DEF 14A 1 definitive_proxy.htm DEFINITIVE PROXY STATEMENT Sample Language Template.p65

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

SCHEDULE 14A INFORMATION

 

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934

 

Filed by the Registrant  x

 

Filed by a Party other than the Registrant  ¨

 



Check the appropriate box:

 

o

 

Preliminary Proxy Statement

  

¨

  

Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))

x

 

Definitive Proxy Statement

  

  

¨

 

Definitive Additional Materials

  

  

¨

 

Soliciting Material under §240.14a-12

  

  

 

WIZZARD SOFTWARE CORPORATION

(Name of Registrant as Specified In Its Charter)

 

N/A

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

Payment of Filing Fee (Check the appropriate box):

 

 

x

No fee required.

¨

Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

 

(1)

Title of each class of securities to which transaction applies:

 

 

 

 

(2)

Aggregate number of securities to which transaction applies:

 

 

 

 

(3)

Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):

 

 

 

 

(4)

Proposed maximum aggregate value of transaction:

 

 

 

 

(5)

Total fee paid:

 

 

 

 ¨

Fee paid previously with preliminary materials.

 ¨

Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.

 

(1)

Amount Previously Paid:

 

 

 

 

(2)

Form, Schedule or Registration Statement No.:

 

 

 

 

(3)

Filing Party:

 

 

 

 

(4)

Date Filed:

 

 

 


 







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5001 Baum Blvd, Suite 770

Pittsburgh, Pennsylvania 15213

 

June 1, 2012

 

Dear Stockholder:

 

You are cordially invited to attend the Annual Meeting of Stockholders of Wizzard Software Corporation, which will be held on July 30, 2012, starting at 8:00 a.m., Eastern Daylight Time, at the offices of Wizzard Software, 5001 Baum Blvd, Suite 770, Pittsburgh, PA 15213.  In addition to the matters to be acted upon at the meeting, which are described in the attached Notice of Annual Meeting of Stockholders and Proxy Statement, there will be a report with respect to the current status of our operations and an opportunity for you to ask questions.

 

Whether or not you plan to attend the meeting, the prompt execution of your proxy card will both assure that your shares are represented at the meeting and minimize the cost of proxy solicitation.

 

The Proxy Statement contains a more extensive discussion of each proposal and therefore you should read the Proxy Statement carefully.  The Board of Directors unanimously recommends that you approve all proposals.

 

Only stockholders of record at the close of business on June 11, 2012 are entitled to vote at the meeting. You are cordially invited to attend the meeting in person.

 

If you have any questions after reading the Proxy Statement and other materials we have sent, please call Art Batson, our Investor Relations Representative, at (407) 478-1120.

 

 

Sincerely,

 

/s/ Christopher J. Spencer

Christopher J. Spencer

Chairman and Chief Executive Officer

 











The Board encourages stockholders to attend the meeting in person. Whether or not you plan to attend the meeting, you are urged to execute your proxy card. The proxy may be revoked at any time before the shares are voted at the meeting. Stockholders who attend the meeting may vote their shares personally even though they have sent their proxies.












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5001 Baum Blvd, Suite 770

Pittsburgh, Pennsylvania 15213


NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

TO BE HELD ON JULY 30, 2012


 

To the Stockholders of Wizzard Software Corporation:

 

The 2012 Annual Meeting of Stockholders of Wizzard Software Corporation, a Colorado corporation (the “Company”), will be held on July 30, 2012, starting at 8:00 a.m., Eastern Daylight Time, at the offices of Wizzard Software, 5001 Baum Blvd, Suite 770, Pittsburgh, PA 15213, for the following purposes:


1.

To elect four directors to serve a two year term from the date of the Annual Meeting of Stockholders, or until their prior resignation or termination and the election and qualification of their successors;

2.

To approve our 2012 Stock Option Plan of 3,000,000 options for shares of common stock;

3.

To approve the Share Exchange Agreement entered into on April 5, 2012, between the Company; Universal Entertainment Group Limited, a British Virgin Islands corporation; Digital Entertainment International Ltd., a corporation organized under the laws of the Hong Kong Special Administrative Region; Beijing Dingtai Guanqun Culture Media Co. Ltd, a corporation organized under the laws of the People’s Republic of China (the “PRC”); Beijing FAB Culture Media Co., Ltd., a corporation organized under the laws of the PRC; and Beijing FAB Digital Entertainment Products Co., Ltd, a corporation organized under the laws of the PRC, (collectively, the “FAB Parties”), and the issuance of up to 40,591,000 shares of our common stock, if all future revenue and corporate governance objectives are met pursuant thereto;

4.

To ratify the selection by the Board of Directors of Gregory & Associates LLC as independent auditors of Wizzard for the fiscal year ending December 31, 2012;

5.

The appointment of two additional directors per the terms of the Share Exchange Agreement, subject to approval of Proposal No. 3 above and the closing of the Share Exchange Agreement;

6.

The amendment of the Company’s Articles of Incorporation to change its name to such name as the Company’s Board of Directors and the FAB Parties shall determine which amendment shall be subject to the prior closing of the Share Exchange Agreement.

7.

To transact such other business as may properly come before the Annual Meeting and any and all adjournments or postponements thereof.

 Our Board of Directors recommends that you vote FOR each of Proposals 1 through 6 above.  Our Board of Directors has chosen the close of business on June 11, 2012, as the record date for determining the stockholders entitled to notice of, and to vote at, the Annual Meeting. Only stockholders of record as of the record date are entitled to notice of, and to vote at, the Annual Meeting and any adjournments or postponements thereof. A copy of our proxy statement and a proxy card accompany this notice. These materials will first be mailed to stockholders on or about June 18, 2012.

 

By Order of the Board of Directors,

 

/s/ Douglas Polinsky

Douglas Polinsky

Director

 

June 1, 2012

 








PROXY STATEMENT TABLE OF CONTENTS

 

SUMMARY TERM SHEET

1

QUESTIONS AND ANSWERS ABOUT THE ANNUAL MEETING

2

EXECUTIVE OFFICERS

6

CORPORATE GOVERNANCE

7

Board Leadership Structure and Risk Oversight

8

Board of Directors Independence

8

Committees of the Board of Directors

8

Communicating Concerns to Directors

8

Board and Committee Meetings

9

Nominating Committee Report

9

Audit Committee Report

10

Compensation Committee Interlocks and Insider Participation

10

COMPENSATION DISCUSSION AND ANALYSIS

10

Overview and General Philosophy

11

Compensation Objectives

11

Compensation Administration

11

Compensation Components

12

Retirement and Other Benefits

13

Compensation Committee Report

13

Restricted Stock Awards

14

Outstanding Equity Awards at Fiscal Year End

14

Nonqualified Deferred Compensation

14

Other Potential Post-Employment Payments

14

Summary Information about Equity Compensation Plans

14

DIRECTOR COMPENSATION

16

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

16

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

17

PROPOSAL NO. 1 - ELECTION OF DIRECTORS

18

PROPOSAL NO. 2 - APPROVAL OF THE WIZZARD SOFTWARE CORPORATION 2012 STOCK OPTION PLAN OF 3,000,000 OPTIONS FOR SHARES OF COMMON STOCK                                            19

PROPOSAL NO. 3 - APPROVAL OF THE SHARE EXCHANGE AGREEMENT DATED APRIL 5, 2012, AND THE ISSUANCE OF UP TO 40,591,000 SHARES OF OUR COMMON STOCK IF ALL REVENUE AND CORPORATE GOVERNANCE OBJECTIVES ARE MET PURSUANT THERETO                             20

PROPOSAL NO. 4 - RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS

75

PROPOSAL NO. 5 - ELECTION OF TWO ADDITIONAL DIRECTORS PER THE TERMS OF THE SHARE EXCAHNGE AGREEMENT SUBJECT TO APPROVAL OF PROPOSAL NO 3 OF THIS PROXY STATEMENT.                                                                                                                                                                  76

PROPOSAL NO. 6- THE AMENDMENT OF THE COMPANY’S ARTICLES OF INCORPORATION TO CHANGE ITS NAME TO SUCH NAME AS THE COMPANY’S BOARD OF DIRECTORS AND THE FAB PARTIES SHALL DETERMINE, WHICH AMENDMENT SHALL BE SUBJECT TO THE PRIOR CLOSING OF THE SHARE EXCHANGE AGREEMENT.                                                                                   78








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PROXY STATEMENT

 

Annual Meeting of Stockholders

To Be Held on July 30, 2012  

 

GENERAL INFORMATION

 

This proxy statement is being furnished to the stockholders of Wizzard Software Corporation, a Colorado corporation, in connection with the solicitation of proxies on behalf of the Board of Directors of Wizzard for use at Wizzard’s Annual Meeting of Stockholders and any and all adjournments or continuations of the annual meeting, to be held Monday, July 30, 2012, starting at 8:00 a.m., Eastern Daylight Time, at the offices of Wizzard Software, 5001 Baum Blvd, Suite 770, Pittsburgh, PA 15213, for the purposes set forth in the accompanying Notice of Annual Meeting of Stockholders.  These materials will be first mailed to stockholders on or about June 18, 2012.

 

When we use “Wizzard,” “we,” “us,” “our” or the “Company,” we are referring to Wizzard Software Corporation.

 

This Proxy Statement and our Annual Report to Shareholders are also available at:

http://annualreports.wizzardsoftware.com.

http://proxystatement.wizzardsoftware.com.

 

SUMMARY TERM SHEET


 The following information summarizes the terms of the Share Exchange Agreement that is the subject of Proposal No. 3 herein.  It is only a summary and you are urged to carefully review the disclosure under Proposal No. 3 for a more detailed description of the Share Exchange Agreement and the transactions contemplated thereby.  This summary includes the material terms of the transactions


Under the Share Exchange Agreement:


·

Wizzard agreed to acquire all of the issued and outstanding shares of Digital Entertainment International Ltd. (“Digital HKCo”) in exchange for such number of common shares as represents 49% of Wizzard’s issued and outstanding shares, on a fully-diluted basis, as of the closing date of the Share Exchange Agreement (the “Initial Shares”);

·

The voting rights of the Initial Shares will be controlled by Wizzard’s Board of Directors until certain Corporate Governance Objectives have been met over a period of eight consecutive and complete quarters after such closing date;

·

Wizzard will issue 290 shares of its Series B Convertible Preferred Stock, which shall be convertible into an additional 29% of Wizzard’s issued and outstanding common stock on a fully diluted basis upon the attainment of certain Corporate Governance Objectives and Revenue Objectives over a period of six consecutive and complete quarters after the closing date. If all Corporate Governance Objectives and Revenue Objectives are met, and all Series B Convertible Preferred Stock is converted into common stock, the selling stockholder of Digital HKCo, together with its designees, will control approximately 78% of Wizzard’s issued and outstanding voting shares and as a result, Wizzard’s current stockholders, who collectively own 100% of its outstanding common shares, will collectively own only 22% of such shares;

·

The FAB parties are to designate two members to serve on Wizzard’s Board of Directors along with Wizzard’s four current directors, and with one of such new members to be designated Chairman of the Board; and

·

Fifty percent of the Initial Shares will be subject to the terms of a Lock-up Agreement restricting transfer thereof for a period of 12 months following the closing date.

·

As a condition to the Closing of the Share Exchange Agreement, Wizzard is to complete the “spin-off” of its wholly-owned subsidiary, Interim Healthcare of Wyoming, Inc., a Wyoming corporation, through which Wizzard conducts its home healthcare operations.  The Share Exchange Agreement provides that the stockholder of Digital HKCo shall not be deemed a stockholder of Wizzard for purposes of the spin-off and shall not be entitled to participate therein.  The spin-off will be subject to the prior approval of Proposal 3 of this Proxy Statement, and Wizzard’s Board of Directors will set a record date for determining which stockholders are eligible to participate in the spin-off , which record date will be prior to the date of the Closing of the Share Exchange Agreement.  For more information about this proposed spin-off, see the caption “The Spin-Off” under Proposal 3 of this Proxy Statement.




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·

Digital HKCo operates through its wholly-owned subsidiary, Beijing Dingtai Guanqun Culture Co., Ltd. (“DGC” or the “WFOE”), which has entered into an Exclusive Service Agreement and related agreements known as “Variable Interest Entity” contracts, or “VIE” contracts  with Beijing FAB Cultural Co., Ltd. (“FAB Media”) and Beijing FAB Digital Entertainment Products Co., Ltd. (“FAB Digital”).  Through DGC and FAB Media and FAB Digital, Digital HKCo is engaged in the marketing and distribution of officially licensed digital entertainment products throughout China under the “FAB” brand.  These products include Compact Discs, Video Compact Discs and Digital Video Discs, as well as books, magazines, mobile phone accessories and cameras.  These products and services are primarily distributed through FAB flagship stores, franchises, proprietary FAB kiosks and online virtual stores.  For a more detailed discussion of the FAB business, see the caption “Business Overview” under Proposal 3 of this Proxy Statement.  


                  Please see the disclosure under Proposal 3 of this Proxy Statement for a detailed discussion of the terms of the Share Exchange Agreement.


There are substantial risks associated with the Share Exchange Agreement and the FAB business.  Please see the caption “Risk Factors Related to the Acquisition” under Proposal 3 of this Proxy Statement.


QUESTIONS AND ANSWERS ABOUT THE ANNUAL MEETING

 

What is the purpose of the annual meeting?

 

At the annual meeting, our stockholders will act upon the matters described in this proxy statement. These actions include: (i) the election of four directors to serve a two year term from the date of the Annual Meeting of Stockholders, or until their prior resignation or termination and the election and qualification of their successors; (ii) the approval of our 2012 Stock Option Plan; (iii) the approval of the Share Exchange Agreement that we entered into on April 5, 2012, with Universal Entertainment Group Limited, a British Virgin Islands corporation; Digital Entertainment International Ltd., a corporation organized under the laws of the Hong Kong Special Administrative Region; Beijing Dingtai Guanqun Culture Media Co. Ltd, a corporation organized under the laws of the People’s Republic of China (the “PRC”); Beijing FAB Culture Media Co., Ltd., a corporation organized under the laws of the PRC; and Beijing FAB Digital Entertainment Products Co., Ltd, a corporation organized under the laws of the PRC, (collectively, the “FAB Parties”), and the issuance of up to 40,591,000 shares of our common stock, if all future revenue and corporate governance objectives are met pursuant thereto; (iv) the ratification of Gregory & Associates LLC as independent auditors of Wizzard for the fiscal year ending December 31, 2012; (v) the appointment of two additional board members per the terms of the Share Exchange Agreement, and subject to the closing thereof; and (vi) the amendment of the Company’s Articles of Incorporation to change its name to such name as the Company’s Board of Directors and the FAB Parties shall determine, which amendment shall be subject to the prior closing of the Share Exchange Agreement. An additional purpose of the Annual Meeting is to transact any other business that may properly come before the Annual Meeting and any and all adjournments or postponements thereof.

 


Who can attend the annual meeting?

 

All stockholders of record at the close of business on the record date, or their duly appointed proxies, may attend the annual meeting. Our Board of Directors has chosen the close of business on June 11, 2012, as the record date for determining the stockholders entitled to notice of, and to vote at, the Annual Meeting. Only stockholders of record as of the record date are entitled to notice of, and to vote at, the Annual Meeting and any adjournments or postponements thereof. 

 

What proposals will be voted on at the annual meeting?

 

Stockholders will vote on four proposals at the annual meeting:


·

the election of four directors to serve a two year term from the date of the Annual Meeting, or until their prior resignation or termination and the election and qualification of their successors;

·

the approval of the 2012 Stock Option Plan of 3,000,000 options for shares of common stock;

·

the approval of the Share Exchange Agreement and the issuance of up to 40,591,000 shares of our common stock, if all future revenue and corporate governance objectives are met pursuant thereto;

·

the ratification of Gregory & Associates LLC as independent auditors of Wizzard for the fiscal year ending December 31, 2012,

·

the appointment of two additional directors per the terms of the Share Exchange Agreement, subject to the approval and the closing thereof; and




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·

the amendment of our Articles of Incorporation to change our name to such name as the Board of Directors and the FAB Parties shall determine, which amendment shall be subject to the prior closing of the Share Exchange Agreement.

