior Notes, the subscriber received a special purchase right to purchase up to 1,000 shares of Common Stock at $20 per share at any time on or before December 31, 2008. The Company issued $544,944 of the 2008-C Senior Notes during the six months ended December 31, 2005 and issued special purchase rights to acquire up to 54,494 shares of Common Stock at $20 per share. During January 2006, the holder of each special purchase right agreed to exchange the purchase rights for warrants to purchase shares of Common Stock at $20 at anytime prior to December 31, 2008. The fair value of the purchase rights issued in conjunction with the 2008-C Senior Notes created debt discount totaled $184,542, which is being amortized to interest expense through the maturity date of these Senior Notes. The fair value was estimated using the Black-Scholes model with the following assumptions: dividend yield of 0%, expected stock price volatility of 0.868, risk-free interest rate of 4.0%, and an expected life of three years. During the year ended June 30, 2006, $363,333 of the 2008-C Senior Notes were converted into 36,333 shares of Common Stock.

During October 2005, the Company approved a non-dilutive private placement offering of up to $1,000,000 of Notes (“Bridge Notes”) due January 6, 2006 with interest payable on the due date at a rate of 10% per annum. The offering terminated on November 30, 2005. The Company issued $770,000 of the Bridge Notes. As all of the aforementioned 2008-C Senior Notes were not subscribed on the due date of the Bridge Notes, the Bridge Notes were automatically exchanged on January 6, 2006, in accordance with the original terms of Bridge Notes, for a like principal amount of new Convertible Senior Notes due December 31, 2010 (“2010-B Senior Notes”). Interest on the 2010-B Senior Notes is payable quarterly at 10% per annum and is convertible into Common Shares at $10 per share. As the Company’s share price on the day of issuance of each of these Senior Notes was greater than the conversion price of $10, the Company recorded the intrinsic value of this beneficial conversion feature totaling $321,399 as additional debt discount, which is being amortized to interest expense through the maturity date of these Senior Notes. In addition, for each $10,000 of 2010-B Senior Notes issued in exchange for the Bridge Notes, the Company also issued special purchase rights that enable the holder to purchase up to 1,000 shares of Common Stock at $20 per share through December 31, 2008. The Company issued $770,000 of the 2010-B Senior Notes and issued special purchase rights to acquire up to 77,000 shares of Common Stock at $20 per share. During January 2006, the holder of each special purchase right agreed to exchange the purchase rights for warrants to purchase shares of Common Stock at $20 at anytime prior to December 31, 2008. The fair value of the purchase rights issued in conjunction with the 2010-B Senior Notes created debt discount totaled $244,399, which is being amortized to interest expense through the maturity date of these Senior Notes. The fair value was estimated using the Black-Scholes model with the following assumptions: dividend yield of 0%, expected stock price volatility of 0.844, risk-free interest rate of 4.0%, and an expected life of three years.

F-24

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES (CONTINUED)

Through December 31, 2003, the holders of the Senior Notes had the right to purchase shares of the Company's Common Stock at $20 per share using quarterly interest payments that were due in lieu of a cash payment of the interest. Additionally, for each share purchased, the note holder was entitled to receive a warrant to purchase one share of the Company's Common Stock at $20 per share exercisable at any time through June 30, 2004 (extended to August 30, 2004). For the year ended June 30, 2004, 10,612 shares of Common Stock were issued for payment of interest due of $212,238. The fair value of the warrants issued and the beneficial conversion feature related to the $20 per share rate used to convert the interest to shares of Common Stock totaled $266,258 for the year ended June 30, 2004 and have been recorded as additional interest expense. There were no shares of Common Stock issued for payment of interest on the Senior Notes during the years ended June 30, 2005 and 2006.

A summary of the activity for the Senior Notes for the years ended June 30, 2006 and 2005 follows:

		Senior Notes Maturing December 31,
		2003			2004			2005			2006			2007			2008			2009			2010
		(2003 Senior			(2004 Senior			(2005 Senior			(2006 Senior			(2007 Senior			(2008 & 2008-C			(2009 Senior			(2010 & 2010-B
		Notes)			Notes)			Notes)			Notes)			Notes)			Senior Notes)			Notes)			Senior Notes)
Face amount of Senior Notes
Balance, June 30, 2004		$	—		$	451,152		$	3,011,791		$	3,213,500		$	3,019,397		$	—		$	—		$	—
Issued for cash			—			—			—			—			—			—			—			—
Repayment			—			(131,152	)		(12,735	)		—			—			—			—			—
2004 Senior Notes exchanged
for June 30, 2006 Senior
Notes			—			(320,000	)		—			—			—			—			—			—
2005 and 2006 Senior Notes
exchanged for 2008 and 2009
Senior Notes			—			—			(1,920,651	)		(1,520,000	)		—			1,920,651			1,520,000			—
2005-B Senior Notes issued
for cash and subsequently
exchanged for 2010 Senior
Notes			—			—			—			—			—			—			—			1,755,000
Conversions to Common Stock			—			—			(21,000	)		—			(34,381	)		—			—			(415,000	)
Balance, June 30, 2005		$	—		$	—		$	1,057,405		$	1,693,500		$	2,985,016		$	1,920,651		$	1,520,000		$	1,340,000
2008-C Issued for cash			—			—			—			—			—			544,944			—			—
Bridge Notes converted into
2010-B Senior Notes			—			—			—			—			—			—			—			770,000
Repayment			—			—			(927,405	)		(1,683,500	)		(12,500	)		(5,343	)		—			—
Conversions to Common Stock			—			—			(130,000	)		(10,000	)		(10,000	)		(363,333	)		—			(98,000	)
Balance, June 30, 2006		$	—		$	—		$	—		$	—		$	2,962,516		$	2,096,919		$	1,520,000		$	2,012,000

		Senior Notes Maturing
		June 30,
		2009			2007
					(2007-B Senior
					Notes)
Face amount of Senior Notes
Balance, June 30, 2004		$	—		$	—
Issued for cash			—			1,550,790
2004 Senior Notes exchanged
for June 30, 2006 Senior
Notes			320,000			—
Conversions to Common Stock			—			(460,827	)
Balance, June 30, 2005		$	320,000		$	1,089,962
Repayment			—			(50,000	)
Conversions to Common Stock			—			(56,136	)
Balance, June 30, 2006		$	320,000		$	983,826

 

F-25

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES (CONTINUED)

		Senior Notes Maturing December 31,
		2003			2004			2005			2006			2007			2008			2009			2010
		(2003 Senior			(2004 Senior			(2005 Senior			(2006 Senior			(2007 Senior			(2008 & 2008-C			(2009 Senior			(2010 & 2010-B
		Notes)			Notes)			Notes)			Notes)			Notes)			Senior Notes)			Notes)			Senior Notes)
Debt discount and other
issuance costs
Unamortized costs at
June 30, 2003		$	(80,233	)	$	(453,930	)	$	(2,153,223	)	$	(1,104,169	)	$	(596,852	)	$	—		$	—		$	—
Debt discount from issuances			—			—			—			(1,155,475	)		(825,532	)		—			—			—
Amortization and write-off of
unamortized costs upon
conversions to Common Stock			32,803			133,180			1,052,231			1,329,255			827,064			—			—			—
Loss on modification for
exchanges of 2003 and 2004
Senior Notes for 2006 and
2007 Senior Notes			47,430			271,485			—			—			—			—			—			—
Unamortized costs at
June 30, 2004			—			(49,265	)		(1,100,992	)		(930,389	)		(595,320	)		—			—			—
Debt discount from issuance			—			—			358,659			308,052			—			(358,659	)		(308,052	)		(1,394,200	)
Amortization and write off
of unamortized costs upon
conversions to Common
Stock			—			49,265			617,089			328,148			174,933			23,911			16,213			376,778
Unamortized costs at
June 30, 2005		$	—		$	—		$	(125,244	)	$	(294,189	)	$	(420,387	)	$	(334,748	)	$	(291,839	)	$	(1,017,422	)
Debt discount from issuance			—			—			—			—			—			(415,406	)		—			(565,798	)
Amortization and write off
of unamortized costs upon
conversions to Common
Stock			—			—			125,244			294,189			170,061			402,128			64,853			302,526
Unamortized costs at
June 30, 2006		$	—		$	—		$	—		$	—		$	(250,326	)	$	(348,026	)	$	(226,986	)	$	(1,280,694	)
Senior Notes reflected in the
Consolidated Balance Sheet:
June 30, 2005
Face amount		$	—		$	—		$	1,057,405		$	1,693,500		$	2,985,016		$	1,920,651		$	1,520,000		$	1,340,000
Unamortized costs			—			—			(125,244	)		(294,189	)		(420,387	)		(334,748	)		(291,839	)		(1,017,422	)
		$	—		$	—		$	932,161		$	1,399,311		$	2,564,629		$	1,585,903		$	1,228,161		$	322,578
June 30, 2006
Face amount		$	—		$	—		$	—		$	—		$	2,962,516		$	2,096,919		$	1,520,000		$	2,012,000
Unamortized costs			—			—			—			—			(250,326	)		(348,026	)		(226,986	)		(1,280,694	)
		$	—		$	—		$	—		$	—		$	2,712,190		$	1,748,893		$	1,293,014		$	731,306