  

What are the Board’s recommendations?

 

Our Board recommends that you vote:

 

 

 

FOR election of the four nominated directors;

  

 

FOR the approval of the 2012 Stock Option Plan of 3,000,000 options for shares of common stock;

  

 

FOR the approval of the Share Exchange Agreement and the issuance of up to 40,591,000 shares of our common stock, if all future revenue and corporate governance objectives are met pursuant thereto;

  

 

FOR the ratification of Gregory & Associates LLC as independent auditors of Wizzard for the fiscal year ending December 31, 2012,

 

 

FOR the appointment of two additional directors per the terms of the Share Exchange Agreement subject to approval and the closing thereof.

 

 

FOR the amendment of our Articles of Incorporation to change our name to such name as the Board of Directors and the FAB Parties shall determine, subject to the prior closing of the Share Exchange Agreement.

 

Will there be any other business on the agenda?

 

The Board knows of no other matters that are likely to be brought before the Annual Meeting. If any other matters properly come before the Annual Meeting, however, the persons named in the enclosed proxy, or their duly appointed substitute acting at the Annual Meeting, will be authorized to vote or otherwise act on those matters in accordance with their judgment.

 

Who is entitled to vote?

 

Only stockholders of record at the close of business on June 11, 2012, which we refer to as the “record date,” are entitled to notice of, and to vote at, the Annual Meeting. As of the record date, there were 8,693,826 shares of our common stock outstanding. Holders of common stock as of the record date are entitled to one vote for each share held for each of the proposals.

 

What is the difference between holding shares as a stockholder of record and as a beneficial owner?

 

Stockholder of Record.  If your shares are registered directly in your name with our transfer agent, Interwest Transfer Company, Inc., you are considered, with respect to those shares, the “stockholder of record.” The proxy statement, Annual Report and proxy card have been sent directly to you by us.

 

Beneficial Owner. If your shares are held in a stock brokerage account or by a bank or other nominee, you are considered the “beneficial owner” of shares held in street name. The proxy statement and Annual Report have been forwarded to you by your broker, bank or nominee who is considered, with respect to those shares, the stockholder of record. As the beneficial owner, you have the right to direct your broker, bank or nominee how to vote your shares by using the voting instruction form included in the mailing.

 

How do I vote my shares?

 

All stockholders who receive proxy materials will receive instructions for voting by mail, telephone, or by using the Internet.

 

What constitutes a quorum?

 

A quorum is the presence, in person or by proxy, of the holders of a majority of the shares of the common stock entitled to vote. Under Colorado law, an abstaining vote and a broker “non-vote” are counted as present and are, therefore, included for purposes of determining whether a quorum of shares is present at the Annual Meeting.

 

What is a broker “non-vote” and what is its effect on voting?

 

A broker “non-vote” occurs when a nominee holding shares for a beneficial owner does not vote on a particular proposal because the nominee does not have the discretionary voting authority with respect to that item and has not received instructions from the beneficial owner. Generally, shares held by brokers who do not have discretionary authority to vote on a particular matter and have not received voting instructions from their customers are not counted or deemed to be present or represented for purposes of determining whether stockholders have approved that matter. More specifically, broker “non-votes” are not included in the tabulation of the voting results on the election of directors or




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issues requiring approval of a majority of the shares present or represented by proxy and entitled to vote at the Annual Meeting and, therefore, do not have an effect on the outcome of any of the proposals.

 

What is required to approve each item?

 

 

 

For Proposal 1 (election of directors), a plurality of the votes duly cast is required for the election of directors (that is, the nominees receiving the greatest number of votes will be elected). Abstentions are not counted for purposes of the election of directors.

 

 

For Proposal 2 (2012 Stock Option Plan), the affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the meeting and entitled to vote, is required.

 

 

For Proposal 3 (approval of the Share Exchange Agreement and the issuance of up to 40,591,000 shares of our common stock, if all future revenue and corporate governance objectives are met pursuant thereto), the affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the meeting and entitled to vote, is required.

 

 

For Proposal 4 (ratification of the selection of the independent auditors), the affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the meeting and entitled to vote, is required.

 

 

For Proposal 5 (election of two additional directors, subject to approval of Proposal 3 and the closing of the Share Exchange Agreement), the affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the meeting and entitled to vote, is required.

 

  •  

 

For Proposal 6 (the amendment of the Company’s Articles of Incorporation to change its name, subject to approval of Proposal 3 and the closing of the Share Exchange Agreement), ), the affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the meeting and entitled to vote, is required.

 

 

For any other matters (other than the election of directors) on which stockholders of Wizzard are entitled to vote, the affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the meeting and entitled to vote, is required.

 

For the purpose of determining whether the stockholders have approved matters other than the election of directors, abstentions are treated as shares present or represented and voting, so abstaining has the same effect as a negative vote. If stockholders hold their shares through a broker, bank or other nominee and do not instruct them how to vote, the broker may have authority to vote the shares.

 

Stockholders may not cumulate votes in the election of directors, which means that each stockholder may vote no more than the number of shares he or she owns for a single director candidate.

 

How will shares of common stock represented by properly executed proxies be voted?

 

All shares of common stock represented by properly executed proxies will, unless such proxies have previously been revoked, be voted in accordance with the instructions indicated in such proxies. If you do not provide voting instructions, your shares will be voted in accordance with the Board’s recommendations on the items listed in the Notice of Annual Meeting. In addition, if any other matters properly come before the Annual Meeting, the persons named in the enclosed proxy, or their duly appointed substitute acting at the Annual Meeting, will be authorized to vote or otherwise act on those matters in accordance with their judgment.

 

Can I change my vote or revoke my proxy?

 

Any stockholder executing a proxy has the power to revoke such proxy at any time prior to its exercise. You may revoke your proxy prior to exercise by:

 

 

 

filing with us a written notice of revocation of your proxy,

  

 

submitting a properly signed proxy card bearing a later date,

   

 

voting in person at the annual meeting.

 

What does it mean if I receive more than one proxy card?

 

If your shares are registered under different names or are in more than one account, you will receive more than one proxy card. To ensure that all your shares are voted, please sign and return all proxy cards, or if you choose, vote by telephone or through the Internet using the personal identification number printed on each proxy card. We encourage you to have all accounts registered in the same name and address (whenever possible). You can accomplish this by contacting our transfer agent, Interwest Transfer Company, Inc.

 

 




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Who paid for this proxy solicitation?

 

This proxy solicitation is made by the Company.  The cost of preparing, printing, assembling and mailing this proxy statement and other material furnished to stockholders in connection with the solicitation of proxies will be borne by us.

 

How are proxies solicited?

 

In addition to the mail solicitation of proxies, our officers, directors, employees and agents may solicit proxies by written communication, telephone or personal call. These persons will receive no special compensation for any solicitation activities. We will reimburse banks, brokers and other persons holding common stock for their expenses in forwarding proxy solicitation materials to beneficial owners of our common stock.

 

What is “householding?”

 

“Householding” means that we deliver a single set of proxy materials to households with multiple stockholders, provided certain conditions are met. Householding reduces our printing and mailing costs.

 

If you or another stockholder of record sharing your address would like to receive an additional copy of the Annual Report on Form 10-K or this Proxy Statement, we will promptly deliver it to you upon your request in one of the following manners:

 

 

 

by sending a written request by mail to:

 John Busshaus, Chief Financial Officer

Wizzard Software Corporation

5001 Baum Blvd, Suite 770

Pittsburgh, PA 15213

 

 

 

by calling John Busshaus, Chief Financial Officer, at (412) 621-0902.

 

If you would like to opt out of householding in future mailings, or if you are currently receiving multiple mailings at one address and would like to request householded mailings, you may do so by contacting Kathy Neal, at (412) 621-0902.

 

Can I receive future stockholder communications electronically through the Internet?

 

Yes. You may elect to receive future notices of meetings, proxy materials and annual reports electronically through the Internet. To consent to electronic delivery, you must vote your shares using the Internet. At the end of the Internet voting procedure, the on-screen Internet voting instructions will tell you how to request future stockholder communications be sent to you electronically.

 

Once you consent to electronic delivery, you must vote your shares using the Internet and your consent will remain in effect until withdrawn. You may withdraw this consent at any time and resume receiving stockholder communications in print form.


What are the requirements for presenting stockholder proposals?

 

Stockholders may submit proposals on matters appropriate for stockholder action at our annual meeting, including the submission of nominees for election to the Board of Directors, consistent with regulations adopted by the Securities and Exchange Commission (the “SEC”) and our Bylaws. For such proposals to be considered for inclusion in the proxy statement and form of proxy relating to the 2013 annual meeting, we must receive them not later than January 1, 2013, or such later date as we may specify in our SEC filings. Your proposals should be addressed to Wizzard Software Corporation at 5001 Baum Blvd, Suite 770, Pittsburgh, PA 15213, Attn: Corporate Secretary.

 

We anticipate that proxies solicited in connection with our 2012 Annual Meeting will confer discretionary authority to vote on matters, among others, of which we do not receive notice prior to April 4, 2012.

 

Am I entitled to dissenter’s rights?


Under Colorado law, stockholders are not entitled to dissenter’s rights in connection with any of the matters described in this proxy statement.





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What are the interests of the Company’s directors and officers in the matters to be acted upon?


Except as indicated below, none of our directors, executive officers, nominees for election as directors, or any of their associates has any substantial interest, direct or indirect, by security holdings or otherwise, in any of the matters to be acted upon.


To the extent that any of the above-referenced persons may be eligible to participate in our 2012 Stock Option Plan, they may be deemed to have an interest in the adoption of such plan.

 

Whom may I contact for further assistance?

 

If you have any questions about giving your proxy or require any assistance, please contact John Busshaus, our Chief Financial Officer:

 

 

 

by mail, to:

John Busshaus, Chief Financial Officer

Wizzard Software Corporation

5001 Baum Blvd, Suite 770

Pittsburgh, PA 15213

  

 

by telephone, at (412) 621-0902


EXECUTIVE OFFICERS

 

The following table sets forth:

 

 

 

the names of our current executive officers,

  

 

their ages as of the record date for the annual meeting and

  

 

the capacities in which they currently serve Wizzard :



Name

  

Age

  

Position(s)

  

Officer Since

Christopher J. Spencer

  

43

  

Chief Executive Officer and Director

  

2001

John Busshaus

  

49

  

Chief Financial Officer

  

2007


See “Proposal No. 1 — Election of Directors” for biographical information regarding Mr. Spencer and each of our other current directors.

 

John Busshaus has served as Chief Financial Officer since January 29, 2007.  Mr. Busshaus has been responsible for our overall accounting and financial reporting functions since joining the Company in April 2006. From 2004 to 2006, Mr. Busshaus was an independent business consultant.  Mr. Busshaus’ efforts were assisting organizations with the implementation of Sarbanes Oxley, filing of SEC reports, and taking a company through an IPO.  Mr. Busshaus worked for Talanga International from 2001 to 2004, where he was the Chief Financial Officer for the company.  From 1999 to 2000, Mr. Busshaus worked for Mellon Bank as Controller and Vice President, and was responsible for strategic planning and managing the annual and monthly budgeting within Global Security Services.  From 1994 to 1998, Mr. Busshaus worked for PepsiCo as Senior Business Planner, and was responsible for annual and quarterly budgets planning, as well as weekly, monthly and quarterly reporting of results.  As a member of management, Mr. Busshaus' efforts contributed to the revenue growth and market share increases in a market that was categorized as saturated.

 

 Involvement in Certain Legal Proceedings


     During the past ten years, none of our present or former directors, executive officers or persons nominated to become directors or executive officers:


(1) A petition under the Federal bankruptcy laws or any state insolvency law was filed by or against, or a receiver, fiscal agent or similar officer was appointed by a court for the business or property of such person, or any partnership in which he was a general partner at or within two years before the time of such filing, or any corporation or business association of which he was an executive officer at or within two years before the time of such filing;


(2) Such person was convicted in a criminal proceeding or is a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses);


(3) Such person was the subject of any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining him from, or otherwise limiting, the following activities:




6





(i) Acting as a futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, floor broker, leverage transaction merchant, any other person regulated by the Commodity Futures Trading Commission, or an associated person of any of the foregoing, or as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company, or engaging in or continuing any conduct or practice in connection with such activity;


(ii) Engaging in any type of business practice; or


(iii) Engaging in any activity in connection with the purchase or sale of any security or commodity or in connection with any violation of Federal or State securities laws or Federal commodities laws;


(4) Such person was the subject of any order, judgment or decree, not subsequently reversed,

suspended or vacated, of any Federal or State authority barring, suspending or otherwise limiting for more than 60 days the right of such person to engage in any activity described in paragraph (f)(3)(i) of this section, or to be associated with persons engaged in any such activity;


(5) Such person was found by a court of competent jurisdiction in a civil action or by the Commission to have violated any Federal or State securities law, and the judgment in such civil action or finding by the Commission has not been subsequently reversed, suspended, or vacated;


(6) Such person was found by a court of competent jurisdiction in a civil action or by the Commodity Futures Trading Commission to have violated any Federal commodities law, and the judgment in such civil action or finding by the Commodity Futures Trading Commission has not been subsequently reversed, suspended or vacated;


(7) Such person was the subject of, or a party to, any Federal or State judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of:


(i) Any Federal or State securities or commodities law or regulation; or


(ii) Any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or


(iii) Any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or


(8) Such person was the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.


Family Relationships


     There are no family relationships between any of our directors or executive officers.


CORPORATE GOVERNANCE

 

We uphold a set of basic values to guide our actions and are committed to maintaining the highest standards of business conduct and corporate governance. We have adopted a Code of Business Conduct and Ethics for directors, officers (including our principal executive officer and principal financial officer) and employees, which, in conjunction with our Certificate of Incorporation, Bylaws and Board of Directors committee charters, form the framework for governance of Wizzard.  The Code of Ethics and Business Conduct, Board of Directors committee charters, Bylaws and Certificate of Incorporation are available at our corporate offices. Stockholders may request free printed copies of these documents from:


Wizzard Software Corporation

Attn: Kathy Neal

5001 Baum Blvd., Suite 770

Pittsburgh, PA 15213

(412) 621-0902





7




Board Leadership Structure and Risk Oversight


Our company is led by Mr. Christopher Spencer, who has served as chief executive officer and chairman of the Board of Directors since inception of the Company.  Our Board of Directors is comprised of Mr. Spencer and three independent directors.  The Board has four standing independent committees—the audit, compensation, nominating, and corporate governance and risk committees.  Each of the Board committees is comprised solely of independent directors. Our risk committee is responsible for overseeing risk management, and our full Board regularly engages in discussions of risk management.  Each of our other Board committees also considers the risk within its area of responsibilities. Our corporate governance guidelines provide that our non-management directors will meet in executive session at each Board meeting.


Our corporate leadership structure is commonly utilized by other public companies in the United States, and we believe that this leadership structure has been effective for the Company. We believe that having a combined chairman/CEO, and only independent Board members for each of our Board committees provides the right form of leadership for our Company. We have a single leader for our Company and he is seen by our customers, business partners, investors and other stakeholders as providing strong leadership for the Company and in our industry. We believe that our Chairman/CEO together with the risk committee, the audit committee and the full Board of Directors, provide effective oversight of the risk management function.

 

Board of Directors Independence

 

The Board of Directors has determined that each of J. Gregory Smith, Denis Yevstifeyev and Douglas Polinsky has no material relationship with us (either directly or as a partner, stockholder or officer of an organization that has a relationship with us) and satisfies the independence requirements required by the NYSE MKT Equities. The non-management independent directors meet in executive session, without management, at least annually. Mr. Polinsky, an independent non-management director, chairs all executive session meetings of directors.


Committees of the Board of Directors

 

The Board of Directors has adopted written charters for two standing committees: the Nominating Committee and the Audit Committee. The Board has determined that all members of the Nominating and Audit Committees are independent and satisfy the relevant SEC or NYSE MKT Equities independence requirements for members of such committees.


Nominating Committee.    The Nominating Committee currently consists of Mr. Polinsky as chair, Mr. Yevstifeyev, and Mr. Smith. This committee provides assistance to the Board in identifies individuals qualified to become members of the Board of Directors consistent with Board criteria. The committee also oversees the evaluation of the Board of Directors and management. 

 

Audit Committee.    The Audit Committee currently consists of Mr. Polinsky as chair, Mr. Yevstifeyev, and Mr. Smith. Mr. Yevstifeyev, the Board of Directors has determined, is an “audit committee financial expert” as defined under SEC rules. This committee oversees the integrity of our financial statements, disclosure controls and procedures, the systems of internal accounting and financial controls, compliance with legal and regulatory requirements, the qualifications and independence of the independent auditors and the performance of our internal audit function and independent auditors, and the quarterly reviews and annual independent audit of our financial statements. The Audit Committee’s report appears hereafter. Gregory & Associates LLC, our independent auditors, reports directly to the Audit Committee.


We will provide a free printed copy of any of the charters of any Board committee to any stockholder on request.


Compensation Committee.    The Compensation Committee currently consists of Mr. Polinsky as chair, Mr. Yevstifeyev, and Mr. Smith. This committee provides assistance to the Board of Directors in overseeing our compensation policies and practices. It reviews and approves the compensation levels and policies for the Board of Directors; reviews and approves corporate goals and objectives with respect to CEO compensation and, based upon these evaluations, determines and approves the CEO’s compensation; makes recommendations to the Board of Directors with respect to non-CEO executive officer compensation. The Compensation Committee also has the responsibility to provide the report to stockholders on executive officer compensation, which appears below.

 

Communicating Concerns to Directors

 

The non-employee directors have established procedures to enable anyone wishing to communicate with our Board of Directors in one of the following ways:

 

 

 

E-mailing the directors at directors@wizzardsoftware .com, or

  

 

Writing to the directors, at the following address:

 




8




Board of Directors

Wizzard Software Corporation   

c/o Corporate Secretary

5001 Baum Blvd

Suite 770

Pittsburgh, PA 15213

 

The Audit Committee has established procedures for employees who have a concern about our accounting, internal accounting controls or auditing matters, to communicate that concern directly to the Audit Committee in one of the following ways:

 

 

 

Calling the whistle blowing hotline @ (888) 363-7411

  

 

Writing to the Audit Committee, at the following address:

Chair of the Wizzard Audit Committee

5001 Baum Blvd

Suite 770

Pittsburgh PA 15213

 

The Corporate General Counsel will forward any communications related to our accounting, internal accounting controls, or auditing matters to the Chair of the Audit Committee, together with any other director named in the communication. All other communications will be forwarded to the designated lead independent director of the Board of Directors, together with any other director named in the communication. Communications may be anonymous.

 

Board and Committee Meetings

 

The Board held five meeting during fiscal 2011.  We encourage but do not require Board member attendance at our Annual Meeting.  The Audit Committee held four meeting in fiscal 2011. Each director attended at least 75% of the aggregate of the total number of board and applicable committee meetings. One director attended the 2011 annual meeting.


Nominating Committee Report

 

The Nominating Committee provides assistance to the Board in evaluating and selecting director nominees of the Company to be considered for election at the annual meeting of stockholders and takes such other actions within the scope of its charter as the committee deems necessary or appropriate.

 

The Nominating Committee has responsibility for identifying and evaluating new nominees to the Board. In evaluating director nominees, the committee will, as described in the committee’s charter, consider various criteria, including relevant industry experience, general business experience, relevant financial experience, and compliance with independence and other qualifications necessary to comply with any applicable tax and securities laws and the rules and regulations of the NYSE MKT Equities.  In addition, directors must have time available to devote to Board activities and to enhance their knowledge of our business. We therefore seek to attract and retain qualified directors who have sufficient time to devote to their responsibilities and duties to us and our stockholders.

 

Between annual meetings of stockholders, the Board may elect directors to serve until the next annual meeting. Nominees for directorship will be selected by the Nominating Committee, in accordance with the policies and principles in its charter, and nominated by the Board for stockholder elections. To date, we have not engaged third parties to identify or evaluate or assist in identifying potential director nominees, although we may do so in the future.

 

To date, we have not received any recommendations from stockholders requesting the Board or any of its committees to consider a nominee for inclusion among the Board’s slate of nominees in our proxy statement for our annual meeting. However, our stockholders may recommend director nominees, and the committee will consider nominees recommended by stockholders. A stockholder wishing to submit such a recommendation should send a letter to the Corporate Secretary at our principal executive offices in accordance with the provisions of our Bylaws and the provisions set forth in the Questions and Answers about the Annual Meeting section under the question, “What are the requirements for presenting stockholder proposals?” The mailing envelope must contain a clear notation indicating that the enclosed letter is a “Director Nominee Recommendation.” The letter must identify the author as a stockholder and provide a brief summary of the nominee’s qualifications, including such information about the nominee as would have been required to be included in a proxy statement filed pursuant to the rules of the SEC had such nominee been nominated by the Board, as well as contact information for both the nominee and the stockholder. Nominees should at a minimum have relevant business and financial experience and must be able to read and understand fundamental financial statements. We anticipate that nominees recommended by stockholders will be evaluated in the same manner as nominees recommended by anyone else, although, the committee may prefer nominees who are personally known to the existing directors and whose reputations are highly regarded. The committee will consider all relevant qualifications as well as our needs in terms of compliance with NYSE MKT Equities listing standards and SEC rules.




9




 

All of the nominees for directors being voted upon at the annual meeting are directors standing for reelection.

 

The Nominating and Corporate Governance Committee assisted the Board and each of its committees in conducting self-evaluations of their functioning and effectiveness. The committee also has reviewed and approved the Company’s CEO succession plan.

 

Nominating Committee

Douglas Polinsky

Denis Yevstifeyev

J. Greg Smith


Audit Committee Report

 

The Audit Committee acts pursuant to a written charter that was approved by the Board of Directors. The Audit Committee oversees our financial reporting process on behalf of the Board. Our management has the primary responsibility for the financial statements, for maintaining effective internal control over financial reporting, and for assessing the effectiveness of internal control over financial reporting. In fulfilling its oversight responsibilities, the committee reviewed and discussed the audited consolidated financial statements with our management, including a discussion of the quality, not just the acceptability, of the accounting principles used; the reasonableness of significant judgments made; and the clarity of the disclosures in the financial statements.

 

The Audit Committee reviewed with Gregory & Associates LLC, our independent auditors, which is responsible for expressing an opinion on the conformity of the consolidated financial statements with U.S. generally accepted accounting principles, its judgments as to the quality, not just the acceptability, of our accounting principles and such other matters as are required to be discussed with the committee by Statement on Auditing Standards No. 61, other standards of the Public Company Accounting Oversight Board, rules of the SEC and other applicable regulations. In addition, the committee has discussed with Gregory & Associates the firm’s independence from Wizzard, including the matters in the letter from Gregory & Associates required by Independence Standards Board Standard No. 1, and considered the compatibility of non-audit services with Gregory & Associates’ independence.

 

The Audit Committee also reviewed management’s report on its assessment of the effectiveness of our internal control over financial reporting.

 

The Audit Committee discussed with Gregory & Associates the overall scope and plans for their respective audits. The committee regularly meets with Gregory & Associates, with and without management present, to discuss the results of their examinations; their evaluations of our internal control, including internal control over financial reporting; and the overall quality of our financial reporting.

 

In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board, and the Board approved, that the audited consolidated financial statements and management’s assessment of the effectiveness of our internal control over financial reporting, together with Gregory & Associates’ reports, be included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the SEC. The committee and the Board also have recommended, subject to stockholder approval, the selection of Gregory & Associates LLC to audit our 2012 consolidated financial statements.

 

Audit Committee

Douglas Polinsky, Chairman

J. Gregory Smith

Denis Yevstifeyev

 

Compensation Committee Interlocks and Insider Participation

 

No interlocking relationship exists between the Board of Directors or Compensation Committee and the board of directors or compensation committee of any other entity, nor has any interlocking relationship existed in the past.

 

 

 




10




COMPENSATION DISCUSSION AND ANALYSIS

 

Overview and General Philosophy

 

At Wizzard, our focus is to create value through the growth of our three separate businesses including our Speech Business, our Media Business and our Healthcare Business. Our executive compensation program supports this goal of value creation by:

 

 

 

rewarding executives for obtaining performance milestones;

 

 

aligning the interests of executives with the interests of stockholders; and

 

 

attracting and retaining highly motivated and talented executives.

Our compensation elements simultaneously fulfill one or more of these three objectives. The elements include:

 

 

base salary;

 

 

discretionary bonuses (in the form of cash, restricted stock, and stock options);

 

 

benefits programs.

 

The type and amount of compensation is determined considering current pay, competitive pay data from the external talent market and the opportunity for future pay. We combine compensation elements for each executive in a manner that will meet the performance, alignment and retention goals listed above as well as eliciting the best possible contribution from the executive.

 

Compensation Objectives

 

Our executive compensation philosophy is built around two objectives: supporting stockholder value creation through, aligning the interests of executives with the interests of stockholders, and attracting and retaining highly motivated and talented executives.

 

Due to our diverse businesses, we have determined that no specific peer group is appropriate to use in defining market pay levels for our named executives. We therefore use general industry data of companies which are a similar size to us based on market capitalization to establish market pay levels.

  

Obtained Performance Milestones:

 

 

 

We construct our annual bonus opportunities to have appropriately aggressive targets that require significant achievement against performance milestones.

  

Aligned Interests:

 

 

 

Our base pay practices reduce fixed costs and emphasize performance-based incentive programs, which we believe are in the best interests of stockholders.

 

 

We base our annual bonus opportunities on performance milestones and value to the shareholder that focus executives on performance results that is of common interest to stockholders.

 

 

We award long-term equity incentive opportunities using stock options and restricted stock so that appreciating stock value is a significant factor in executive compensation.

  

Executive Retention:

 

 

 

We believe our use of lower base salary levels accompanied by an emphasis on incentive programs attracts executives that are appropriately aggressive, innovative, and willing to risk a larger share of their compensation on their own performance and the performance of the Company.

 

 

Discretionary bonuses allow us to adjust to unique market conditions in a timely fashion in order to retain key executives.

  

Compensation Administration

 

General Process.    Executive compensation decisions at Wizzard are the product of several factors, modified by judgment and discretion as necessary. The predominant factors include:

 

 

 

key performance measurements such as revenue, monthly download of content, and key business developments;

 

 

strategic initiatives such as acquisitions, and implementation of process improvements;

 

 

achievement of specific operational goals relating to the sphere of influence led by the executive;

 

 

compensation of other executives within the Company (to ensure internal equity); and


For the CEO, these factors are judged and compensation is recommended by the Compensation Committee of the Board of Directors and approved by the Board. For the other executive officers (including all of the named executives in




11




the Summary Compensation Table), the factors are considered by the CEO, who recommends compensation levels. These judgments and recommendations are then reviewed and approved or revised by the Compensation Committee.

 

Generally, the Compensation Committee reviews and makes adjustments to base compensation once per year, effective at the beginning of each fiscal year (January 1). Annual incentives are typically paid within two months of the fiscal year end, usually in mid-February.  Equity grants are typically awarded in the spring of each year, in March or early April.

 

Role of Compensation Committee.    The Compensation Committee oversees the design, development and implementation of our compensation program. The Committee evaluates the performance of the CEO and determines CEO compensation consistent with the objectives of the compensation program. The Committee also approves all incentive compensation plans and approves or revises recommendations made by the CEO for compensation decisions affecting other executives. The Committee also approves all bonuses, awards and grants under all incentive plans.

 

Role of CEO.    Our CEO is responsible for the implementation and administration of our compensation program throughout the organization. The CEO evaluates the performance of executives and, consistent with the objectives of the compensation program, meets with the Compensation Committee to consider and recommend compensation programs, set and evaluate performance milestone, and make specific recommendations on the form and amount of compensation for named executives. 

 

Compensation Components

 

Short-Term Compensation.    Consistent with our stated compensation philosophy, our key metric for executive short-term compensation is annual total cash compensation. Discretionary bonuses provide significant upside potential which results in targeted annual total cash compensation.

 

Our performance for fiscal 2011 was well above targeted levels, even in a year that was very challenging. Company-wide, total revenue for the year was $6.5 million, an increase of 18% from the previous year.  In January, 2011, the Company closed a subscription agreement whereby six institutional investors invested a total of $3.1 million in cash in exchange for 1,166,672 shares of common stock and 440,268 warrants.


Base Salary.    We consider base salary a tool to provide executives with a reasonable base level of income relative to the scope of the positions they hold. Base salaries are established based on the level of responsibility for the position. With the exception of the CEO and named executives all base salaries are reviewed annually, and are adjusted from time to time to reflect changes in responsibility level.

 

In 2011, our named executives’ base salaries range from $166,375 to $188,760.  In 2010, our named executives’ base salaries ranged from $133,100 to $145,200.  There were no changes in salaries for senior executives during 2009 or 2010.


Annual Bonus.    Currently, there is not an established annual incentive bonus plan.

 

Discretionary Bonuses.    Because there is not an annual incentive plan, the Compensation Committee may determine a discretionary bonus is to be awarded to appropriately reward senior executives.  In these cases, discretionary bonuses are used to assure that executives are appropriately rewarded. The Committee determines discretionary bonuses for the CEO. The CEO recommends discretionary bonuses for all other named executives, which are then approved or adjusted by the Committee.

 

In fiscal year 2011, discretionary bonuses were awarded to the executive officers.

 

Our Compensation Committee believes that we have executed on our compensation philosophy given the level of Company performance in fiscal 2011.

 

Long-Term Incentive Compensation.    In 2011, we offered a limited group of employees, including all named executives, stock options.

 

In fiscal 2012, we plan to execute a long-term incentive design that will utilize stock options. For senior management, including named executives, the primary emphasis will be on stock option awards. This results primarily in senior management focus on stock price performance, directly aligning the interests of executives with the interests of stockholders. It also puts a higher percentage of long-term compensation at risk as the design delivers less immediate value to executives.

 

All stock-options granted to the named executives by the Company must have prior Compensation Committee approval. The exercise price for all stock-based awards coincides with the date the Committee approves the award grant.




12




It is against Company policy to back-date stock-based awards or to try to time stock-based awards for any reason and we have never engaged in these practices.

 

Award Adjustment or Recovery.    We do not have a policy to recover or otherwise adjust payments made or awards earned as a result of changes in subsequent periods relating to performance measures upon which such payments or awards are based, sometimes referred to as a “clawback” policy. We have not required any named executive to return any award or repay any payment received in any fiscal year.

 

Tax Deductibility of Compensation.    Section 162(m) of the Internal Revenue Code of 1986, as amended, imposes a $1,000,000 limit on the amount that a public company may deduct for compensation paid to named executives unless compensation is based on an individual’s meeting pre-established performance goals determined by a compensation committee and approved by stockholders.

  

Retirement and Other Benefits

 

Generally, we view retirement savings as a personal matter. We currently do not offer any pre-tax retirement savings through the use of a traditional 401(k) plan; a deferred compensation plan or other retirement programs.

  

Perquisites.    Eligible employees, including named executives, participate in various other employee benefit plans, including medical and dental care plans; flexible spending accounts for health care; life, accidental death and dismemberment and disability insurance; and vacation plans. The primary purpose of providing these plans and limited perquisites to senior executives is to attract and retain talented executives to manage the Company. With respect to non-insurance perquisites, we prefer to take a minimalist approach. For fiscal 2011, the Company did not have executive non-insurance perquisites.