F-26

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES (CONTINUED)

		Senior Notes Maturing
		June 30,
		2009			2007
					(2007-B Senior
					Notes)
Debt discount and other
issuance costs
Unamortized costs at
June 30, 2004		$	—		$	—
Debt discount from issuance			—			(518,645	)
Amortization and write off
of unamortized costs upon
conversions to Common
Stock			—			225,415
Unamortized costs at
June 30, 2005		$	—		$	(293,230	)
Debt discount from issuance			—			—
Amortization and write off
of unamortized costs upon
conversions to Common
Stock			—			160,890
Unamortized costs at
June 30, 2006		$	—		$	(132,340	)
Senior Notes reflected in the
Consolidated Balance Sheet:
June 30, 2005
Face amount		$	320,000		$	1,089,962
Unamortized costs			—		$	(293,230	)
		$	320,000		$	796,732
June 30, 2006
Face amount		$	320,000		$	983,826
Unamortized costs			—		$	(132,340	)
		$	320,000		$	851,486

 

F-27

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

10. SENIOR NOTES (CONTINUED)

Aggregate maturities of Senior Notes as of June 30, 2006 are as follows:

2007		$	3,946,342
2008			2,096,919
2009			1,840,000
2010			2,012,000
		$	9,895,261
Less discount			2,238,372
		$	7,656,889

 

11. PREFERRED STOCK

The authorized Preferred Stock may be issued from time to time in one or more series, each series with such rights, preferences or restrictions as determined by the Board of Directors. Each share of Series A Preferred Stock shall have the right to one-hundredth of a vote and is convertible at any time into one-hundredth of a share of Common Stock. Each share of Common Stock entitles the holder to one voting right. Series A Preferred Stock provides for an annual cumulative dividend of $1.50 per share, payable when, as and if declared by the Board of Directors, to the shareholders of record in equal parts on February 1 and August 1 of each year. Any and all accumulated and unpaid cash dividends on the Series A Preferred Stock must be declared and paid prior to the declaration and payment of any dividends on the Common Stock.

Cumulative unpaid dividends at June 30, 2006 and 2005 amounted to $8,226,261 and $7,461,293, respectively. Cumulative unpaid dividends are convertible into common shares at $1,000 per common share at the option of the shareholder. During the years ended June 30, 2006 and 2004, certain holders of the Preferred Stock converted 1,200 and 1,750, respectively, into 12 and 17 shares of Common Stock, respectively. Certain of these shareholders also converted cumulative preferred dividends of $18,320 and $22,440, respectively, into 18 and 22 shares of Common Stock during the years ended June 30, 2006 and 2004, respectively. There were no conversions of preferred stock or cumulative preferred dividends during the year ended June 30, 2005. The Series A Preferred Stock may be called for redemption at the option of the Board of Directors at any time on and after January 1, 1998 for a price of $11.00 per share plus payment of all accrued and unpaid dividends. No such redemption has occurred as of June 30, 2004, 2005, or 2006. In the event of any liquidation, the holders of shares of Series A Preferred Stock issued shall be entitled to receive $10.00 for each outstanding share plus all cumulative unpaid dividends. If funds are insufficient for this distribution, the assets available will be distributed ratably among the preferred shareholders.

F-28

---

 

USA Technologies, Inc.

Notes to Consolidated Financial Statements

16. COMMITMENTS AND CONTINGENCIES (CONTINUED)

On May 11, 2006, the Company and Mr. Jensen entered into an Amended and Restated Employment Agreement pursuant to which the term of Mr. Jensen’s employment with the Company was extended to June 30, 2009. Effective May 11, 2006, Mr. Jensen’s base salary was increased to $325,000 per annum. Mr. Jensen’s base salary had not been increased since January 1, 2004. The Agreement requires Mr. Jensen to devote his full time and attention to the business and affairs of the Company, and obligates him not to engage in any investments or activities which would compete with the Company during the term of the Agreement and for a period of one year thereafter. Mr. Jensen was granted the right (exercisable at any time prior to the 60th day following the commencement of each fiscal year) to elect to have one-half of his base salary for each of the fiscal years ending June 30, 2007, June 30, 2008, and June 30, 2009 paid in shares of Common Stock rather than cash. Mr. Jensen has elected to receive shares in lieu of cash for one-half of his base salary for the fiscal year ending June 30, 2007. As a result of such election, 22,080 shares will be issued to him which will vest as follows: 5,520 on July 1, 2006; 5,520 on October 1, 2006; 5,520 on January 1, 2007; and 5,520 on April 1, 2007. Mr. Jensen was also granted 75,000 shares of Common Stock and an additional amount of options to purchase up to 75,000 shares of Common Stock at $7.50 per share. The 75,000 shares of Common Stock vest as follows: 25,000 on June 1, 2006; 25,000 on January 1, 2007; and 25,000 on June 1, 2007. The options vest as follows: 25,000 on May 11, 2006; 25,000 on June 30, 2007; and 25,000 on June 30, 2008. The options may be exercised at any time within 5 years of vesting. The Company recorded a non-cash compensation charge of $264,000 and $172,127 related to the grant of restricted Common Stock and Common Stock Options, respectively, during the fiscal year ended June 30, 2006. See note 13 for additional option disclosures. All of the shares granted to or to be issued to Mr. Jensen under his employment agreement, and the shares underlying the options granted to Mr. Jensen, are not and will not be registered under the Securities Act of 1933, as amended, and constitute restricted securities as such term is defined in Rule 144 promulgated under the 1933 Act.

As previously provided in his employment agreement, upon the occurrence of a "USA Transaction" (as defined below), the Company will issue to Mr. Jensen 140,000 shares of Common Stock subject to adjustment for stock splits or combinations ("Jensen Shares"). The Jensen Shares have not been reserved for issuance by the Company and are not reflected or included in the number of issued and outstanding shares of the Company on a fully diluted basis in this Form 10-K. Mr. Jensen is not required to pay any additional consideration for the Jensen Shares. At the time of any USA Transaction, all of the Jensen Shares are automatically deemed to be issued and outstanding immediately prior to any USA Transaction, and are entitled to be treated as any other issued and outstanding shares of Common Stock in connection with such USA Transaction.

The term USA Transaction is defined as (i) the acquisition of fifty-one percent or more of the then outstanding voting securities entitled to vote generally in the election of Directors of the Company by any person, entity or group, or (ii) the approval by the shareholders of the Company of a reorganization, merger, consolidation, liquidation, or dissolution of the Company, or the sale, transfer, lease or other disposition of all or substantially all of the assets of the Company. The Jensen Shares are irrevocable and fully vested, have no expiration date, and will not be affected by the termination of Mr. Jensen’s employment with the Company for any reason whatsoever. If a USA Transaction shall occur at a time when there are not a sufficient number of authorized but unissued shares of Common Stock, then the Company shall as a condition of such USA Transaction promptly take any and all appropriate action to make available a sufficient number of shares of Common Stock. In the alternative, the Company may structure the USA Transaction so that Mr. Jensen would receive the same amount and type of consideration in connection with the USA Transaction as any other holder of Common Stock.

 

F-39

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

16. COMMITMENTS AND CONTINGENCIES (CONTINUED)

On May 11, 2006, the Company and Mr. Herbert entered into an Amended and Restated Employment Agreement pursuant to which the term of Mr. Herbert’s employment with the Company was extended to June 30, 2009. Effective May 11, 2006, Mr. Herbert’s base salary was increased to $285,000 per annum. Mr. Herbert’s base salary had not been increased since January 1, 2004. The Agreement requires Mr. Herbert to devote his full time and attention to the business and affairs of the Company and obligates him not to engage in any investments or activities which would compete with the Company during the term of the agreement and for a period of one year thereafter. In the event that a USA Transaction (as defined in Mr. Jensen's employment agreement) shall occur, then Mr. Herbert has the right to terminate his agreement upon 30 days notice to USA. Mr. Herbert was granted the right to elect to have one-half of his base salary for each of the fiscal years ending June 30, 2007, June 30, 2008, and June 30, 2009 paid in shares of Common Stock rather than cash. Mr. Herbert was also granted 50,000 shares of Common Stock and an additional amount of options to purchase up to 18,000 shares of Common Stock at $7.50 per share. The 50,000 shares of Common Stock vest as follows: 16,667 on June 1, 2006; 16,667 on January 1, 2007; and 16,666 on June 1, 2007. The options vest as follows: 6,000 on May 11, 2006; 6,000 on June 30, 2007; and 6,000 on June 30, 2008. The options may be exercised at any time within 5 years of vesting. The Company recorded a non-cash compensation charge of $176,003 and $41,310 related to the grant of restricted Common Stock and Common Stock Options, respectively, during the fiscal year ended June 30, 2006. See note 13 for additional option disclosures. All of the shares granted to or to be issued to Mr. Herbert under his employment agreement, and the shares underlying the options granted to Mr. Herbert, are not and will not be registered under the Securities Act of 1933, as amended, and constitute restricted securities as such term is defined in Rule 144 promulgated under the 1933 Act.

On May 11, 2006, the Company and Mr. DeMedio entered into an amendment to his Employment Agreement pursuant to which the term of Mr. DeMedio’s employment with the Company was extended to June 30, 2008. Effective May 11, 2006, Mr. DeMedio’s base salary was increased to $165,000 per annum. Mr. DeMedio was granted the right to elect to have one-half of his base salary for each of the fiscal years ending June 30, 2007, and June 30, 2008 paid in shares of Common Stock rather than cash. Mr. DeMedio was also granted options to purchase up to 7,000 shares of Common Stock at $7.50 per share. The options vest as follows: 2,334 on May 11, 2006; 2,333 on June 30, 2007; and 2,333 on June 30, 2008. The options may be exercised at any time within 5 years of vesting. The Company recorded a non-cash compensation charge of $16,068 related to the grant of restricted Common Stock Options during the fiscal year ended June 30, 2006. See note 13 for additional option disclosures. All of the shares underlying the options granted to Mr. DeMedio under his employment agreement are not and will not be registered under the Securities Act of 1933, as amended, and constitute restricted securities as such term is defined in Rule 144 promulgated under the 1933 Act.

Various legal actions and claims occurring in the normal course of business are pending or may be instituted or asserted in the future against the Company. The Company does not believe that the resolution of these matters will have a material effect on the financial position or results of operations of the Company.

In February 2005, a Complaint was filed against the Company by Swartz Private Equity, LLC (“Swartz”) alleging that the Company breached various agreements entered into with Swartz in August and September 2000 in connection with the so-called equity line of credit provided by Swartz to the Company. The Complaint requests money damages of $4,350,381 representing the alleged value of the warrants currently held by or claimed to be due to Swartz, money damages of $196,953 representing a termination fee allegedly due in connection with the termination of the agreements, and unspecified money damages relating to the alleged breach of the rights of first refusal.

The Company’s response to the Complaint denied any liability to Swartz and asserted various counterclaims against Swartz that seek money damages and other affirmative relief against Swartz. The Company’s response, among other things, states that the entire transaction is void and unenforceable because Swartz had failed to register as a broker-dealer under applicable Federal and state securities laws as required in order for Swartz to be engaged in the business of providing equity line products.

 

F-40

---

USA Technologies, Inc.

Notes to Consolidated Financial Statements

16. COMMITMENTS AND CONTINGENCIES (CONTINUED)

On September 20, 2006, the parties agreed to fully settle this litigation. In this regard, we agreed to issue to Swartz 33,184 shares of our Common Stock. We also agreed to honor the cashless exercise of warrants by Swartz in 2003 for 6,816 shares of Common Stock. We had previously disputed that Swartz had validly exercised those warrants. We have granted to Swartz certain registration rights in connection with the 33,184 shares. The parties are currently preparing the settlement agreement and release implementing the settlement. The Company has recorded a contingent liability of $270,000 as of June 30, 2006 to accrue for the value of the 40,000 shares of Common Stock to be issued under the proposed settlement agreement.

17. QUARTERLY FINANCIAL SUMMARY (UNAUDITED)

Unaudited quarterly results of operations for the years ended June 30, 2006 and 2005 follow and should be read in conjunction with the Company's quarterly reports on Form 10-Q.

		First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Year
YEAR ENDED JUNE 30, 2006
Revenues		$	1,363,886		$	1,957,753		$	1,618,776		$	1,474,388		$	6,414,803
Gross profit		$	314,927		$	787,882		$	687,749		$	219,788		$	2,010,346
Net loss		$	(3,196,872	)	$	(2,864,091	)	$	(3,313,868	)	$	(5,472,245	)	$	(14,847,076	)
Cumulative preferred dividends		$	(392,057	)	$	—		$	(391,232	)	$	—		$	(783,289	)
Loss applicable to common shares		$	(3,588,929	)	$	(3,705,100	)	$	(5,472,245	)	$	(15,630,365	)	$	(2,864,091	)
Loss per common share (basic and diluted)		$	(0.90	)	$	(0.61	)	$	(0.74	)	$	(0.96	)	$	(3.15	)
YEAR ENDED JUNE 30, 2005
Revenues		$	1,032,578		$	1,135,449		$	1,122,330		$	1,387,632		$	4,677,989
Gross profit		$	130,534		$	342,705		$	566,720		$	159,357		$	1,119,316
Net loss		$	(3,640,637	)	$	(3,805,004	)	$	(3,702,049	)	$	(4,351,500	)	$	(15,499,190	)
Cumulative preferred dividends		$	(392,057	)	$	—		$	(392,056	)	$	—		$	(784,113	)
Loss applicable to common shares		$	(4,032,694	)	$	(3,805,004	)	$	(4,094,105	)	$	(4,351,500	)	$	(16,283,303	)
Loss per common share (basic and diluted)		$	(1.14	)	$	(1.01	)	$	(1.02	)	$	(1.12	)	$	(4.18	)

 

18. SUBSEQUENT EVENTS (UNAUDITED)

From July 1 through September 15, 2006, the Company issued 258,040 shares of Common Stock under the 2006 Common Stock Agreement for total gross proceeds of $1,653,500.

On September 25, 2006, the Company entered into a Common Stock Purchase Agreement (the “2006-B Common Stock Agreement”) with Mr. Illes, an accredited investor. Mr. Illes agreed to purchase shares of the Company's Common Stock with an aggregate purchase price not to exceed $15,000,000. Under the 2006-B Common Stock Agreement, the Company has the right at any time to require Mr. Illes to purchase Common Stock from the Company at the lower of: (i) $30.00 per share; or (ii) 90% of the closing bid price per share on the date prior to the date of the delivery by the Company to Mr. Illes of notice of his obligation to purchase. The Company can require Mr. Illes to purchase shares only if the shares have been registered by the Company for resale under the Act. The agreement also states that no additional shares shall be registered under the 2006 Common Stock Agreement. During any calendar month, Mr. Illes cannot be required by the Company to purchase Common Stock for an aggregate purchase price in excess of $800,000. The initial number of shares of Common Stock subject to this agreement is 1,000,000. The Company has the right in the future, if necessary, to register additional shares in order to ensure that a sufficient number of shares are available for purchase by Mr. Illes. The 2006-B Common Stock Agreement terminates August 30, 2009. The Company agreed to pay Mr. Illes 20,000 shares of Common Stock as a due diligence fee in connection with this transaction.

 

F-41

---

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures.

The principal executive officer and principal financial officer have evaluated the Company's disclosure controls and procedures as of June 30, 2006. Based on this evaluation, they conclude that the disclosure controls and procedures effectively ensure that the information required to be disclosed in the Company's filings and submissions under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

(b) Changes in internal controls.

There have been no changes during the quarter ended June 30, 2006 in the Company's internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.

Item 9B. Other Information.

Not Applicable.

PART III

Item 10. Directors and Executive Officers of the Registrant.

DIRECTORS AND EXECUTIVE OFFICERS

Our Directors and executive officers, on August 31, 2006, together with their ages and business backgrounds were as follows:

 

Name		Age		Position(s) Held
George R. Jensen, Jr.		57		Chief Executive Officer,
				Chairman of the Board of Directors
Stephen P. Herbert		43		Chief Operating Officer and President, Director
David M. DeMedio		35		Chief Financial Officer
William L. Van Alen, Jr. (1)(2)		73		Director
Steven Katz (1)(2)		58		Director
Douglas M. Lurio		49		Director
Albert Passner		67		Director
Stephen W. McHugh (2)		50		Director

 

(1)	Member of Compensation Committee

 

(2)	Member of Audit Committee

Each Director holds office until the next Annual Meeting of shareholders and until his successor has been elected and qualified.