 

Compensation Committee Report

 

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis set forth in this proxy statement with our management. Based on such review and discussions, the Compensation Committee recommended to our Board of Directors that the Compensation Discussion and Analysis be included in this proxy statement and incorporated by reference into our 2011 Annual Report on Form 10-K.

  

Compensation Committee

Douglas Polinsky, Chairman

J. Gregory Smith

Denis Yevstifeyev

 

Summary Compensation Table

 

The following sets forth the compensation of Wizzard’s Chief Executive Officer during fiscal 2011, and the other persons who served as executive officers during fiscal 2011. Unless otherwise noted, the amounts shown represent what was earned in fiscal 2011.


SUMMARY COMPENSATION TABLE – FISCAL 2011


Name and principal position

 

Salary

($)

 

Bonus ($)



   (1)

Stock awards ($)

 

Non-equity incentive plan compensation ($)

 

All other compensation ($)

 

Total ($)

Christopher Spencer – Chief Executive Officer

 

 

 

 

 

 

2011

 

175,806

 

30,000

 

31,163

(2)

0

 

0

 

236,969

2010

 

145,200

 

0

 

0

 

0

 

0

 

145,200

2009

 

145,200

 

0

 

0

 

0

 

0

 

145,200

John Busshaus – Chief Financial Officer

 

 

 

 

 

 

2011

 

155,705

 

25,000

 

31,163

(2)

0

 

0

 

211,868

2010

 

133,100

 

0

 

0

   

0

 

0

 

133,100

2009

 

133,100

 

0

 

0

   

0

 

0

 

133,100


 

(1)

The bonuses shown in this column represent discretionary awards.

(2)

Stock-based compensation represents the amounts recognized for financial reporting purposes for granting of stock options totaling $31,163, calculated in accordance with the requirements of SFAS No. 123R.  Reference is made to Note 8 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year 2011 for a detailed description of the assumptions used in valuing stock-based awards under SFAS No. 123R.








13




   

Restricted Stock Awards

 

There were no issuances of restricted stock award during fiscal 2011 to any named executive.

 

Outstanding Equity Awards at Fiscal Year End

 

The following table sets forth information concerning outstanding equity awards for the named executives as of December 31, 2011:


OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2011

 

 

Option awards

 

Stock awards

Name

 

Number
of securities
underlying
unexercised
options
(#)
exercisable

Number
of securities
underlying
unexercised
options
(#)
unexercisable

Equity incentive plan awards: number of securities underlying unexercised unearned options (#)

Option
exercise
price
($)

Option 
expiration date

 

Number
of shares
or units
of stock
that have
not vested
(#)

Market value
of shares
or units
of stock
that have
not vested
($)

Equity incentive plan awards: number of unearned shares, units or other rights that have not vested (#)

Equity incentive plan awards: market or payout value of unearned shares, units or other rights that have not vested ($)

John L. Busshaus

 

11,459

0

0

19.08

5/22/2016

 

0

0

0

0

John L. Busshaus

 

16,667

0

0

26.40

5/16/2017

 

0

0

0

0

John L. Busshaus

 

20,834

0

0

2.40

4/26/2014

 

0

0

0

0

Chris Spencer

 

20,834

0

0

2.40

4/26/2014

 

0

0

0

0

   

 

 

  Grants of Plan-Based Awards for 2011


There were no plan-based equity awards made to our executive officers during fiscal 2011.


Option Exercises and Stock Vested

 

The following table sets forth information concerning fiscal 2011 option exercises and restricted stock that vested during fiscal 2011 for the named executives.

  

OPTION EXERCISES AND STOCK VESTED DURING FISCAL 2011

  

 

 

Option awards

 

Stock awards

Name

 

Number

of shares

acquired

on exercise

(#)

 

Value

realized on

exercise

($)

 

Number

of shares

acquired
on vesting

(#)

 

Value

realized

on vesting

($)

Christopher Spencer

 

0

 

0

 

0

 

0

John L. Busshaus

 

0

 

0

 

0

 

0

 

Nonqualified Deferred Compensation

 

The Company does not have a Deferred Compensation Plan for its executive officers.

  

Other Potential Post-Employment Payments

 

As of December 31, 2011, there were no named executives with employment contracts that require or required severance or other post-employment payments.


Summary Information about Equity Compensation Plans

 

As of December 31, 2011, we had six stock option plans, which were not approved by stockholders. A total of 544,792 shares of common stock have been reserved for ultimate issuance under the plans. Four of the plans have expired




14




and awards can no longer be granted under those plans. As of December 31, 2011, options for approximately 137,063 shares of common stock could be granted under the remaining plans.

 

The Compensation Committee, or in its absence, the full Board, administers and interprets the plans. This Committee is authorized to grant options and other awards both under the plans and outside of any plan to eligible employees, officers, directors, and consultants. Terms of options and other awards granted under the plans, including vesting requirements, are determined by the Committee and historically have varied significantly. Options and other awards granted under the plans vest over periods ranging from zero to ten years, expire ten years from the date of grant and are not transferable other than by will or by the laws of descent and distribution. Incentive stock option grants are intended to meet the requirements of the Internal Revenue Code.

 

2006 Stock Option Plan.    A total of 11,459 shares of common stock are reserved for issuance under the 2006 Stock Option Plan. The 2006 Plan expired in 2006 and awards can no longer be granted under the 2006 Plan. The 2006 Plan provided for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).


2007 Stock Option Plan.    A total of 16,667 shares of common stock are reserved for issuance under the 2007 Stock Option Plan. The 2007 Plan has not expired and awards up to 21 can be granted under the 2007 Plan. The 2007 Plan provided for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).


2007 Key Employee Stock Option Plan.    A total of 16,667 shares of common stock are reserved for issuance under the 2007 Key Employee Stock Option Plan. The 2007 Key Employee Plan expired in 2007 and awards can no longer be granted under the 2007 Key Employee Plan. The 2007 Key Employee Plan provides for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).


2008 Stock Option Plan.    A total of 16,667 shares of common stock are reserved for issuance under the 2008 Stock Option Plan. The 2008 Plan has not expired and awards up to 32 can be granted under the 2008 Plan. The 2008 Plan provides for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).


2008 Key Employee Stock Option Plan.    A total of 33,334 shares of common stock are reserved for issuance under the 2008 Key Employee Stock Option Plan. The 2008 Key Employee Plan has not expired and awards up to 220 can be granted under the 2008 Key Employee Plan.  The 2008 Key Employee Plan provides for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).

 

2009 Stock Option Plan.    A total of 166,667 shares of common stock are reserved for issuance under the 2009 Stock Option Plan. The 2009 Plan has not expired and awards up to 13,106 can be granted under the 2009 Plan. The 2009 Plan provides for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).

 

2010 Stock Option Plan.    A total of 166,667 shares of common stock are reserved for issuance under the 2010 Stock Option Plan. The 2010 Plan has not expired and awards up to 123,889 can be granted under the 2010 Plan. The 2010 Plan provides for the granting of both incentive stock options (ISOs) and non-statutory stock options (NSOs).


No Loans for Option Exercises.    It is our policy to not make loans to employees or officers for the purpose of paying for the exercise of stock options.

 

Stockholder Approval of Equity Compensation Plans.    The following table presents information as of December 31, 2011, about our common stock that may be issued upon the exercise of options granted to employees, consultants or members of the Board of Directors under all of our existing equity compensation plans and individual arrangements. As described above, we have seven stock option plans under which options have been granted.

 

  

 

  

 

  

 

Plan Category

  

Maximum shares
to be issued upon
exercise of options

  

Weighted-average
exercise price of
outstanding options

  

Shares remaining
available for future
issuance under
existing equity
compensation plans
(excluding shares
reflected in
first column)

Plans approved by stockholders

  

32,000

  

$

20.88

  

53

Plans not approved by stockholders

  

87,597

  

 

2.88

  

137,011

 

  

 

  

 

 

  

 

Total

  

119,597

  

$

7.68

  

137,064

 

  

 

  

 

 

  

 

   




15




DIRECTOR COMPENSATION

 

In 2011, we paid our non-employee directors a cash retainer. In 2012, the Board of Directors will consider stock options or other appropriate equity incentive grants to the outside directors. We reimburse directors for out-of-pocket expenses they incur when attending meetings of the Board. Salaried executives who serve as directors are not paid for their services as directors and accordingly, Christopher Spencer is not included in the director compensation table below.

 

The following table sets forth the compensation we paid our non-employee directors in 2011. Unless otherwise noted, the amounts shown represent what was earned in fiscal 2011.

 

DIRECTOR COMPENSATION TABLE – FISCAL 2011  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Name

  

Fees earned
or paid
in cash
($)

  

Stock awards 
($)

 

Option awards 
($)

 

Non-equity incentive plan compensation ($)

 

Nonqualified deferred compensation earnings ($)

 

All other compensation ($)

 

Total
($)

Doug Polinsky

  

32,000

  

0

 

0

 

0

 

0

 

0

 

32,000

J. Gregory Smith

  

32,000

  

0

 

0

 

0

 

0

 

0

 

32,000

Denis Yevstifeyev

  

32,000

  

0

 

0

 

0

 

0

 

0

 

32,000

 

All outside directors are entitled to base annual cash compensation of $24,000, which we pay monthly.  Currently, the outside directors also receive options for the purchase of common stock which normally vest at the rate of 24,000 shares each year, through December 31, 2011. The outside directors were granted 12,000 stock options on January 22, 2010, with a fair value of $50,400 on that date.  As of December 31, 2011, there were 12,000 stock options outstanding that were granted to the outside directors.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS


The following table sets forth certain information as of June 11, 2012, regarding the beneficial ownership of our common stock, for:

 

 

 

each person (or group of affiliated persons) who, insofar as we have been able to ascertain, beneficially owned more than 5% of the outstanding shares of our common stock;

  

 

each director;

  

 

each named executive; and

  

 

all directors and executive officers as a group.


We relied on information received from each stockholder as to beneficial ownership, including information contained on Schedules 13D and 13G and Forms 3, 4 and 5.  As of June 11, 2012, there were 8,693,826 shares of common stock outstanding.  As of that date, there were options to purchase 86,844 shares of common stock and warrants to purchase 497,738 shares of common stock.


Name and Address of

Beneficial Owner (1)

  

Amount and Nature of

Beneficial Ownership (2)

 

 

Percent of

Class

 

5% Stockholders:

  

 

 

 

 

 

Christopher Spencer, Chief Executive Officer

  

274,995

(3)

 

3.1%

 

 

 

 

Directors:

  

 

 

 

 

 

Douglas Polinsky

  

16,500

(4)

 

*

 

J. Gregory Smith

  

16,500

(4)

 

*

 

Denis Yevstifeyev

  

16,500

(4)

 

*

 

 

 

 

Executive Officers:

  

 

 

 

 

 

John L. Busshaus, Chief Financial Officer

  

70,557

 (3)

 

*

 

All directors and executive officers as a group (5 persons)

  

395,052

 

 

4.5%

 

*

Less than 1%

 (1)

The address of each director and officer is c/o Wizzard Software Corporation, 5001 Baum Blvd.  Suite 770, Pittsburgh, Pennsylvania 15213.

 (2)

The persons named in this table have sole voting and investment power with respect to all shares of common stock reflected as beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such person within sixty (60) days from June 1, 2012, and the total outstanding shares used to calculate each beneficial owner’s percentage includes such shares, although such shares are not taken into account in the calculations of the total number of shares or percentage of outstanding shares. Beneficial ownership as reported does not include shares subject to option or conversion that are not exercisable within 60 days of June 1, 2012.

  (3)

Includes 20,834 stock options that are vested or will vest within 60 days of June 1, 2012.

  (4)

Includes 4,000 stock options that are vested or will vest within 60 days of June 1, 2012.


CHANGES IN CONTROL


There are no pledges by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.  However, if the Share Exchange Agreement is approved by stockholders at the Annual Meeting and closed, the issuance of the Initial Company Shares thereunder, together with the issuance of common stock upon conversion of Convertible Preferred Shares under the terms thereof, will result in such a change in control.  See Proposal 3 of this Proxy Statement.


SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE


Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than 10% of a registered class of our equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors, and greater than 10% stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely on a review of the copies of such forms furnished to us with respect to fiscal 2011 and on representations that no other reports were required, we believe that during the 2011 fiscal year all applicable Section 16(a) filing requirements were met.


TRANSACTIONS WITH RELATED PERSONS


Review and Approval of Transactions with Management and Others

 

We maintain various policies and procedures relating to the review, approval or ratification of transactions in which we and our subsidiaries are a participant and in which any of our directors, executive officers, major stockholders or their family members have a direct or indirect material interest. We refer to these individuals and entities in this proxy statement as “related persons.” Our Code of Ethics and Business Conduct, which is available on our website at www.wizzardsoftware.com, prohibits our employees, including our executive officers, from engaging in specified activities without prior approval. These activities typically related to conflicts of interest situations where an employee may have significant financial or business interests in another company competing with or doing business with us, or who stands to benefit in some way from such a relationship or activity.

 

Our Board of Directors has responsibility for reviewing and approving or ratifying related person transactions as defined under SEC regulations to the extent not delegated to another committee of the Board. In addition, the Board annually determines the independence of directors based on a review by the directors and the Nominating Committee.  The Compensation Committee reviews and approves compensation arrangements for the executive officers and directors.

 

We believe that these policies and procedures collectively assure that all related person transactions requiring disclosure under SEC rules are appropriately reviewed and approved or ratified. Each of the transactions disclosed below has been reviewed and approved or ratified by our Board of Directors and we believe that the terms of each of these transactions are no less favorable to us than we could obtain from an unaffiliated party.

 

Transactions with Related Persons

 

During the fiscal years ended December 31, 2011 and 2010, there were no transactions, and there are no currently proposed transactions, in which the Company was or is to be a participant and the amount involved exceeds the lesser of $120,000 or one percent of the average of the Company’s total assets at year end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest.  Survival Spanish, an Education podcaster, ran advertising campaigns on its shows and sold podcast Apps during 2011.  Survival Spanish is owned by David Spencer.  David Spencer is a sibling of the CEO of the Company.  During 2011, payments were made to Mr. Spencer totaling $1,132. 


Legal Proceedings


Wizzard is involved in routine legal and administrative proceedings and claims of various types.  We have no material pending legal or administrative proceedings, other than as discussed below or ordinary routine litigation incidental to our business, to which we or any of our subsidiaries are a party or of which any property is the subject.  




17




While any proceeding or claim contains an element of uncertainty, management does not expect that any such proceeding or claim will have a material adverse effect on our results of operations or financial position.  There are no material proceedings to which any director or officer is a party adverse to Wizzard or any of its subsidiaries or has a material interest adverse to Wizzard or any of its subsidiaries.


 PROPOSAL NO. 1 - ELECTION OF DIRECTORS

 

Our directors hold office until the end of their respective terms or until their successors have been duly elected and qualified. Our executive officers are appointed by the Board of Directors and serve at the discretion of the Board.

  

Nominees for Election as Directors

 

At the time of the Annual Meeting, the Board will consist of four members: Christopher Spencer, J. Gregory Smith, Denis Yevstifeyev, and Douglas Polinsky. At the Annual Meeting, the stockholders will elect four directors to serve a two year term, or until their prior resignation or termination and the election and qualification of their successors.

 

The Board proposes that the four individuals listed below be elected as directors. The nominees have consented to serve if elected to the Board. In the event that one or more of the nominees is unable to serve as director at the time of the Annual Meeting (which is not expected), proxies with respect to which no contrary direction is made will be voted FOR such substitute nominee(s) as shall be designated by the Board to fill the vacancy or vacancies.