34

---

George R. Jensen, Jr., has been our Chief Executive Officer and a Director since our inception in January 1992. Mr. Jensen was Chairman, Director, and Chief Executive Officer of American Film Technologies, Inc. ("AFT") from 1985 until 1992. AFT was in the business of creating color imaged versions of black-and-white films. From 1979 to 1985, Mr. Jensen was Chief Executive Officer and President of International Film Productions, Inc. Mr. Jensen was the Executive Producer of the twelve hour miniseries, "A.D.", a $35 million dollar production filmed in Tunisia. Procter and Gamble, Inc., the primary source of funds, co-produced and sponsored the epic, which aired in March 1985 for five consecutive nights on the NBC network. Mr. Jensen was also the Executive Producer for the 1983 special for public television, "A Tribute to Princess Grace". From 1971 to 1978, Mr. Jensen was a securities broker, primarily for the firm of Smith Barney, Harris Upham. Mr. Jensen was chosen 1989 Entrepreneur of the Year in the high technology category for the Philadelphia, Pennsylvania area by Ernst & Young LLP and Inc. Magazine. Mr. Jensen received his Bachelor of Science Degree from the University of Tennessee and is a graduate of the Advanced Management Program at the Wharton School of the University of Pennsylvania. Mr. Jensen is also a Director of The Noah Fund, a publicly traded mutual fund.

Stephen P. Herbert was elected a Director in April 1996, and joined USA on a full-time basis on May 6, 1996. Prior to joining us and since 1986, Mr. Herbert had been employed by Pepsi-Cola, the beverage division of PepsiCo, Inc. From 1994 to April 1996, Mr. Herbert was a Manager of Market Strategy. In such position he was responsible for directing development of market strategy for the vending channel and subsequently the supermarket channel for Pepsi-Cola in North America. Prior thereto, Mr. Herbert held various sales and management positions with Pepsi-Cola. Mr. Herbert graduated with a Bachelor of Science degree from Louisiana State University.

David M. DeMedio joined USA Technologies on a full-time basis in March 1999 as Controller. In the Summer of 2001, Mr. DeMedio was promoted to Director of Financial Services where he was responsible for the sales and financial data reporting to customers, the Company's turnkey banking services and maintaining and developing relationships with credit card processors and card associations. In July 2003, Mr. DeMedio served as interim Chief Financial Officer through April, 2004. From April, 2004 until April 12, 2005, Mr. DeMedio served as Vice President - Financial & Data Services. On April 12, 2005, he was appointed as the Company's Chief Financial Officer. From 1996 to March 1999, prior to joining the Company, Mr. DeMedio had been employed by Elko, Fischer, Cunnane and Associates, LLC as a supervisor in its' accounting and auditing and consulting practice. Prior thereto, Mr. DeMedio held various accounting positions with Intelligent Electronics, Inc., a multi-billion reseller of computer hardware and configuration services. Mr. DeMedio graduated with a Bachelor of Science in Business Administration from Shippensburg University and is a Certified Public Accountant.

William L. Van Alen, Jr., joined the Board of Directors of USA in May 1993. Mr. Van Alen is President of Cornerstone Entertainment, Inc., an organization engaged in the production of feature films of which he was a founder in 1985. Since 1996, Mr. Van Alen has been President and a Director of The Noah Fund, a publicly traded mutual fund. Prior to 1985, Mr. Van Alen practiced law in Pennsylvania for twenty-two years. Mr. Van Alen received his undergraduate degree in Economics from the University of Pennsylvania and his law degree from Villanova Law School.

35

---

Steven Katz joined the Board of Directors in May 1999. He is President of Steven Katz & Associates, Inc., a management consulting firm specializing in strategic planning and corporate development for technology and service-based companies in the health care, environmental, telecommunications and Internet markets. Mr. Katz`s prior experience includes five years with PriceWaterhouse & Co. in audit, tax and management advisory services; two years of corporate planning with Revlon, Inc.; five years with National Patent Development Corporation (NPDC) in strategic planning, merger and acquisition, technology in-licensing and out-licensing, and corporate turnaround experience as President of three NPDC subsidiaries; and two years as a Vice President and General Manager of a non-banking division of Citicorp, N.A. Mr. Katz is also a Director of Health Systems Solutions Inc., Vivid Learning Systems Inc., Nanoscience Technologies Inc. and Biophan Technologies Inc., all publicly traded companies.

Douglas M. Lurio joined the Board of Directors of USA in June 1999. Mr. Lurio is President of Lurio & Associates, P.C., attorneys-at-law, which he founded in 1991. He specializes in the practice of corporate and securities law. Prior thereto, he was a partner with Dilworth, Paxson LLP. Mr. Lurio received Bachelor of Arts Degree in Government from Franklin & Marshall College, a Juris Doctor Degree from Villanova Law School, and a Masters in Law (Taxation) from Temple Law School.

Albert Passner joined the Board of Directors of USA in April 2006. Mr. Passner is a consultant in the fields of physics and engineering. He was a former member of the technical staff at Lucent/AT&T Bell Labs where he participated in many projects including designing systems in electronics, optics, lasers, pulsed magnets, electron-optics, cryogenics and thin films. He has authored and co-authored more than fifty scientific publications.

Stephen W. McHugh joined the Board of Directors of USA in June 2006. Mr. McHugh was appointed by the Board to fill the vacancy on the Board caused by the death of William W. Sellers. Mr. McHugh is the President and co-founder of Santa Barbara Infrared, Inc., a designer and manufacturer of military and commercial Electro-Optical test equipment that was recently acquired by HEICO Corporation. Mr. McHugh formerly was a mechanical engineer and technical sales expert at Electro Optical Industries where he designed optical and mechanical instruments for the test of infrared camera systems.

AUDIT COMMITTEE FINANCIAL EXPERT

The Company’s Board of Directors has determined that Steven Katz is the Audit Committee financial expert serving on the Audit Committee as defined by applicable SEC rules. The Board has also determined that Mr. Katz is “independent” as such term is defined by applicable SEC rules.

CODE OF BUSINESS CONDUCT AND ETHICS

In May 2006, we adopted an amended and restated Code of Business Conduct and Ethics that applies to all executive officers, directors and employees of the Company, including our Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, and Controller. A copy of our Code of Business Conduct and Ethics is filed with this Form 10-K as Exhibit 14.1.

36

---

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors and executive officers, and persons who own more than 10% of the Company's Common Stock, to file with the Securities and Exchange Commission reports of ownership and changes in ownership of Common Stock. Officers, directors and greater than 10% beneficial owners are required by Securities and Exchange Commission regulations to furnish the Company with copies of all Section 16(a) forms they file.

Stephen P. Herbert filed a late Form 4, William Van Alen, Jr., filed two late Form 4s and each of Albert Passner and Stephen W. McHugh filed a late Form 3.

Item 11. Executive Compensation.

The following table sets forth certain information with respect to compensation paid or accrued by the Company during the fiscal years ended June 30, 2004, June 30, 2005 and June 30, 2006 to each of the executive officers and employees of the Company named below:

 SUMMARY COMPENSATION TABLE

 

Name and Principal Position			Fiscal Year			Annual Compensation									Long Term Compensation
						Salary			Bonus(1)			Other Annual Compensation(2)			Restricted Stock Awards($)			Securities Underlying Options(#)
George R. Jensen, Jr.			2006		$	270,288		$	200,000		$	18,563		$	400,000(6	)		75,000
Chief Executive Officer &			2005		$	250,000			—		$	17,875			—			—
Chairman of the Board			2004		$	217,500		$	4,870,000(3	)	$	17,875			—			—
Stephen P. Herbert			2006		$	246,673		$	133,336		$	18,563		$	266,664(6	)		18,000
Chief Operating Officer &			2005		$	231,923			—		$	17,875			—			—
President			2004		$	192,692		$	225,000		$	17,875			—			—
H. Brock Kolls (5)			2006		$	171,346		$	30,000		$	12,375			—			—
Senior Vice-President,			2005		$	165,000		$	110,000		$	11,917			—			—
Research & Development			2004		$	156,923		$	60,000		$	63,205			—			—
David M. DeMedio			2006		$	162,385		$	—		$	20,112			—			7,000
Chief Financial Officer (4)			2005		$	131,689		$	11,000		$	7,800			—			3,000
Wendy Jenkins			2006		$	130,850		$	20,000		$	16,200			—			—
Vice-President of Marketing			2005		$	103,653		$	26,000		$	14,850			—			—
			2004		$	65,384		$	—		$	10,500			—			—

(1) Fiscal year 2006 includes 25,000 shares that vested on June 1, 2006 valued at $8.00 per share for Mr. Jensen; 16,667 shares that vested on June 1, 2006 valued at $8.00 per share for Mr. Herbert, a $30,000 cash bonus for Mr. Kolls, and a $20,000 cash bonus for Ms. Jenkins. Fiscal year 2005 includes a $110,000 cash bonus for Mr. Kolls, cash bonuses totaling $11,000 for Mr. DeMedio, and a $20,000 cash bonus and $6,000 stock bonus for Ms. Jenkins. Fiscal year 2004 includes 105,000 shares valued at $44 per share, in connection with the amendment of his employment agreement, and a $250,000 cash bonus for Mr. Jensen; a $225,000 cash bonus for Mr. Herbert; and a $60,000 cash bonus for Mr. Kolls.

(2) Represents cash payments authorized to reimburse certain executive officers for tax payments incurred from the award of a previous bonus as well as car allowance payments.

 

37

---

(3) Prior to July 2003, Mr. Jensen's employment agreement provided that upon the occurrence of a USA Transaction he would receive that number of shares equal to seven percent of all of the then issued and outstanding shares on a fully converted basis. During July 2003, the Company and Mr. Jensen agreed to amend Mr. Jensen's employment agreement so that upon the occurrence of a USA Transaction he would receive only 140,000 shares. Under the new amended agreement, the 140,000 shares became subject to dilution (i.e., did not increase in order to reflect subsequent issuances by the Company of its shares). Under the prior agreement, the number of shares to be issued to Mr. Jensen was not subject to dilution (i.e., would be increased in order to reflect subsequent issuances by the Company of its shares) and was based upon the actual total number of shares outstanding at the time of a USA Transaction.

For example, if a USA Transaction occurred while there were 4,750,000 shares then outstanding on a fully converted basis, Mr. Jensen would have received 332,500 shares under his prior agreement rather than the fixed number of 140,000 shares under his new amended agreement.

During July 2003, the Company issued to Mr. Jensen an aggregate of 105,000 shares of restricted Common Stock, 25,000 shares of which were issued as compensation to Mr. Jensen, and 80,000 shares of which were issued to Mr. Jensen in connection with the employment agreement amendment described above. In accordance with generally accepted accounting principles, the Company was required to value all of these shares at $44 per share or an aggregate of $4,620,000.

(4) Employment as Chief Financial Officer commenced on April 12, 2005.

(5) During May 2006, Mr. Kolls notified the Company that he was resigning as an employee effective as of June 30, 2006, and requested that his employment agreement not be renewed.

(6) Under the terms of Mr. Jensen’s existing employment agreement with us, he received an award of 75,000 shares of restricted stock upon his signing of the agreement in May 2006. These shares vest as follows: 25,000 on June 1, 2006; 25,000 on January 1, 2007; and 25,000 on June 1, 2007. As of June 30, 2006, based upon a price per share of $7.80, the closing bid price for our common stock as of such date, the value of the restricted stock held by Mr. Jesnen was $390,000. This stock will be treated like all other shares of our stock, including the right to receive any dividends declared on our common stock. The 25,000 shares that vested on June 1, 2006 are reflected in the Bonus column of the above table.

Under the terms of Mr. Herbert’s existing employment agreement with us, he received an award of 50,000 shares of restricted stock upon his signing of the agreement in May 2006. These shares vest as follows: 16,667 on June 1, 2006; 16,667 on January 1, 2007; and 16,666 on June 1, 2007. As of June 30, 2006, based upon a price per share of $7.80, the closing bid price for our common stock as of such date, the value of the restricted stock held by Mr. Herbert was $259,997. This stock will be treated like all other shares of our stock, including the right to receive any dividends declared on our common stock. The 16,667 shares that vested on June 1, 2006 are reflected in the Bonus column of the above table.

 

38

---

OPTION GRANTS IN LAST FISCAL YEAR

(Individual Grants)

		Number of			Percent of
		securities			total options
		underlying			granted to			Exercise
		options			employees in			base price			Expiration
Name		granted (1)			fiscal year			($/share)			date
George R. Jensen			75,000			75	%	$	7.50			(2)
Stephen P. Herbert			18,000			18	%	$	7.50			(2)
David M. DeMedio			7,000			7	%	$	7.50			(2)

 

(1)	Conditioned upon continued employment, the options vest as follows: one-third on May 11, 2006, one-third on June 30, 2007, and one-third on June 30, 2008.

 

(2)	The options expire five years from the date of vesting.

 

TOTAL OPTIONS EXERCISED IN FISCAL YEAR ENDED JUNE 30, 2006 AND YEAR END VALUES

The following table gives information for options exercised by an executive officer and an employee in fiscal year 2006, and the number of options held by the executive officer and the employee at fiscal year end:

Number of

Securities

Value of

Underlying

Unexercised

Unexercised

In-the-Money

Shares

Options at

Options at

Acquired

FY-End (#)

FY-End($)

On

Value

Exercisable/

Exercisable/

Name

Exercise (#)

Realized ($)

Unexercisable

Unexercisable

George R. Jensen

0

0

25,000/50,000

7,500/15,000

Stephen P. Herbert

0

0

6,000/12,000

1,800/3,600

David M. DeMedio

0

0

3,834/6,166

700/1,400

 

39

---

EXECUTIVE EMPLOYMENT AGREEMENTS

On May 11, 2006, the Company and Mr. Jensen entered into an Amended and Restated Employment Agreement pursuant to which the term of Mr. Jensen’s employment with the Company was extended to June 30, 2009. Effective May 11, 2006, Mr. Jensen’s base salary was increased to $325,000 per annum. The Agreement requires Mr. Jensen to devote his full time and attention to the business and affairs of the Company, and obligates him not to engage in any investments or activities which would compete with the Company during the term of the Agreement and for a period of one year thereafter. Mr. Jensen was granted the right (exercisable at any time prior to the 60th day following the commencement of each fiscal year) to elect to have one-half of his base salary for each of the fiscal years ending June 30, 2007, June 30, 2008, and June 30, 2009 paid in shares of Common Stock rather than cash. Mr. Jensen has elected to receive shares in lieu of cash for one-half of his base salary for the fiscal year ending June 30, 2007. As a result of such election, 22,080 shares will be issued to him which will vest as follows: 5,520 on July 1, 2006; 5,520 on October 1, 2006; 5,520 on January 1, 2007; and 5,520 on April 1, 2007. Mr. Jensen was also granted 75,000 shares of Common Stock and an additional amount of options to purchase up to 75,000 shares of Common Stock at $7.50 per share. The 75,000 shares of Common Stock vest as follows: 25,000 on June 1, 2006; 25,000 on January 1, 2007; and 25,000 on June 1, 2007. The options vest as follows: 25,000 on May 11, 2006; 25,000 on June 30, 2007; and 25,000 on June 30, 2008. The options may be exercised at any time within 5 years of vesting. All of the shares granted to or to be issued to Mr. Jensen under his employment agreement, and the shares underlying the options granted to Mr. Jensen, are not and will not be registered under the Securities Act of 1933, as amended, and constitute restricted securities as such term is defined in Rule 144 promulgated under the 1933 Act.

As previously provided in his employment agreement, upon the occurrence of a "USA Transaction" (as defined below), the Company will issue to Mr. Jensen 140,000 shares of Common Stock subject to adjustment for stock splits or combinations ("Jensen Shares"). The Jensen Shares are not reflected or included in the number of issued and outstanding shares of the Company on a fully diluted basis in this Form 10-K. Mr. Jensen is not required to pay any additional consideration for the Jensen Shares. At the time of any USA Transaction, all of the Jensen Shares are automatically deemed to be issued and outstanding immediately prior to any USA Transaction, and are entitled to be treated as any other issued and outstanding shares of Common Stock in connection with such USA Transaction.

The term USA Transaction is defined as (i) the acquisition of fifty-one percent or more of the then outstanding voting securities entitled to vote generally in the election of Directors of the Company by any person, entity or group, or (ii) the approval by the shareholders of the Company of a reorganization, merger, consolidation, liquidation, or dissolution of the Company, or the sale, transfer, lease or other disposition of all or substantially all of the assets of the Company. The Jensen Shares are irrevocable and fully vested, have no expiration date, and will not be affected by the termination of Mr. Jensen’s employment with the Company for any reason whatsoever.