 

The names of the nominees, together with certain information about them, are set forth below:

 

Name

  

Age

  

Position with Wizzard

  

Director Since

Christopher Spencer

 

43

 

Director and CEO

 

1995

J. Gregory Smith

  

43

  

Director

  

2007

Douglas Polinsky

  

53

  

Chairman of Audit Committed and Director

  

2007

Denis Yevstifeyev

  

30

  

Director

  

2007

 

 Christopher Spencer has served as our Chief Executive Officer, President and as a director of Wizzard since February 7, 2001.  Mr. Spencer has been responsible for our overall direction since our inception and has been instrumental in leading us to our current position in the speech recognition industry.  From 1994 until 1996, Mr. Spencer founded and worked for ChinaWire, Inc., a high-technology company engaged in financial remittance between international locations and China.  Mr. Spencer worked for Lotto USA, Inc. from 1992-1994, where he was founder and Chief Executive Officer for the Pennsylvania computer networking company.  From 1990 until 1992, Mr. Spencer worked for John Valiant, Inc., and was responsible for business concept development and obtaining financing.  Mr. Spencer's efforts combined an effective advertising/promotions campaign with proper timing in the young adult/college restaurant/nightclub market.  John Valiant was sold for a profit in 1992 after successfully operating three revenue-generating divisions.


Douglas Polinsky has served as a director of Wizzard since October 2007.  Mr. Polinsky serves as the President of Great North Capital Corp., a Minnesota-based financial services company he founded in 1995.  Great North advises corporate clients on capital format and other transaction-related financial matters.  Mr. Polinsky earned a Bachelor of Science degree in Hotel Administration at the University of Nevada at Las Vegas.


Greg Smith has served as a director of Wizzard since October 2007.  Mr. Smith is an award-winning producer and entrepreneur with over 10 years of experience in Non-Fiction Television.  In 2000, Mr. Smith established The Solution Film Group, LLC and acts as the Company’s President.  Mr. Smith provides professional production and editorial support for various forms of non-fiction television entertainment, including the direction of media projects from development through production and post-production.  His clients include Discovery Channel, Science Channel, Discovery HD Theater, Animal Planet, The Military Channel, PBS, and Discovery Networks International.  Mr. Smith most recently won an Emmy in 2006 for the Discovery Channel’s animated special Before the Dinosaurs.  His other awards for excellence in production and editing include Emmys for the Discovery Channel’s, Walking with Prehistoric Beasts and Allosaurus:  A Walking with Dinosaurs Special.  From 1997 to 2000, Mr. Smith worked for Discovery Communications, Inc. in the capacity of Supervising Producer from January 1998 to November 2000, and Producer/Editor from October 1997 to January 1998. From 1995 to 1996, Mr. Smith worked for Discovery Channel Pictures serving as Assistant Editor from March 1996 to October 1997, and Production Assistant from September 1995 to March 1996. From 1994 to 1995, Mr. Smith worked for Crawford Communications in Atlanta, Georgia as a Manager of Satellite Services for The Learning Channel.


Denis Yevstifeyev has served as a Director of Wizzard since October 2007.  Mr. Yevstifeyev currently serves as the Director of Financial Planning & Analysis for Education Management Corporation - Online Higher Education.  From




18




2007 to 2008, Mr. Yevstifeyev served as Sr. Financial Reporting Analyst for American Eagle Outfitters, Inc, in Pittsburgh.  His duties included: preparing and analyzing various internal and external financial reports; researching new accounting pronouncements and evaluating any impact on the financial statements.  He also reviewed accounting workpapers and prepared the Company’s SEC filings for Forms 8-K, 10-Q and 10-K.  From 2005 to 2007, Mr. Yevstifeyev worked Schneider Downs, Inc., where he worked on Sarbanes-Oxley compliance engagements. In 2005, Mr. Yevstifeyev graduated with a Bachelor of Science degree in Business from Washington and Jefferson College.  He also graduated with honors from the Moscow Bank College of the Central Bank of Russia in Moscow with a degree in Finance in 2000.  From 2002 to 2003, Mr. Yevstifeyev served as the Settlement Department Manager for SDM BANK in Moscow, where he dealt with domestic and international corresponding banks, among other responsibilities.


Your Board of Directors unanimously recommends a vote FOR the election of Messrs. Spencer, Polinsky, Smith and Yevstifeyev.


PROPOSAL NO. 2 - APPROVAL OF THE WIZZARD SOFTWARE CORPORATION 2012 STOCK OPTION PLAN OF 3,000,000 OPTIONS FOR SHARES OF COMMON STOCK

 

The Board of Directors recommends stockholder approval of the 2012 Stock Option Plan (2010 Plan) for the issuance of 3,000,000 options.  The 2012 Plan shall be administered by the Board of Directors of the Company. A copy of the full text of the 2012 Stock Option Plan is included as Annex A to this Proxy Statement.


The Company shall grant options pursuant to the 2012 Plan upon determinations of the Board as to which of the eligible persons shall be granted options, the number of shares to be optioned and the term during which any such options may be exercised.  At all times, a majority of the members of the Board making determinations about the grant of options to employee-directors or employee-officers must be disinterested in the grant being made.  


Options will expire no later than ten years from the date of grant.  Vested options generally will terminate upon the first to occur of: (1) expiration of the option; or (2) three months following the optionee’s termination of employment.


All employees, non-employee directors and any other persons providing valuable services to the Company are eligible to receive stock options.  Incentive Stock Options under the 2012 Plan may only be granted to such employees of the Company or any subsidiary thereof, as selected by the Board.  Non-Qualified Stock Options may be granted to employees, non-employee directors and any other persons providing valuable services to the Company.


In selecting the employees or other persons to whom stock options shall be granted, as well as determining the number of shares subject to each option, the Board shall take into consideration such factors as it deems relevant in connection with accomplishing the purpose of the 2012 Plan.  An optionee who has been granted an option may, if he or she is otherwise eligible, be granted an additional option or options if the Board shall so determine.  


No stock option may be granted under the 2012 Plan later than the expiration of 10 years from the effective date of the 2012 Plan. No options have been granted under the 2012 Stock Option Plan and no determination has been made as to who will receive an option grant if the 2012 Stock Option Plan is approved by the shareholders.


Because benefits under the 2012 Stock Option Plan will depend on the Board’s actions and the fair market value of the our Common Stock at various future dates, it is not possible to determine the benefits that will be received by executive officers and other employees if the 2012 Stock Option Plan is approved by our shareholders.


We are seeking your approval for the 2012 Plan. If stockholder approval is not obtained, no options may be granted under the 2012 Plan.

 

The Board of Directors believes that it is in our best interests to be able to continue to provide a means by which our employees, including officers, may increase their equity ownership in Wizzard and thereby to provide them with an incentive to enhance stockholder returns.  At this time, there are no plans, proposals or arrangements, written or otherwise, to grant any of the authorized options under the 2012 Plan.

 

 Stockholder Approval

 

The affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the annual meeting and entitled to vote is required to approve the 2012 Stock Option Plan.

  

Your Board of Directors unanimously recommends a vote FOR the approval of the Company’s 2012 Stock Option Plan of 3,000,000 options for shares of common stock.






19




PROPOSAL NO. 3 - APPROVAL OF THE SHARE EXCHANGE AGREEMENT DATED APRIL 5, 2012, AND THE ISSUANCE OF UP TO 40,591,000 SHARES OF OUR COMMON STOCK IF ALL REVENUE AND CORPORATE GOVERNANCE OBJECTIVES ARE MET PURSUANT THERETO

 

On April 5, 2012, the Company executed a Share Exchange Agreement (the “Agreement”), to acquire (the “Acquisition”) from Universal Entertainment Group Limited, a British Virgin Islands company (“UEG”), 100% of the issued and outstanding shares of Digital Entertainment International Ltd., a Hong Kong company, (“DigitalHKCo”). Wizzard agreed to purchase all the shares of Digital HKCo in a stock-for-stock transaction as described below.   UEG directly holds 100% of the issued and outstanding shares of Digital HKCo, which owns 100% of Beijing Dingtai Guanqun Culture Co., Ltd. (the “WFOE”).  The WFOE controls the management and financials of the operating entities, Beijing FAB Culture Media Co., Ltd., a People’s Republic of China (“PRC”) corporation (“FAB Media”); and Beijing FAB Digital Entertainment Products Co., Ltd., a PRC corporation (“FAB Digital”), in China through variable interest entity (“VIE”) contracts.  Collectively, FAB Media and FAB Digital shall be referred to herein as the “VIE Entities” and Digital HKCo, the WFOE and the VIE Entities shall be referred to collectively herein as the “FAB Companies.”


In exchange for all of the Digital HKCo shares, Wizzard will issue such number of common shares as represents 49% of the issued and outstanding shares of Wizzard, on a fully diluted basis, after the issuance of these shares as of the date of the Closing of the Agreement (the “Initial Shares”).  The voting rights of the Initial Shares shall be controlled by the Board of Directors of Wizzard until such time as the Corporate Governance Objectives (as defined in the Agreement) have been met over a period of eight consecutive and complete reporting quarters of the Company after the Closing.  After the completion of the Corporate Governance Objectives for two consecutive and complete quarters after the Closing, the voting rights to 50% of such shares shall be released; upon the successful completion of the Corporate Governance Objectives for six consecutive and complete quarters after the Closing, the voting rights to an additional 25% of such shares shall be released; and the voting rights to the remaining 25% of such shares shall be released upon the successful completion of the Corporate Governance Objectives for eight consecutive and complete reporting quarters after the Closing.  Upon Closing, Wizzard will issue up to 11,000,000 “unregistered” and “restricted” shares of common stock under the Agreement.


As additional consideration for the Digital HKCo shares, Wizzard will issue at the Closing 290 shares of its Series B Convertible Preferred Stock (the “Preferred Stock”), which shall have no dividend rights or voting rights or the right to receive any assets of Wizzard upon liquidation, dissolution or winding up.  The Preferred Stock will be convertible into shares of Wizzard’s common stock in three tranches upon the occurrence of the following conversion events:


The first tranche of 210 shares of Preferred Stock will be convertible into common stock upon the successful completion of the Corporate Governance Objectives for the four consecutive quarters immediately following the Closing.  The common shares to be issued for meeting the Corporate Governance Objectives in this tranche represent an additional 21% ownership interest of the issued and outstanding common shares of Wizzard on a fully diluted basis as of the date of the Closing. Upon attainment of these Corporate Governance Objectives and the conversion of the first tranche of Preferred Stock, Wizzard will issue up to an additional 15,714,000 shares of common stock.


The second tranche of 40 shares of Preferred Stock will be convertible into common stock upon the successful completion of the Corporate Governance Objectives for the four consecutive quarters immediately following the Closing and Revenue Objectives requiring that the FAB Companies receive sales revenue of at least US$60 million and net income of at least $12 million US in fiscal year 2011.  The common stock issuable upon conversion of the second tranche of Preferred Stock will represent an additional 4% ownership interest of the issued and outstanding common shares of Wizzard on a fully diluted basis as of the date of the Closing.  Upon attainment of these Corporate Governance and Revenue Objectives and the conversion of the second tranche of Preferred Stock, Wizzard will issue up to an additional 5,871,000 shares of common stock.


The third tranche of 40 shares of Preferred Stock will be convertible into common stock upon the successful completion of the Corporate Governance Objectives for the six consecutive and complete reporting quarters immediately following the Closing and Revenue Objectives requiring that the FAB Companies receive sales revenue of at least US$70 million and net income of at least $ 14 million US in fiscal year 2012.  The common stock issuable upon conversion of the third tranche of Preferred Stock will represent an additional 4% ownership interest of the issued and outstanding common shares of Wizzard on a fully diluted basis as of the date of the .  Upon attainment of these Corporate Governance and Revenue Objectives and the conversion of the third tranche of Preferred Stock, Wizzard will issue up to an additional 8,006,000 shares of common stock. The precise number of common shares issuable upon conversion of each tranche of Preferred Stock will be determined at Closing, based on the total number of issued and outstanding shares of the Company’s common stock on a fully diluted basis at that time.  The Company will deliver to UEG at Closing a Certificate of Designation of Preferences, Rights and Limitations of the Preferred Stock as filed with the Colorado Secretary of State.





20




Fifty percent of the Initial Shares (the “Lock-up Shares”) will be subject to the terms of a Lock-up Agreement by which UEG will agree not to transfer, sell, hypothecate or gift such Lock-up Shares for a period of 12 months following the Closing date.  In addition, during the first 24 months after the Closing, Digital HKCo and each of its permitted transferees or designees will have piggyback registration rights with respect to all Initial Shares that are not then subject to the restrictions of the Lock-up Agreement or the Voting Agreement, and all Company shares that have been issued upon conversion of Preferred Stock to cause such shares to be included in (i) any registration statement that the Company files with the Securities and Exchange Commission to register under the Securities Act of 1933, as amended, common shares held by any person who was a stockholder of the Company at the time of Closing (or any transferee thereof); or (ii) any other registration statement filed by the Company so long as a majority of the Company’s Board of Directors has made a good faith determination that such piggyback registration will not significantly prejudice the Company’s ability to raise capital.


All shares to be issued to UEG and/or its designees will be issued pursuant to Regulation S of the Securities and Exchange Commission, in reliance upon such recipients’ status as non-US persons. No directed selling efforts (as defined in Rule 902(c) of Regulation S of the Securities and Exchange Commission) have been or will be made in the U.S. with respect to such issuances.


The Agreement further provides that Wizzard’s Board of Directors will consist of its four current directors and two new members to be appointed by UEG and the FAB Companies prior to or at the Closing, with one of such new members to be designated Chairman.  Proposal 5 below is submitted to a vote of the Company’s stockholders in order to effectuate this provision of the Agreement.


Wizzard Software will continue to operate its other businesses without any modification, change or interruption, other than the Interim Healthcare business, if the share exchange agreement is approved


Digital HKco’s offices are located at Room 6841, Building 3, No.3 Xijing Lu, Badachu High-tech Garden, Shijingshan District, Beijing, China with a phone number of 01186-010-6601-1728.


The Closing of the Agreement is subject to usual and customary closing conditions, and is scheduled to take place not more than 120 days after the execution date.  In addition, prior to the Closing, the Company must obtain stockholder approval of the transaction; complete the “spin-off” of its home healthcare operations through a special dividend to its current stockholders (which shall not include UEG); and amend its Articles of Incorporation to change its name to a name to be agreed upon by the parties.  In addition, prior to the Closing, the FAB Companies must have completed a restructuring pursuant to a Restructuring Plan attached as Exhibit F to the Agreement.


Interim Healthcare of Wyoming, Inc., the wholly-owned subsidiary through which the Company conducts its home healthcare operations, has filed a Registration Statement on Form S-1 for the registration of the Interim shares that are to be issued to the Company’s stockholders in connection with the spin-off.  The completion of the spin-off will be subject to the SEC’s declaration of effectiveness of such registration statement, and neither the Company nor Interim can provide any assurance as to when or if this will occur.  In addition, prior to the closing of the Share Exchange Agreement, certain registrations and applications for transfer of intellectual property to the PRC entities under Chinese law must have occurred.


INITIAL TRANSACTION TIMELINE


On January 31st, 2011, our Company CEO, Chris Spencer, had a telephone conference call with several individuals with whom the Company had some small business transactions in the past relating to Speech Recognition.  On this call, Mr. Spencer was introduced to three Chinese companies.  Two of the companies were in industries unrelated to Wizzard’s businesses including shoe manufacturing and steel production.  However, one company, FAB, was in the media distribution business, which had similarities and potential synergies with Wizzard’s Media business.