40

---

On May 11, 2006, the Company and Mr. Herbert entered into an Amended and Restated Employment Agreement pursuant to which the term of Mr. Herbert’s employment with the Company was extended to June 30, 2009. Effective May 11, 2006, Mr. Herbert’s base salary was increased to $285,000 per annum. The Agreement requires Mr. Herbert to devote his full time and attention to the business and affairs of the Company and obligates him not to engage in any investments or activities which would compete with the Company during the term of the agreement and for a period of one year thereafter. In the event that a USA Transaction (as defined in Mr. Jensen's employment agreement) shall occur, then Mr. Herbert has the right to terminate his agreement upon 30 days notice to USA. Mr. Herbert was granted the right to elect to have one-half of his base salary for each of the fiscal years ending June 30, 2007, June 30, 2008, and June 30, 2009 paid in shares of Common Stock rather than cash. Mr. Herbert was also granted 50,000 shares of Common Stock and an additional amount of options to purchase up to 18,000 shares of Common Stock at $7.50 per share. The 50,000 shares of Common Stock vest as follows: 16,667 on June 1, 2006; 16,667 on January 1, 2007; and 16,666 on June 1, 2007. The options vest as follows: 6,000 on May 11, 2006; 6,000 on June 30, 2007; and 6,000 on June 30, 2008. The options may be exercised at any time within 5 years of vesting. All of the shares granted to or to be issued to Mr. Herbert under his employment agreement, and the shares underlying the options granted to Mr. Herbert, are not and will not be registered under the Securities Act of 1933, as amended, and constitute restricted securities as such term is defined in Rule 144 promulgated under the 1933 Act.

On May 11, 2006, the Company and Mr. DeMedio entered into an amendment to his Employment Agreement pursuant to which the term of Mr. DeMedio’s employment with the Company was extended to June 30, 2008. Effective May 11, 2006, Mr. DeMedio’s base salary was increased to $165,000 per annum. Mr. DeMedio was granted the right to elect to have one-half of his base salary for each of the fiscal years ending June 30, 2007, and June 30, 2008 paid in shares of Common Stock rather than cash. Mr. DeMedio was also granted options to purchase up to 7,000 shares of Common Stock at $7.50 per share. The options vest as follows: 2,334 on May 11, 2006; 2,333 on June 30, 2007; and 2,333 on June 30, 2008. The options may be exercised at any time within 5 years of vesting. All of the shares underlying the options granted to Mr. DeMedio under his employment agreement are not and will not be registered under the Securities Act of 1933, as amended, and constitute restricted securities as such term is defined in Rule 144 promulgated under the 1933 Act.

Mr. Kolls entered into an employment agreement with the Company that required Mr. Kolls or the Company to deliver written notice of termination at least sixty days prior to June 30, 2006, or the agreement would be automatically renewed until June 30, 2007. During May 2006, Mr. Kolls notified the Company that he was resigning as an employee effective as of June 30, 2006, and requested that his employment agreement not be renewed for another year. The Company does not believe that Mr. Kolls’ resignation was timely. The agreement provided for an annual base salary of $165,000 per year. Mr. Kolls was entitled to a payment of $5,000 upon each of the following: (i) filing of a new patent application by USA for which he is listed as the inventor; (ii) granting of any such patent application; and (iii) issuance of a patent for any patent application that had been filed prior to April 20, 2004. Mr. Kolls is also entitled to receive such bonus or bonuses, as may be awarded to him by the Board of Directors. The Agreement required Mr. Kolls to devote his full time and attention to the business and affairs of the Company, and obligated him not to engage in any investments or activities which would compete with the Company during the term of his agreement and for a period of one year thereafter. In the event that a USA Transaction (as defined in Mr. Jensen's employment agreement) occured, then Mr. Kolls had the right to terminate his agreement upon 30 days notice to USA.

COMPENSATION OF DIRECTORS

Members of the Board of Directors receive cash and equity compensation for serving on the Board of Directors, as determined from time to time by the Compensation Committee with subsequent approval thereof by the Board of Directors.

During fiscal year 2006, we paid each of Messrs. Sellers, Van Alen, Katz and Lurio $20,000 each for serving as a Director during the fiscal year and $10,000 each for serving on Board Committees.

41

---

On April 21, 2006, the Board of Directors approved the grant of 12,000 Common Stock Options to each of Messrs. Sellers, Van Alen, Katz, and Lurio and 6,000 Common Stock Options to Mr. Passner, a new director as of April 12, 2006, all with an exercise price of $7.50 per share and all exercisable at any time within five years following the date of vesting. The options granted to Mr. Sellers and Mr. Van Allen are fully vested. Of the options granted to Mr. Katz and Mr. Lurio, 6,000 vest immediately, 3,000 vest on April 1, 2007, and 3,000 vest on April 1, 2008. Of the options granted to Mr. Passner, 3,000 vest on April 1, 2007, and 3,000 vest on April 1, 2008.

In conjunction with the appointment of Stephen McHugh to the Board of Directors on June 20, 2006, the Company granted Mr. McHugh 6,000 Common Stock Options with an exercise price of $8.00 per share. The options vest as follows: 3,000 on June 20, 2007 and 3,000 on June 20, 2008. The options are exercisable at any time within five years of vesting.

Item 12. Security Ownership Of Certain Beneficial Owners And Management And Related Shareholder Matters

COMMON STOCK

The following table sets forth, as of June 30, 2006, the beneficial ownership of the Common Stock of each of the Company's directors and executive officers, the other employees named in the summary compensation table set forth above, as well as by the Company's directors and executive officers as a group. Except as set forth below, the Company is not aware of any beneficial owner of more than five percent of the Common Stock. Except as otherwise indicated, the Company believes that the beneficial owners of the Common Stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable:

 

		Number of
		Shares of
Name and Address of		Common Stock			Percent of Beneficial
Beneficially Owned(1)		of Class(2)			Owner
George R. Jensen, Jr.			132,210 shares(3	)		1.81	%
100 Deerfield Lane, Suite 140
Malvern, Pennsylvania 19355
Stephen P. Herbert			46,527 shares(4	)		*
100 Deerfield Lane, Suite 140
Malvern, Pennsylvania 19355
Haven Brock Kolls, Jr.			5,537 shares(5	)		*
100 Deerfield Lane, Suite 140
Malvern, Pennsylvania 19355
David M. DeMedio			7,535 shares(8	)		*
100 Deerfield Lane, Suite 140
Malvern, Pennsylvania 19355
Douglas M. Lurio			15,280 shares(7	)		*
2005 Market Street, Suite 2340
Philadelphia, Pennsylvania 19103

 

42

---

 

Steven Katz			12,350 shares(6	)		*
440 South Main Street
Milltown, New Jersey 08850
William L. Van Alen, Jr.			63,023 shares(9	)		*
P.O. Box 727
Edgemont, Pennsylvania 19028
Albert Passner			- shares			*
3 Disbrow Ct
East Brunswick, New Jersey 08816
Stephen W. McHugh			- shares			*
100 Deerfield Lane, Suite 140
Malvern, Pennsylvania 19355
Wendy Jenkins			2,819 shares(10	)		*
100 Deerfield Lane, Suite 140
Malvern, Pennsylvania 19355
Wellington Management Company, LLP			710,000 shares(11	)		9.71	%
75 State Street
Boston, Massachusetts 02109
All Directors and Executive Officers
As a Group (10 persons)			285,281 shares			3.90	%

 

---

*Less than one percent (1%)

(1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and derives from either voting or investment power with respect to securities. Shares of Common Stock issuable upon conversion of the Preferred Stock, shares issuable upon the conversion of Convertible Senior Notes, or shares of Common Stock issuable upon exercise of warrants and options currently exercisable, or exercisable within 60 days of June 30, 2006, are deemed to be beneficially owned for purposes hereof.

(2) On June 30, 2006 there were 6,327,175 shares of Common Stock and 521,542 shares of Preferred Stock issued and outstanding. For purposes of computing the percentages under this table, it is assumed that all shares of issued and outstanding Preferred Stock have been converted into 5,215 shares of Common Stock, and that all of the options to acquire Common Stock which have been issued and are fully vested as of June 30, 2006 (or within 60-days of June 30, 2006) have been converted into 87,142 shares of Common Stock. For purposes of computing such percentages it has also been assumed that all of the remaining Common Stock Warrants have been exercised for 219,481 shares of Common Stock; that all of the Senior Notes have been converted into 669,635 shares of Common Stock; and that all of the accrued and unpaid dividends on the Preferred Stock as of June 30, 2006 have been converted into 8,226 shares of Common Stock. Therefore, 7,316,874 shares of Common Stock were treated as issued and outstanding for purposes of computing the percentages under this table. Does not reflect or include the shares issuable to Mr. Jensen upon a “USA Transaction”.

(3) Includes 2,000 shares of Common Stock beneficially owned by his spouse. Does not include the right granted to Mr. Jensen under his Employment Agreement to receive Common Stock upon the occurrence of a USA Transaction (as defined therein). See "Executive Employment Agreements". Includes 60,000 shares owned by George R. Jensen, Jr. Grantor Retained Unitrust dated July 14, 2003 over which Mr. Jensen retains beneficial ownership. Includes 25,000 shares underlying vested stock options.

(4) Includes 10 shares of Common Stock beneficially owned by his child and 4,000 shares of Common Stock beneficially owned by his spouse. Includes 6,000 shares underlying vested stock options.

 

43

---

(5) Includes 120 shares of Common Stock owned by Mr. Kolls' spouse and 1,500 shares issuable to his spouse upon conversion of her Senior Note.

(6) Includes 6,000 shares underlying vested stock options.

(7) Includes 2,250 shares issuable upon conversion of Senior Notes. Includes 6,000 shares underlying vested stock options.

 

(8) Includes 565 shares of Common Stock issuable to Mr. DeMedio upon conversion of his Senior Notes, 3,834 shares underlying vested stock options and 375 shares underlying stock options that vest within 60 days of June 30, 3006.

(9) Includes 17,339 shares of Common Stock issuable to Mr. Van Alen upon conversion of his Senior Notes, 5,333 shares issuable upon the exercise of warrants and 100 shares of Common Stock beneficially owned by his spouse. Includes 12,000 shares underlying vested stock options.

(10) Includes 790 shares underlying vested stock options.

(11) Wellington Management Company, LLP ("Wellington Management"), in its capacity as an investment adviser, may be deemed to have beneficial ownership of 71,000,000 shares of common stock that are owned by numerous investment advisory clients, none of which is known to have such interest with respect to more than five percent of the class of shares. Wellington Management has shared voting authority over 45,600,000 shares and shared dispositive power over 71,000,000 shares. Wellington Management is a registered investment adviser under the Investment Advisers Act of 1940, as amended.

PREFERRED STOCK

There were no shares of Preferred Stock that were beneficially owned by the Company's directors, executive officers, or the other employees named in the Summary Compensation Table set forth above.

 

Item 13. Certain Relationships and Related Transactions.

During the fiscal year ended June 30, 2006, the Company incurred charges to Lurio & Associates, P.C., of which Mr. Lurio is President and a shareholder, for professional fees of approximately $258,000 for legal services rendered to the Company by such law firm. Mr. Lurio is a Director of the Company. As of June 30, 2006, the Company had accrued approximately $28,000 for these services.

During fiscal year 2006, William Van Alen, Jr., a Director, invested $33,333 in the 2008-C Senior Note offering and received warrants to purchase 3,333 shares of Common Stock at $10 per share, pursuant to his investment in this offering. Mr. Van Alen also invested $20,000 in the 2010-B Senior Note offering and received warrants to purchase 2,000 shares of Common Stock at $10 per share, pursuant to his investment in this offering.

44

---

Item 14. Principal Accounting Fees and Services.

AUDIT AND NON-AUDIT FEES

Effective July 7, 2005, the Company dismissed Ernst & Young LLP as the Company’s independent registered public accounting firm and engaged Goldstein Golub Kessler LLP as the Company’s new independent registered public accounting firm. Ernst & Young LLP served as the Company’s independent registered public accounting firm during the fiscal year ended June 30, 2004. Ernst & Young LLP reviewed the Company’s quarterly financial statements for the first, second, and third quarters of the fiscal year ended June 30, 2005. Ernst & Young LLP provided audit services related to the transition to Goldstein Golub Kessler LLP and the issuance of multiple offering documents during the fiscal year ended June 30, 2006. Accordingly, the Company was billed for professional services rendered by each of Ernst & Young LLP and Goldstein Golub Kessler LLP in connection with the fiscal years ended June 30, 2006 and 2005.

During the fiscal years ended June 30, 2006 and 2005, fees in connection with services rendered by Ernst & Young LLP were as set forth below:

		Fiscal 2006			Fiscal 2005
Audit Fees		$	43,949		$	177,839
Audit-Related Fees			—			—
Tax Fees			—		$	80,314
All Other Fees			—			—
TOTAL		$	43,949		$	258,153

During the fiscal years ended June 30, 2006 and 2005, fees in connection with services rendered by Goldstein Golub Kessler LLP were as set forth below:

		Fiscal 2006			Fiscal 2005
Audit Fees		$	225,000		$	138,000
Audit-Related Fees			—			—
Tax Fees			—			—
All Other Fees			—			—
TOTAL		$	225,000		$	138,000

Audit fees consisted of fees for the audit of our annual financial statements and review of quarterly financial statements as well as services normally provided in connection with statutory and regulatory filings or engagements, consents and assistance with and review of Company documents filed with the Securities and Exchange Commission.

Tax fees consisted primarily of fees for tax compliance, tax advice and tax planning services.

There were no fees categorized as Audit-related or Other fees during fiscal years 2005 and 2006.

AUDIT COMMITTEE PRE-APPROVAL POLICY

The Audit Committee's policy is to pre-approve all audit and permissible non-audit services provided by the independent registered public accounting firm on a case-by-case basis.

 

45

---

PART IV

Item 15. Exhibits, Financial Statement Schedules

 

Exhibit Number

Description

2.1	Asset Purchase Agreement dated July 11, 2003 by and between USA and Bayview Technology Group LLC (Incorporated by reference to Exhibit 2.1 to Form 8-K filed July 14, 2003)

3.1	Amended and Restated Articles of Incorporation of USA filed January 26, 2004 (Incorporated by reference to Exhibit 3.1.19 to Form 10-QSB filed on February 12, 2004).

3.1.1

First Amendment to Amended and Restated Articles of Incorporation of USA filed on March 17, 2005 (Incorporated by reference to Exhibit 3.1.1 to Form S-1 Registration Statement No. 333-124078).

3.1.2

Second Amendment to Amended and Restated Articles of Incorporation of USA filed on December 13, 2005 (Incorporated by reference to Exhibit 3.1.2 to Form S-1 Registration Statement No. 333-130992).

3.2	By-Laws of USA (Incorporated by reference to Exhibit 3.2 to Form SB-2 Registration Statement No. 33-70992).

4.1	Form of 2004 Senior Note (Incorporated by reference to Exhibit 4.24 to Form SB-2 Registration Statement No. 333-101032).

4.2	Form of 2005 Senior Note (Incorporated by reference to Exhibit 4.25 to Form SB-2 Registration Statement No. 333-101032).

4.3	Addendum to 2006 Senior Note. (Incorporated by reference to Exhibit 4.30 to Form 10-KSB filed on September 28, 2004).

4.4	Addendum to 2007 Senior Note. (Incorporated by reference to Exhibit 4.30 to Form 10-KSB filed on September 28, 2003).

4.5	Common Stock Purchase Agreement between the Company and Steve Illes dated April 4, 2005 (Incorporated by reference to Exhibit 4.13.1 to Form S-1 Registration Statement No. 333-124078).

4.6	Form of 2004-B Note (Incorporated by reference to Exhibit 4.28 to Form S-1 Registration Statement No. 333-119951).

4.7	Form of 2005-C Note (Incorporated by reference to Exhibit 4.15 to Form S-1 Registration Statement No. 333-124078).

4.8	Stock Purchase Agreement dated December 13, 2005 by and between the Company and certain clients of Wellington Management Company, LLC (Incorporated by reference to Exhibit 4.1 to Form 8-K filed December 19, 2005).

4. 9	Stock Purchase Agreement dated January 9, 2006, by and between the Company and Rationalwave On Shore Equity Fund, L.P. (Incorporated by reference to Exhibit 4.19 to Form S-1 Registration Statement No. 333-130992).

 

46

---

4.10	Form of 2006-A 10% Convertible Senior Note due December 31, 2010 (Incorporated by reference to Exhibit 4.20 to Form S-1 Registration Statement No. 333-130992).

4.11	Form of 2006-A Warrant(Incorporated by reference to Exhibit 4.21 to Form S-1 Registration Statement No. 333-130992).