             Initial Negotiations


On May 24, 2011, Wizzard began discussions with FAB regarding a possible merger or acquisition of FAB by Wizzard.  Over the next several months, there were numerous telephone and e-mail communications during which general structural concepts were discussed.   These discussions included general transaction terms such as the general percentage ownership post acquisition and stock voting rights; control of the board of directors; corporate governance and controls and procedures; future management of the combined companies; future business direction of the combined companies; restrictions on the sale of stock issued to Digital HKCo; and other general terms and conditions.  On July 10, 2011, Mr. Spencer flew to Beijing to meet with FAB and begin formal discussions regarding Wizzard acquiring FAB.  At such time, Mr. Spencer met with FAB’s officers, directors and senior management.  He also toured several of FAB’s retail stores and kiosk locations. On the second day of this visit, Mr. Spencer provided to FAB a first draft of the Memorandum of Understanding.  This document was created by the officers of Wizzard based upon what they felt were fair terms for both parties and represented the best interests of the current Wizzard shareholders. The staggered share




21




issuance scheme provides for a change in control, only if FAB is actually able to perform financially, and gives greater Board and management continuity than if the current Wizzard officers and directors had resigned immediately upon closing.  We believe this provides additional protection to Wizzard’s existing shareholders.  


On August 9th, 2011, after a month of formal discussions, which in large part were based upon explaining the reasons behind the terms and conditions outlined in the draft Memorandum of Understanding, understanding both parties’ businesses, management and other roles going forward and dealing with cultural and language differences, both in person and through e-mail and telephone, Wizzard entered into a binding Memorandum of Understanding to acquire FAB.  The binding Memorandum of Understanding had no material changes from the original Memorandum of Understanding presented to FAB in Beijing on or about July 10, 2011.


Due Diligence Period


From September 2011 to October 2011, the Board of Directors and the officers of Wizzard began interviewing due diligence companies to assist in the due diligence process.  During such time, Wizzard retained Ernst & Young’s Transaction Advisory Services for accounting due diligence; King & Wood, a prominent international law firm, for tax and legal due diligence; and Arcstone, for valuation due diligence.  


From October, 2011, to January, 2012, Wizzard worked towards an assessment of FAB’s quality of earnings including the identification of any overly aggressive accounting policies and the assessment of the adequacy of judgmental accounts in accordance with Generally Accepted Accounting Principles.  Additionally, Wizzard analyzed cash flows, reviewed assets and liabilities, and identified key business drivers focusing on trends in profitability and significant concentrations of risk.


In December, 2011, Messrs. Spencer and Busshaus, who are Wizzard’s CEO and CFO, respectively, traveled to Beijing, where they met with FAB management as well as their attorneys and auditors.  Messrs. Spencer and Busshaus reported to Wizzard’s stockholders:  “We were very happy with the progress of the FAB team as they work hard to prepare to be a publicly listed company.  Additionally, we toured FAB retail stores; licensing stores and saw several new kiosk models.”


On January 18, 2012, Wizzard announced that all due diligence had been completed and the Board of Directors agreed to proceed to the final stage of the acquisition of FAB and the drafting of all final closing documents.  


On February 8th, 2012, Wizzard announced that its shareholder approved a 1 for 12 reverse stock split, as required by the terms of the Memorandum of Understanding.  


On April 10, 2012, Wizzard announced that it had signed a definitive Share Exchange Agreement to acquire 100% of the outstanding shares of Digital HKCo.


Digital HKCo, operating through the VIE Entities, offers the largest selection in China of copyrighted digital entertainment products and unique digital entertainment experience through its three channels; wholesale and retail, FAB kiosks network, and online store. Digital HKCo is a champion of the anti-piracy movement in China.  Its founder, Mr. Zhang Hongchen, has served as Chairman of Anti-Piracy Alliance in China.  


Digital HKCo offers a variety of digital entertainment products including CD, VCD, DVD, blue-ray disks, books magazines, mobile phone accessories and cameras.  Its products and services are primarily distributed through its flagship stores, proprietary “FAB” kiosks network and online virtual stores. FAB kiosk are conveniently located at high-traffic areas of office buildings, shopping malls, retails stores and airports, and is a self-service terminal that provides a range of entertainment and business applications.  Revenue from FAB kiosk sales includes download service revenue, membership card revenue, advertisement revenue and licensing revenue. Membership card revenue is amortized over the life of the membership period.  The membership cards are sold at various levels.  Membership levels at RMB $100 have an expiration period of three months, and levels at RMB $200, $300, $400 and $500 have expiration periods of twelve months.  This FAB membership program brings in tens of thousands of paid members and loyal customers.


Digital HKCo operates two flagship stores in the heart of the Beijing commercial district.  The flagship stores are the largest audio-video stores in China, with each store over 30,000 square feet in size.  The flagship stores are recognized as the #1 place of choice for Chinese stars to host autograph and signing events in China.


Digital HKCo’s internet portal, www.fab123.com, offers an online sales and membership fulfillment platform.  Digital HKCo is improving this web service with more features and functionality to offer an on-line experience of the latest release of copyrighted music and movies vial download and mail order.






22




BUSINESS OVERVIEW

 

FAB, through its wholly owned subsidiary and its VIEs, is engaged in marketing and distributing various officially licensed digital entertainment products under the “FAB” brand throughout the PRC, including but not limited to audiovisual products such as Compact Discs, Video Compact Discs and Digital Video Disks as well as books, magazines, mobile phone accessories and cameras. The Company’s products and services are primarily distributed through its flagship stores, licenses, proprietary “FAB” kiosks and online virtual stores. FAB kiosks, located in high-traffic areas of office buildings, shopping malls, retails stores and airports, are self-service terminals that provide a range of entertainment and business applications.


           FAB’s organizational structure consists of Digital Entertainment International Limited (“Digital HK”); its wholly owned subsidiary, Beijing Dingtai Guanqun Culture Co., Ltd. (“DGC”), and Beijing FAB Cultural Media Co., Ltd. (“FAB Media”) and Beijing FAB Digital Entertainment Products Co., Ltd. (“FAB Digital”), which are variable interest entities (“VIEs”) of DGC.


           In February and March 2012, a series of contractual arrangements were entered into among DGC, FAB Digital, FAB Media and the individual shareholders of FAB Digital and FAB Media.  Such arrangements include an Exclusive Service Agreement; an Equity Pledge Agreement; a Call Option Agreement; and a Shareholders’ Voting Right Proxy Agreement.


           Pursuant to these agreements, DGC has the exclusive right to provide to FAB Digital and FAB Media consulting services related to their business operation and management.  The terms of these agreements are summarized below:


Exclusive Service Agreement

        

        Under the exclusive service agreements among DGC (WFOE), Beijing FAB Digital and FAB Media, as well as the respective registered shareholders of Beijing FAB Digital and FAB Media, the registered shareholders of Beijing FAB Digital and FAB Media agree:


to irrevocably entrust the right of management and operation of FAB Digital and FAB Media and the responsibilities and authorities of their shareholders and board of directors to the WFOE in accordance with the terms and conditions of this Agreement.

the WFOE, as the entrusted manager, shall provide full management to FAB Digital and FAB Media’s operations.

 the WFOE  possesses its exclusive rights in nominate and approve the directors, chairman, general managers, financial controllers or other senior managers of Beijing FAB Digital and FAB Media.

the WFOE,  for its provision of services,  shall be paid with service fee by FAB Digital and FAB Media, which equals to 100% of the residual return of FAB Digital and FAB Media, and which can be waived by the WFOE from time to time in its sole discretion.

 

Call Option Agreement

       

         DGC (WFOE) entered into call option agreement with FAB Digital, FAB Media and their respective registered shareholders, who irrevocably granted DGC (WFOE) or its designated person exclusive options to purchase, when and to the extent permitted under PRC law, all of the equity interests in Beijing FAB Digital and FAB Media. The exercise price for the options to purchase all of the equity interests in Beijing FAB Digital and FAB Media is the minimum amount of consideration permissible under the then applicable PRC law. The agreements have an initial term of ten years and are renewable at DGC (WFOE)'s sole discretion. These call option agreements provide, among other things, that without DGC (WFOE)'s prior written consent:


the registered shareholders of each VIE may not transfer, encumber, grant security interest in, or otherwise dispose of in any way any equity interests in their respective VIEs;

Beijing FAB Digital and FAB Media may not sell, transfer, mortgage or otherwise dispose of in any way their respective assets, business or income, nor may they create any security interest therein (other than created in the ordinary course of their respective business);

no shareholders resolution should be passed to increase or reduce the registered capital of each VIE or otherwise alter the capital structure of such VIE;

Beijing FAB Digital and FAB Media may not declare or pay any dividends to their respective registered shareholders;

Beijing FAB Digital and FAB Media may not merge with any third parties, or purchase or transfer any assets or businesses from or to any third parties;

Beijing FAB Digital and FAB Media may not engage in any transactions that may cause substantially adverse effects on their respective assets, obligations, operations, share capital and other rights;




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Beijing FAB Digital and FAB Media may not incur any indebtedness, except where transactions were entered into in the ordinary course of business; 


Equity Pledge Agreement

      

        Under DGC (WFOE)'s equity pledge agreement with FAB Digital, FAB Media and their respective registered shareholders, the registered shareholders of Beijing FAB Digital and FAB Media pledged all of their respective equity interests in Beijing FAB Digital and FAB Media to DGC (WFOE) to secure the performance of the registered shareholders', Beijing FAB Digital and FAB Media's obligations under the various VIE agreements, including the Exclusive Service Agreements and other agreements described above.


       If FAB Digital, FAB Media or any of their respective registered shareholders breaches any of their respective contractual obligations under these agreements, DGC (WFOE), as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests.

 

       The registered shareholders of Beijing FAB Digital and FAB Media agreed not to transfer, sell, pledge, dispose of or otherwise create any new encumbrance on their respective equity interests in Beijing FAB Digital and FAB Media, as the case may be, without DGC (WFOE)'s prior written consent. Unless terminated at DGC (WFOE)'s sole discretion, each equity pledge agreement has a term of ten years and will be automatically renewed upon the expiration of the term.


 Shareholder’s Voting Right Proxy Agreement

      

       Each registered shareholder of Beijing FAB Digital and FAB Media has executed a power of attorney to appoint DGC (WFOE) to be his or her attorneys, and irrevocably authorize DGC (WFOE) to vote on his or her behalf on all of the matters concerning Beijing FAB Digital and FAB Media, as the case may be, that may require shareholders' approval.



Complete copies of the variable interest entity agreements are included in Annex B of this proxy statement.


The following schematic diagram illustrates the relationships between the various FAB entities:


 

 

 

 

 

 

 

 

Universal Entertainment Group Ltd

(British Virgin Islands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Digital Entertainment International Limited

(Hong Kong)

 

 

 

 

 

 

 

 

Outside PRC

 

 

100%

 

 

Inside PRC

 

 

100%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beijing Dingtai Guanqun Culture Co. Ltd

(WFOE)

 

 

 

 

  é

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ê

 

 

ê

Beijing FAB Cultural Media Co. Ltd

(PRC)

 

 

Beijing FAB Digital Entertainment Products Co. Ltd

(PRC)

 

 

 

 

 

 


FAB Media conducts businesses relating to value-added telecommunications services and distribution of audio-visual products.  The Catalog for the Guidance of Foreign Investment Industries (the “Catalog”) as promulgated and amended from time to time by the Ministry of Commerce and the National Development and Reform Commission, is the principal guide to foreign investors’ investment activities in the PRC. The most updated version of the Catalog became effective in January 2012; both businesses relating to value-added telecommunications services and businesses relating to distribution of audio-visual products fall within the scope of foreign investment restricted industries.  Furthermore, in accordance with the Provisions on Administration of Foreign Invested Telecommunications Enterprises promulgated by the State Council in December 2001 and amended in September 2008, the foreign equity ownership in a value-added




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telecommunications services provider must not exceed 50%.  In accordance with the Measures on Administration of Sino-foreign Audio-visual Product Distribution Enterprises effective in January 2004, the percentage of foreign equity ownership in such enterprises distributing audio-visual products cannot be higher than 49%. Due to such regulatory restrictions, the FAB parties have to operate their businesses in a VIE structure.


In Section 3.21(c) of the Share Exchange Agreement, UEG has represented that each of the VIE agreements is enforceable in accordance with its terms, and we have entered into the Share Exchange Agreement in reliance on this representation, among others.  As of the date hereof, we have not obtained an opinion of counsel regarding the enforceability of the VIE agreements.  However, Section 9.2 b. (iv) of the Share Exchange Agreement requires, as a condition to closing, that special counsel to the FAB parties provide a legal opinion in a form to be agreed upon by the parties.   The parties have agreed on a form of closing legal opinion from FAB counsel that includes the following opinions, among others:  (i) each of the VIE Agreements has been duly executed and is legally binding on each of the parties thereto under PRC Laws; (ii) each of the parties to the VIE Agreements has full power, authority and legal capacity to enter into, execute and perform its obligations thereunder; (iii) the execution and delivery by each party of the VIE Agreements does not, and the performance by each party of its obligations thereunder will not, violate or breach any governmental authorization or any PRC Laws or the organizational documents or any other agreement or obligation of such party; and (iv) to the knowledge of opining counsel, there is no issue, fact or circumstance that would lead it to believe that any government agency would revoke the VIE Agreements or any transaction thereunder.  The delivery of this opinion letter is a condition to the closing of the Share Exchange Agreement.


Digital HK is a holding company and conducts its business through its wholly owned subsidiary, Beijing Dingtai Guanqun Culture Co., Ltd. (“DGC”), which is a wholly foreign-owned enterprise (“WFOE”) with limited liability incorporated in the PRC in March 2011. DGC has entered into a series of contractual agreements with the owners of FAB Digital and FAB Media.


In March 2012, a series of contractual arrangements were entered into among DGC, FAB Digital, FAB Media and its individual shareholders. Such arrangements include an Exclusive Service Agreement, a Share Pledge Agreement, an Option Agreement and a Voting Right Proxy Agreement.


Pursuant to these agreements, DGC has the exclusive right to provide to FAB Digital and FAB Media consulting services related to business operation and management. The key terms of these agreements include:

·

DGC has the sole discretion to make all operating and business decisions for FAB Digital and FAB Media on behalf of the equity owners, including business operations, policies and management, approving all matters requiring shareholder approval;

·

FAB Digital and FAB Media have agreed to pay all of the operating costs incurred by DGC, and intended to transfer 100% of the income earned to DGC; DGC also has the right to determine the amount of the fees it will receive;

·

During the term of these agreements, DGC will retain the rights to the intellectual properties if they are created by DGC;

·

FAB Digital and FAB Media may not enter into any other agreements with any third party to receive consulting service without the prior consent of DGC;

·

The equity owners pledge their respective equity interests in the FAB Digital and FAB Media as a guarantee for the payment of technical and consulting services fees under the Exclusive Service Agreement;

·

The shareholders of FAB Digital and FAB Media have irrecoverably and unconditionally granted DGC or its designee an exclusive option to purchase, to the extent permitted by PRC laws, all or any portion of equity interest of the FAB Digital and FAB Media.


All these contractual agreements obligate DGC to absorb a majority of the risk of loss from FAB Digital and FAB Media’s activities and entitle DGC to receive a majority of its residual returns. In essence, DGC has gained effective control over both FAB Digital and FAB Media. Based on these contractual arrangements, the Company believes that both FAB Digital and FAB Media should be considered as variable interest entities (“VIEs”) under the FASB Accounting Standards Codification (“ASC”) 810, “Consolidation.”  Accordingly, management believes that the accounts of these two entities should be consolidated with those of DGC, the primary beneficiary.  Each of the VIE agreements is discussed in more detail under the caption “Business Overview” above.


Digital HK is effectively controlled by the majority shareholders of FAB Digital and FAB Media. Digital HK has 100% equity interest in DGC. Accordingly, DGC, FAB Digital and FAB Media are effectively controlled by the same majority shareholders.  Therefore, DGC, FAB Digital and FAB Media are considered under common control. The consolidation of DGC, FAB Digital and FAB Media has been accounted for at historical cost and prepared on the basis as if the aforementioned exclusive contractual agreements between DGC and FAB Digital and FAB Media had become effective as of the beginning of the first period presented in the accompanying consolidated financial statements.