4.12	Form of 2005-G Warrant (Incorporated by reference to Exhibit 4.22 to Form S-1 Registration Statement No. 333-130992).

4.13	Common Stock Purchase Agreement between the Company and Steve Illes dated February 17, 2006 (Incorporated by reference to Exhibit 4.23 to Form S-1 Statement No. 333-132019).

**4.14

2006-B Common Stock Purchase Agreement between the Company and Steve Illes dated September 25, 2006

10.14

Amended And Restated Employment and Non-Competition Agreement between USA and Stephen P. Herbert dated May 11, 2006 (Incorporated by reference to Exhibit 10.2 to Form 10-Q filed on May 15, 2006).

10.2	Amended And Restated Employment and Non-competition Agreement between USA and George R. Jensen, Jr. dated May 11, 2006 (Incorporated by reference to Exhibit 10.1 to Form 10-Q filed on May 15, 2006).

10.3	Investment Agreement between USA and Swartz Private Equity, LLC dated September 15, 2000 (incorporated by reference to Exhibit 10.1 to Form 8-K dated September 21, 2000).

10.4	Commitment Warrant issued to Swartz Private Equity LLC dated August 23, 2000 (incorporated by reference to Exhibit 10.2 to Form 8-K dated September 21, 2000).

10.5	Warrant Anti-Dilution Agreement between USA and Swartz Private Equity, LLC dated September 15, 2000 (incorporated by reference to Exhibit 10.3 to Form 8-K dated September 21, 2000).

10.6	Registration Rights Agreement between USA and Swartz Private Equity dated September 15, 2000 (incorporated by reference to Exhibit 10.4 to Form 8-K dated September 21, 2000).

10.7

Agreement and Plan of Merger dated April 10, 2002, by and among the Company, USA Acquisition, Inc., Stitch Networks Corporation, David H. Goodman, Pennsylvania Early Stage Partners, L.P., and Maytag Holdings, Inc. (Incorporated by reference to Exhibit 2.1 to Form 10-QSB for the quarter ended March 31, 2002).

10.8	Strategic Alliance Agreement between USA and ZiLOG Corporation dated October 15, 2002 (Incorporated by reference to Exhibit 10.39 to Form SB-2 Registration Statement No. 333-101032).

10.9	Vending Placement, Supply and Distribution Agreement between Stitch Networks Corporation, Eastman Kodak Company, Maytag Corporation and Dixie-Narco, Inc. dated December 2000 (Incorporated by reference to Exhibit 10.40 to Form SB-2 Registration Statement No. 333-101032).

10.10

Design and Manufacturing Agreement between USA and RadiSys dated June 27, 2000 (Incorporated by reference to Exhibit 10.41 to Form SB-2 Registration Statement No. 333-101032).

 

47

---

10.11

Termination Agreement dated December 31, 2003 by and between Eastman Kodak Company, Maytag Corporation, Dixie-Narco, Inc. and Stitch Networks Corporation. (Incorporated by reference to Exhibit 10.6 to Form 10-QSB filed on February 12, 2004).

10.12

Option Certificate (No. 198) dated April 28, 2004 in favor of Mary West Young. (Incorporated by reference to Exhibit 10.45 to Form SB-2 Registration Statement No. 333-116977).

10.13

Agreement of Lease between Pennswood Spring Mill Associates, as landlord, and the Company, as tenant, dated September 2002, and the Rider thereto (Incorporated by reference to Exhibit 10.21 to Form 10-KSB filed on September 28, 2004).

10.14

Agreement of Lease between Deerfield Corporate Center 1 Associates LP, as landlord, and the Company, as tenant, dated March 2003 (Incorporated by reference to Exhibit 10.22 to Form 10-KSB filed on September 28, 2004).

10.15

Amendment to Office Space Lease dated as of April 1, 2005 by and between the Company and Deerfield Corporate Center Associates, LP. (Incorporated by reference to Exhibit 10.19.1 to Form S-1Registration Statement No. 333-124078)

10.16

Co-Marketing Agreement between Honeywell D.M.C. Services, LLC and the Company dated July 13, 2004 (Incorporated by reference to Exhibit 99.1 to Form 8-K filed on September 29, 2004).

10.17

Employment and Non-Competition Agreement between USA and David M. DeMedio dated April 12, 2005 (Incorporated by reference to Exhibit 10.22 to Form S-1 Registration Statement No. 333-124078).

10.18

First Amendment to Employment and Non-Competition Agreement between USA and David M. DeMedio dated May 11,2006 (Incorporated by reference to Exhibit 10.3 to Form 10-Q filed on May 15, 2006).

10.19

Option Certificate (No. 200) dated April 12, 2005 in favor of David M. DeMedio (Incorporated by reference to Exhibit 10.23 to Form S-1 Registration Statement No. 333-124078).

10.20

Agreement dated December 28, 2004 between USA Technologies and PepsiCo, Inc. (Incorporated by reference to Exhibit 10.01 of Form 8-K filed July 27, 2005)

**10.21

Option Certificate (No. 201) dated May 11, 2006 in favor of George R. Jensen, Jr.

**10.22

Option Certificate (No. 202) dated May 11, 2006 in favor of Stephen P. Herbert.

**10.23

Option Certificate (No. 203) dated May 11, 2006 in favor of David M. Demedio.

**10.24

Option Certificate (No. 204) dated April 21, 2006 in favor of William W. Sellers.

**10.25

Option Certificate (No. 205) dated April 21, 2006 in favor of William L. Van Alen, Jr.

**10.26

Option Certificate (No. 206) dated April 21, 2006 in favor of Steven Katz.

**10.27

Option Certificate (No. 207) dated April 21, 2006 in favor of Douglas M. Lurio.

**10.28

Option Certificate (No. 208) dated April 21, 2006 in favor of Albert Passner.

48

---

**10.29

Option Certificate (No. 209) dated July 20, 2006 in favor of Stephen W. McHugh.

10.30

USA Technologies, Inc. 2006-A Stock Compensation Plan (Incorporated by reference to Exhibit 10.1 to Form S-8 filed June 19, 2006).

14.1	Code of Business Conduct and Ethics. (Incorporated by reference to Exhibit 14.1 to Form 8-K filed on April 17, 2006).

**23.1

Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.

**23.2

Consent of Goldstein Golub Kessler LLP, Independent Registered Public Accounting Firm.

**31.1

Certifications of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

**31.2

Certifications of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

**32	Certifications by the Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

---

** Filed herewith

49

---

 

SCHEDULE II

 

USA TECHNOLOGIES, INC.

VALUATION AND QUALIFYING ACCOUNTS

YEARS ENDED JUNE 30, 2006, 2005 AND 2004

ACCOUNTS RECEIVABLE								Deductions
					Additions			uncollectible
		Balance at			(reductions)			receivables			Balance
		beginning of			charged to			written off, net			at end
		period			earnings			of recoveries			of period
June 30, 2006		$	196,000			131,000			98,000		$	229,000
June 30, 2005		$	240,000			(23,000	)		20,000		$	196,000
June 30, 2004		$	65,000			194,000			19,000		$	240,000

 

INVENTORY		Balance at			Additions			Deductions			Balance
		beginning of			charged to			shrinkage and			at end
		period			earnings			obsolescence			of period
June 30, 2006		$	321,000			484,000			546,000		$	259,000
June 30, 2005		$	229,000			286,000			194,000		$	321,000
June 30, 2004		$	63,000			190,000			24,000		$	229,000

50

---

SIGNATURES

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

	USA TECHNOLOGIES, INC.
	By:	/s/ George R. Jensen, JR,
		George R. Jensen, Jr., Chairman and Chief Executive Officer

 

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

SIGNATURES		TITLE		DATE
/s/ George R. Jensen, Jr.		Chairman of the Board of Directors		September 28, 2006
George R. Jensen, Jr.		and Chief Executive Officer
		(Principal Executive Officer)
/s/ David M. DeMedio		Chief Financial Officer (Principal		September 28, 2006
David M. DeMedio		Accounting Officer)
/s/ Stephen P. Herbert		Chief Operating Officer, President		September 28, 2006
Stephen P. Herbert		and Director
/s/ William L. Van Alen, Jr.		Director		September 28, 2006
William L. Van Alen, Jr.
/s/ Douglas M. Lurio		Director		September 28, 2006
Douglas M. Lurio
/s/ Steven Katz		Director		September 28, 2006
Steven Katz
/s/ Albert Passner		Director		September 28, 2006
Albert Passner
/s/ Stephen W. McHugh		Director		September 28, 2006
Stephen W. McHugh

51

---