There are risks involved with the operation of our business in reliance on the VIE agreements, including the risk that the VIE agreements may be determined by PRC regulators or courts to be unenforceable. UEG has




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represented in the Share Exchange Agreement that the VIE agreements are binding and enforceable under applicable law.  However, if the VIE agreements were for any reason determined to be in breach of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:

·

imposing economic penalties;

·

discontinuing or restricting the operations of the DGC, FAB Digital and/or FAB Media;

·

imposing conditions or requirements in respect of the VIE agreements with which DGC may not be able to comply;

·

requiring the various entities to restructure the relevant ownership structure or operations; and

·

taking other regulatory or enforcement actions that could adversely affect the companies’ businesses.


Moreover, FAB Digital and/or FAB Media could violate the VIE agreements, go bankrupt, suffer from difficulties in their businesses or otherwise become unable to perform their obligations under the VIE agreements.  Due to the above-referenced uncertainties surrounding the treatment of VIE arrangements under PRC law, we may have difficulty enforcing the VIE agreements and, as a result, our operations, reputation, business and stock price could be severely adversely affected.


        For a more detailed discussion of the risks associated with the VIE structure, see the Risk Factor “There are risks associated with Digital HKCo’s business structure.”


Retail and Wholesale


FAB conducts their retail and wholesale business through their flagship stores since 2003.  Each store has over 3,000 square meters in size and carries the largest selection of copyrighted audio and video products in China, including Cds, VCDs, DVDs, blu-rays, books, magazines and portable electronic devices. FAB markets their products to individual consumers and audio-video retailers.  With their strong market position, FAB flagship stores have been used by most Chinese music and movie stars as an important venue for their signing and promotion events.  The flagship stores have also been recognized by many Chinese consumers as the right place to buy copyright products.


Licensing and Kiosk


FAB kiosk is an innovative self-service vending kiosk designed and launched by FAB in 2008.  The kiosk targets the millions of mobile and portable device users, and it combines and interactive touch screen and LED display with web-linked electron communications.  There are thousands of licensed digital culture content items being loaded and update in each kiosk, which allows the customer to play or stream to his portable device or memory card with payment by cash, FAB membership card, Beijing Metro-Card or ATM card.  FAB has deployed over 3,000 kiosks through their licensing program.  Most of the kiosks are located in high-traffic areas, such as, office buildings, shopping malls, and retail stores. Revenue is generated by selling pre-paid membership cards, charging licensing fees and providing advertising.


FAB Membership


In order to retain customers and increase cross-sales, FAB launched their client retention program, the FAB member ship program in 2008.  This program entitles customers to download digital content from FAB kiosks at lower costs than non-member customers.  The membership also provides bonus points for member’s purchasing products in any of the flagship stores.  The bonus points can be exchanged later for non-cash gives. FAB offers five different membership levels ranging from $15 for a 3 month period and allowing 40 downloads per month to $75 for 12 months and 500 downloads per month.


Research and Development


The costs for research and development were immaterial during 2011 and 2010 and are included in the selling, general and administrative expenses.


Licenses


FABs suppliers are mainly media publishers and manufacturers who provide FAB different types of digital content products, such as, copyrighted CD, DVD, memory card, education software, etc.  The products and content are obtained through direct purchases.  FAB is committed to provide licensed audio-video products and digital content to their customers.






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Patents

 

FAB has received patents for the software developed as set forth below:


Patents

Date of Authorization

Self-service photo printing system of FAB kiosk V1.0

2009.12.24

Self-service voucher printing system of FAB kiosk V2.0

2009.12.24

Management system of FAB kiosk V2.4

2009.09.22

Operating system of FAB kiosk V2.4

2009.09.22

Operating software of FAB kiosk V1.0

2008.10.09


Environmental Compliance


We do not believe that there are any material laws, rules or regulations regarding environmental concerns that are applicable to our present or intended business operations.


Governmental Regulations


Wholly Foreign-owned Enterprises


Digital HKCo’s wholly-owned subsidiary, DGC, is deemed to be a “wholly foreign-owned enterprise.”  Wholly foreign-owned enterprises are governed by the Law of the PRC Concerning Enterprises with Sole Foreign Investments (which was promulgated in April 1986, as amended in October 2000, and its Implementation Regulations promulgated in December 1990, as amended in April 2001 (together the “Foreign Enterprises Law”). The establishment of a wholly foreign-owned enterprise will have to be approved by Ministry of Commerce of the PRC (or its local counterparts). A wholly foreign-owned enterprise must also obtain a business license from Administration for Industry and Commerce Authority before it can commence business.


A wholly foreign-owned enterprise is a limited liability company under the Foreign Enterprise Law. It is a legal person which may independently assume civil obligations, enjoy civil rights and has the right to own, use and dispose of property. It is required to have a registered capital contributed by the foreign investor(s). The liability of the foreign investor(s) is limited to the amount of registered capital contributed. A foreign investor may make its contributions by installments and the registered capital must be contributed within the period as approved by Ministry of Commerce of the PRC (or its local counterparts) in accordance with relevant regulations.  As a wholly-foreign-owned enterprise, DGC is subject to these regulations.


Regulations relating to Dividend Distribution


        Under the Old EIT Law effective prior to January 1, 2008, dividends paid to foreign investors by foreign-invested enterprises would be exempt from PRC withholding tax. Dividends generated after January 1, 2008 and distributed to Digital HKCo by DGC, its PRC subsidiary, are subject to withholding tax at a rate of 5%, provided that the Hong Kong based holding company is determined by the relevant PRC tax authorities to be a “non-resident enterprise” under the New EIT Law and holds at least 25% of the equity interest of its PRC subsidiary.  Digital HKco, has not obtained the approval for a withholding tax rate of 5% from the local tax authority yet, because DGC and FAB Media and FAB Digital, have not paid any dividends to Digital HKco after they effectively became consolidated subsidiaries in March 2012. According to SAT Circular 601, a beneficial owner generally must be engaged in substantive business activities. An agent or conduit company will not be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits. The conduit company normally refers to a company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits. In addition, as described above, Digital HKco may be considered a PRC resident enterprise for PRC enterprise income tax purposes, in which case, dividends received by it, as the case may be, from the relevant PRC subsidiary would be exempt from the PRC withholding tax because such income is exempt under the New EIT Law for a PRC resident enterprise recipient.  There remains uncertainty regarding the interpretation and implementation of the New EIT Law and its implementation rules.  It is uncertain whether, if we are deemed a PRC resident enterprise, any dividends to be distributed by us to our non-PRC shareholders, would be subject to any PRC withholding tax.


Foreign Ownership Restrictions


The Catalog for the Guidance of Foreign Investment Industries (the “Catalog”) as promulgated and amended from time to time by the Ministry of Commerce and the National Development and Reform Commission, is the principal guide to foreign investors’ investment activities in the PRC. The most updated version of the Catalog, which became effective in January 2012, divides the industries into three categories: encouraged ones, restricted ones and prohibited ones. The industries not listed in the Catalog fall within the scope of permitted ones.


        While for restricted industries, such as the distribution of audio-visual products operated by FAB Digital and FAB Media, the consolidated affiliates of the FAB Parties, and operating of value-added telecommunications service conducted by FAB Digital Entertainment, there are some limitations to the ownership and/or corporate structure of the




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foreign invested companies that operate in such industries. In addition, under the Administration of Audio-visual Products which was promulgated by the State Council and became effective in February 2002, the State implements a license system for the publication, production, reproduction, importation, wholesale, retail, and rental of audio-visual products. Any entity or individual, without a license, shall not be engaged in the publication, production, reproduction, importation, wholesale, retail or rental of audio-visual products. Any license or approval documents issued according to these Regulations shall not be assigned by means of rental, lending, sale or any other means.  The consolidated affiliated entities of the FAB Parties have obtained Publication Operation Permits and License for operating the business of retailing audio-visual products.



Regulations on Value-Added Telecommunication Services


In September 2000, the State Council promulgated the Telecommunications Regulations (the “Telecom Regulations”). The Telecom Regulations draw a distinction between “basic telecommunication services” and “value-added telecommunication services.” Internet content provision services(“ICP services”) is a subcategory of value-added telecommunications businesses. Under the Telecom Regulations, commercial operators of value-added telecommunications services must first obtain an operating license from the Ministry of Industry and Information Technology of the PRC (the “MIIT”) or its provincial level counterparts.


In September, 2000, the State Council issued the Administrative Measures on Internet Information Services (the “Internet Measures”). According to the Internet Measures, commercial ICP service operators must obtain an ICP license from the relevant government authorities before engaging in any commercial ICP operations within the PRC. In December 2001, the MIIT promulgated the Administrative Measures on Telecommunications Business Operating License (the “Telecom License Measures” which was revised by the MIIT in March 2009. The Telecom License Measures set forth the types of licenses required to operate value-added telecommunications services and the qualifications and procedures for obtaining such licenses.


According to the Administrative Rules for Foreign Investment in Telecommunications Enterprises promulgated by the State Council which became effective in January 2002 and was amended in September 2008, a foreign investor may hold up to 50% equity interest in a value-added telecommunications services operator in China and such foreign investor must have experiences in providing value-added telecommunications services overseas and maintain a good track record.  To comply with the PRC regulations noted above, the FAB Parties operate value-added telecommunications services for the online sale of audio-visual products through the consolidated affiliated entity FAB Digital and hold an ICP license.


Regulations Relating to Distribution of Audio-visual Products


The FAB Parties are also subject to regulations relating to the distribution of audio-visual products. Under the Administrative Measures for the Publication Market which were promulgated by the General Administration of Press and Publication and became effective in September 2003, as amended in June 2004 and March 2011, respectively, any entity or individual engaging in the distribution of publications, including audio-visual products, must obtain an approval from the competent press and publication administrative authority and receive the Publication Operation Permit. The consolidated affiliated entities of the FAB Parties, FAB Digital and FAB Media have obtained Publication Operation Permits for the sale of publications.


Regulations on Internet Culture Activities


On May 10, 2003, the Ministry of Culture promulgated the Internet Culture Administration Tentative Measures, or the Internet Culture Measures, which was revised on July 1, 2004. The Internet Culture Measures require ICP operators engaging in “Internet culture activities” to obtain a permit from the Ministry of Culture. The term “Internet culture activities” includes, among other things, online dissemination of Internet cultural products (such as audio-visual products, gaming products, performances of plays or programs, works of art and cartoons) and the production, reproduction, importation, sale (wholesale or retail), leasing and broadcasting of Internet cultural products.  FAB parties have hosted certain audio/video programs on the website www.fab.com.cn and www.fab123.com operated by FAB Media. FAB Media has been granted an Internet culture business permit.


On November 20, 2006, the Ministry of Culture issued Several Suggestions of the Ministry of Culture on the Development and Administration of the Internet Music, or the Suggestions, which became effective on November 20, 2006. The Suggestions, among other things, reiterate the requirement for the Internet service provider to obtain an Internet culture business permit to carry on any business relating to Internet music products. In addition, foreign investors are prohibited from operating Internet culture businesses. However, the laws and regulations on Internet music products are still evolving, and there have not been any provisions stipulating whether or how music video will be regulated by the Suggestions.





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On August 18, 2009, the Ministry of Culture promulgated the Notice on Strengthening and Improving the Content Review of Online Music. According to this notice, only “Internet culture operating entities” approved by the Ministry of Culture may engage in the production, release, dissemination (including providing direct links to music products) and importation of online music products. The content of online music shall be reviews by or filed with the Ministry of Culture. Internet culture operating entities should establish a strict self-monitoring system of online music content and set up a special department in charge of such monitoring. FAB’s PRC websites currently do not engage in the producing, broadcasting or transferring Internet cultural products, but exhibit the products which are offered in the retail stores.





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Regulation relating to Franchise


Pursuant to the Administrative Measures on Filings for Commercial Franchise promulgated by the Ministry of Commerce in April 2007 and effective as of May 2007, franchisors are required to file with the MOFCOM for its cross-province franchising business. One of the preconditions for conducting a franchising business and making such filings is that franchisors should have at least two direct operating stores with an operation period of no less than 1 year. Legal consequences for such non-compliance include a fine up to RMB 10,000 or RMB 50,000 in worse circumstances. FAB Culture has filed with the competent commercial authority of record and the file number is 0110100810900018.


Foreign Currency Exchange


The principal regulation governing foreign currency exchange in the PRC is the Regulations of the PRC on Foreign Exchange Administration (the “Foreign Exchange Regulations”), as amended in August 2008. Under the Foreign Exchange Regulations and other relevant regulations and rules, Renminbi are freely convertible for current account transactions, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. In order to convert Renminbi for capital account transactions, such as capital injections, loans, repatriation of investments and investments in securities outside the PRC, the prior approval of, or registration with, the State Administration of Foreign Exchange (the “SAFE”) or its competent local branches is required. FAB has not taken any funds outside China, and if they intend to do so in the future, they will make the proper registration with SAFE prior to such transaction.


In August 2008, the SAFE promulgated the Circular on Operating Issues Concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises ( “Circular 142”), pursuant to which the registered capital of a foreign-invested company settled in Renminbi and converted from foreign currencies can only be used for purposes within the approved business scope and cannot be used for equity investments made by such foreign-invested company within the PRC, unless otherwise provided. In addition, a foreign-invested company may not change the use of its Renminbi-denominated registered capital without the SAFE’s or its competent local branch’s approval, and may not in any case use such capital to repay Renminbi-denominated loans if the proceeds of such loans have not been used within the permitted scope. Violations of Circular 142 could result in severe penalties, including heavy fines. In addition, the SAFE promulgated the Notice on Relevant Issues Concerning Strengthening the Administration of Foreign Exchange Businesses in November 2010, which requires the authenticity of settlement of the funds raised from offshore offerings to be closely examined and the settlement of funds should conform to their intended use as listed in the offering document. For the settlement of funds in excess of those intended by the offering document or for a purpose other than that listed in the offering document, a board of directors resolution relating to the use of funds shall be submitted as a separate application document.


Investment in Offshore Special Purpose Vehicles


In October 2005, the SAFE issued the Notice on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles (the “Circular 75”), which became effective in November 2005. Under Circular 75, PRC residents are required to register with the local SAFE branch prior to establishing, or acquiring control of, an offshore company for the purpose of financing that offshore company with equity interests in, or assets of, an onshore enterprise. In addition, PRC residents are required to amend their registrations with the local SAFE branch after contributing equity interests in, or assets of, an onshore enterprise to the offshore company, or making any other material change in the capital of the offshore company. Furthermore, according to the relevant rules and regulations issued by the SAFE, the shareholders, beneficial owners and/or the PRC operating subsidiaries who apply for remedial SAFE registrations under the Circular 75 shall first be subject to various administrative sanctions, in accordance with the Foreign Currency Administration Regulations, before they can be granted a remedial SAFE registration.


Failure to comply with the registration procedures of Circular 75 may result in restrictions on the foreign exchange activities of the onshore company, including increases in its registered capital, payments of dividends and other distributions to its offshore parent or affiliate, and may also subject the relevant PRC residents and onshore entities to penalties under foreign exchange administration regulations.  As required by the Restructuring Plan that is attached as Exhibit F to the Share Exchange Agreement, Mr. Zhang has submitted the FAB parties’ initial registrations under Circular 75 and provided evidence of such submission to the Company.  


Regulations relating to Labor Laws


The principal labour laws and regulations in the PRC include the PRC Labour Law, the PRC Labour Contract Law and the Implementation Regulations of the PRC Labour Contract Law. Pursuant to the PRC Labour Law and the PRC Labour Contract Law, employers must enter into written labour contracts with employees. Employers must pay their employees’ wages equal to or above local minimum wage standards, establish labour safety and workplace sanitation




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systems, comply with government labour rules and standards and provide employees with appropriate training regarding workplace safety. In addition, the PRC Labour Contract Law imposes more stringent requirements on employers with regard to, among others, severance payment and non-fixed-term employment contracts, time limits for probation periods, as well as the duration and the times that an employee can be placed on a fixed-term employment contract. Violations of the PRC Labour Contract Law and the PRC Labour Law may result in liabilities to employees and subject employer to administrative sanctions including fines or, in the case of serious violations, criminal liability.  UEG has represented, in Section 3.19 of the Share Exchange Agreement, that Digital HKCo and its subsidiaries are in compliance with all applicable laws and orders relating to employment and labor other than those laws and orders for which failure to comply would not cause a Material Adverse Effect as defined in the Share Exchange Agreement.


The PRC regulatory authorities have passed a variety of laws and regulations regarding statutory social welfare benefits, including, among others, the PRC Social Insurance Law effective in July 2011, the Regulations of Insurance for Occupational Injury, the Regulations of Insurance for Unemployment, the Provisional Insurance Measures for Maternal Employees, and the Interim Provisions on Registration of Social Insurance. Pursuant to these laws and regulations, companies in China have to make sufficient contributions of statutory social welfare benefits for their employees, including medical care insurance, occupational injury insurance, unemployment insurance, maternity insurance, pension benefits and housing funds. Failure to comply with such laws and regulations may result in supplementary payments, surcharges or fines.


Regulations relating to Intellectual Properties


China has enacted various laws and regulations relating to the protection of intellectual property rights, including copyrights, software, trademarks, patents, domain names and other forms of intellectual property. China is a signatory to some main international conventions on protection of intellectual property rights and became a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization in December 2001.


Trademark


In accordance with the PRC Trademark Law, first promulgated in August 1982, as amended by the Standing Committee of the NPC in February 1993 and October 2001, the Trademark Office of the SAIC is responsible for the registration and administration of trademarks in China. The SAIC has established a Trademark Review and Adjudication Board for resolving trademark disputes.


China has adopted a “first-to-file” principle for trademarks. If two or more applicants apply for registration of identical or similar trademarks for the same or similar commodities, the application that was filed first will receive preliminary approval and will be publicly announced. For applications filed on the same day, the trademark that was first used will receive preliminary approval and will be publicly announced.


Registered trademarks remain valid for ten years from the date that registration is approved. A registrant may apply to renew a registration within six months prior to the expiration date of the registration. If the registrant fails to apply in a timely manner, a grace period of six additional months may be granted. If the registrant fails to apply before the grace period expires, the registered trademark will be deregistered. Renewed registrations remain valid for ten years.  Under the PRC Trademark Law, a registered trademark may be transferred between parties upon execution of a transfer agreement and approval and publication by the Trademark Office of the SAIC. FAB has represented it has registered trademarks under the PRC Trademark Law.


Patent


In accordance with the PRC Patent Law, first promulgated in March 1984, as amended by the Standing Committee of the NPC in September 1992, August 2000 and December 2009, the State Intellectual Property Office is responsible for administering patents in the PRC. The patent administration departments at the provincial or municipal level are responsible for administering patents within their respective jurisdictions.


Under the PRC Patent Law, patents are grouped into three categories: inventions, utility models and designs.  The PRC patent system adopts a “first-to-file” principle, which means that, where more than one person files a patent application for the same invention, a patent will be granted to the person who filed the application first.  In addition, the PRC requires absolute novelty in order for an invention to be patentable.  Under this requirement, any relevant written or oral publication, demonstration or use prior to filing a patent application may prevent an invention from being patented in the PRC.  Patents for inventions remain valid for twenty years, and patents for utility models and designs remain valid for ten years, in each case from the filing date of the patent application.





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In accordance with the PRC Patent Law, a patent application or patent right may be transferred between parties upon execution of a written agreement between the parties, which becomes effective upon registration with the State Intellectual Property Office. FAB has received acceptance notices on 15 patents which were filed in October 2010.


Copyright


The PRC Copyright Law, promulgated in September 1990 and amended in October 2001 and February 2010, and its implementing rules, set forth the basic legal system for the protection of copyright in the PRC. The Regulations on Computer Software Protection (“the Software Regulations”), promulgated in December 2001 by the State Council, and the Measures on the Registration of Computer Software Copyright, promulgated in February 2002, were formulated in accordance with the PRC Copyright Law. In accordance with the Software Regulations, a software copyright owner may apply for the registration of software at software registration organs recognized by the National Copyright Administration. A registration certificate may serve as preliminary proof of the copyright ownership of the registrant. A software copyright of a legal person remains valid for a period of fifty years from the date of publication of such copyright. FAB has represented it has registered copyright under the PRC Copyright Law.


In Section 3.14 of the Share Exchange Agreement, UEG has represented that, to its knowledge, neither Digital HKCo’s nor any of its subsidiaries ownership and use of its intellectual property materially infringes upon or misappropriates any third party’s intellectual property rights.


Taxation


Enterprise Income Tax


In March 2007, the NPC promulgated the PRC Enterprise Income Tax Law (the “EIT Law”). The State Council promulgated the Implementation Regulations to the PRC Enterprise Income Tax Law in December 2012 (the “EIT Law Implementation Regulations”).


Under the EIT Law and the EIT Law Implementation Regulations, (i) PRC resident enterprises are generally subject to enterprise income tax at the rate of 25% on their worldwide income, (ii) non-PRC resident enterprises with presence in the PRC are generally subject to enterprise income tax at the rate of 25% on their income sourced from such presence in the PRC and (iii) non-PRC resident enterprises with no presence in the PRC are generally subject to enterprise income tax at the rate of 10% for their PRC-sourced income.


Under the EIT Law, enterprises organized under the laws of jurisdictions outside China with “de facto management bodies” that are located within China may be considered PRC resident enterprises and therefore be subject to PRC enterprise income tax at the rate of 25% on their worldwide income. The EIT Law Implementation Regulations define the term “de facto management body” as a management body that exercises full or substantial control and management authority over the production, operation, personnel, accounts and assets of an enterprise. The State Administration of Taxation (the “SAT”), issued the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies (the “Circular 82”) in April 2009.


Circular 82 provides specific criteria for determining whether the “de facto management body” of a Chinese-controlled offshore enterprise is located in China, which include the presence in the PRC of the following locations: (1) the location where senior management members responsible for an enterprise’s daily operations discharge their duties; (2) the location where financial and human resource decisions are made or approved by organizations or persons; (3) the location where the major assets and corporate documents are kept; and (4) the location where more than half (inclusive) of all directors with voting rights or senior management have their habitual residence.


In July 2011, the SAT issued Administrative Measures of Enterprise Income Tax of Chinese-controlled Offshore Incorporated Resident Enterprises (Trial) (the “Bulletin 45”), which became effective in September 2011, to provide further guidance on the implementation of Circular 82.


Bulletin 45 clarifies certain issues related to determining PRC resident enterprise status, post-determination administration and which competent tax authorities are responsible for determining for offshore incorporated PRC resident enterprise status. Bulletin 45 specifies that when provided with a copy of a Chinese tax resident determination certificate issued by the competent tax authorities from an offshore incorporated PRC resident enterprise, the payer should not withhold 10% income tax when paying PRC-sourced dividends, interest and royalties to the offshore incorporated PRC resident enterprise.


Although Circular 82 applies only to offshore enterprises controlled by PRC enterprises or PRC corporate groups and not those controlled by PRC individuals, the determining criteria set forth in Circular 82 may reflect the SAT’s




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general position on how the “de facto management body” test should be applied in determining the tax residency status of offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals or foreign enterprises.


There are currently no detailed rules or precedents governing the procedures and specific criteria for determining whether a given entity constitutes a “de facto management body,” and a final confirmation by the SAT as to the “residency” status of offshore enterprises is generally necessary. Therefore, it remains unclear whether the PRC tax authorities would classify the Company as a PRC resident enterprise. Because substantially all of its operations and senior management are located within the PRC and are expected to remain so for the foreseeable future, Digital HKCo. may be considered a PRC resident enterprise for enterprise income tax purposes and therefore subject to the PRC enterprise income tax at the rate of 25% on its worldwide income. If Digital HKCo. were treated as a PRC resident enterprise, although under the EIT Law and the EIT Law Implementing Regulations dividends paid to Digital HKCo. from its PRC subsidiary, it should qualify as tax-exempt income, there is no assurance that Digital HKCo. would enjoy such tax-exempt treatment on dividends paid to it from its PRC subsidiary as offshore incorporated PRC resident enterprises controlled by PRC enterprises or PRC corporate groups enjoy under Bulletin 45.


In addition, the EIT Law Implementation Regulations provide that, (i) if an enterprise that distributes dividends is domiciled in the PRC, or (ii) if gains are realized from transferring equity interests of enterprises domiciled in the PRC, then such dividends or gains are treated as PRC-sourced income. It is not yet clear how the term “domicile” will be interpreted under the EIT Law, and it may be interpreted as the jurisdiction where an enterprise is a tax resident. As a result, if Digital HKCo. were deemed to be a PRC resident enterprise, any dividends that Digital HKCo. pay to its non-resident enterprise shareholders, as well as gains realized by such shareholders from the transfer of the Shares, may be regarded as PRC-sourced income and thus subject to a 10% PRC tax, unless a reduced rate is provided under any applicable tax treaty.


Under the PRC Individual Income Tax Law (the “IITL”), if Digital HKCo. were treated as a PRC resident enterprise, it is possible that non-resident individual investors may be subject to PRC individual income tax at a rate of 20% on any dividends paid to such investors and any capital gains realized from the transfer of the Shares if such dividends or capital gains are deemed income derived from sources within the PRC, unless such individuals qualify for a lower rate under a tax treaty. A non-resident individual is an individual who has no domicile in the PRC and does not stay within the PRC or has stayed within the PRC for less than one year. Pursuant to the IITL and its implementation rules, for purposes of the PRC capital gains tax, the taxable income will be based on the total income obtained from the transfer of the Shares minus all the costs and expenses that are permitted under PRC tax laws to be deducted from the income.


In connection with the EIT Law, the Ministry of Finance (the “MOF”), and the SAT jointly issued, in April 2009, the Notice on Issues Concerning Process of Enterprise Income Tax in Enterprise Restructuring Business (the “Circular 59”). In December 2009, the SAT issued the Notice Concerning the Strengthening of Enterprise Income Tax Administration with Respect to Equity Transfers by Non-resident Enterprises (the “Circular 698”). Both Circular 59 and Circular 698 became effective retroactively as of 1 January 2008. By promulgating and implementing these circulars, the PRC tax authorities have enhanced their scrutiny over the direct or indirect transfer of equity interests in a PRC resident enterprise by a non-PRC resident enterprise. The PRC tax authorities have the discretion under Circular 698 to make adjustments to the taxable capital gains based on the difference between the fair value of the equity interests transferred and the cost of investment.


Under Circular 698, if a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly via disposing of the equity interests of an overseas holding company other than through public markets, such as the ASX where Digital HKCo. is expected to be listed (the “Indirect Transfer”) and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the foreign investor is required to report this Indirect Transfer to the competent PRC tax authorities. Using a “substance over form” principle, the PRC tax authorities may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of avoiding PRC tax. As a result, gains derived by a shareholder from such Indirect Transfer may be subject to PRC tax at the rate of up to 10%.


Enterprise Income Tax Preference


The New EIT Law and its implementation rules permit certain “high and new technology enterprises strongly supported by the state” that hold independent ownership of core intellectual property and simultaneously meet a list of other criteria, financial or non-financial, as stipulated in the implementation rules and other regulations, to enjoy a reduced 15% enterprise income tax rate subject to certain new qualification criteria. The State Administration of Taxation, the Ministry of Science and Technology and the Ministry of Finance jointly issued the Administrative Rules for the Certification of High and New Technology Enterprises delineating the specific criteria and procedures for the “high and new technology enterprises” certification in April 2008.


FAB Digital was recognized by the provincial level Science and Technology Commission, Finance Bureau, and State and Local Tax Bureaus as “high and new technology enterprise”, which recognition is valid for 3 years. Therefore,




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FAB Digital is entitled to the preferential enterprise income tax rate of 15%. FAB cannot assure you that FAB Digital will continue to be recognized as “high and new technology enterprise” or be able to renew this qualification when the term expires, and thus continue to be entitled to the preferential enterprise income tax rate of 15% or any other preferential enterprise income tax treatment.


Value Added Tax


The Provisional Regulations of the PRC concerning Value Added Tax were promulgated by the State Council in December 1993 and amended in November 2008. Under these Regulations and the Implementing Rules of the Provisional Regulations of the People’s Republic of China Concerning Value Added Tax, value added tax is imposed on goods sold in or imported into the PRC and on processing, repair and replacement services provided within the PRC.


Value added tax payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided but excluding, in respect of both goods and services, any amount paid in respect of value added tax included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year.


Business Tax


Under the Provisional Regulations on Business Tax, as amended in November 2008, businesses that provide services, assign intangible assets or sell immovable property are subject to business tax at a rate ranging from 3% to 20% of the income for services rendered, intangible assets assigned or immovable property sold.


In Section 3.22 of the Share Exchange Agreement, UEG has represented, among other things, that it has duly filed all tax returns required to be filed after December 31, 2008, and that it has duly and timely paid all taxes due and payable with respect to all periods after December 31, 2008.


Employees


Currently, FAB has approximately 150 employees, of which 46 are managerial staff, 31 operations staff and 78 sales and marketing.


Description of Property


FAB's corporate offices are located at Room 6841, Building 3, No.3 Xijing Lu, Badachu High-tech Garden, Shijingshan District, Beijing, China.  Lease terms generally range up to 6 years and provide for escalations in base rents.  FAB does not have any obligations to renew the lease.


Digital HKCo has operated two flagship stores in Beijing downtown commercial district through its VIE subsidiary, Beijing FAB Digital Entertainment Co., Ltd in excess of 30,000 square feet. One of the stores is located at Xidan Joy City Shopping Mall, while another one used to be at Oriental Plaza but now is relocated to GuoSheng Plaza at Dong-Zhi-Men.

 The down town store is located in Oriental Plaza. The stores have been recognized as the largest Digital Entertainment market places in China, offering a variety of digital culture and entertainment products including CD, VCD, DVD and blue-ray disks and books.


In April 2011, FAB purchased a building for $12,237,468 (RMB 80,000,000). FAB has not received the related property ownership certificate and the land use right certificate. Management of FAB estimate these certificates will be obtained in the first half of 2012, and the building has been used for operations since April 2011.


Legal Proceedings


FAB is involved in routine legal and administrative proceedings and claims of various types.  FAB has no material pending legal or administrative proceedings, other than as discussed below or ordinary routine litigation incidental to their business, to which they or any of their subsidiaries are a party or of which any property is the subject.  While any proceeding or claim contains an element of uncertainty, FAB management does not expect that any such proceeding or claim will have a material adverse effect on their results of operations or financial position.


Management's Discussion and Analysis of Financial Condition and Results of Operations.(FAB)


Safe Harbor Statement.


Statements made in this proxy which are not purely historical are forward-looking statements with respect to the goals, plan objectives, intentions, expectations, financial condition, results of operations, future performance and business




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of FAB.  Statements preceded by, followed by or that include the words "may", "would", "could", "should", "expects", "projects", "anticipates", "believes", "estimates", "plans", "intends", "targets" or similar expressions.


Forward-looking statements involve inherent risks and uncertainties, and important factors (many of which are beyond Wizzard's  or FAB’s control) that could cause actual results to differ materially from those set forth in the forward-looking statements, including the following, in addition to those contained in our reports on file with the SEC: general economic or industry conditions, nationally and/or in the communities in which Wizzard and FAB conducts business, changes in the interest rate environment, legislation or regulatory requirements, conditions of the securities markets, changes in the  industries in which we operate, the development of products that may be superior to the products offered by Wizzard and FAB, demand for financial services, competition, changes in the quality or composition of Wizzard's and FAB’s products, the ability to develop new products, the ability to raise capital, changes in accounting principles, policies or guidelines, financial or political instability, acts of war or terrorism, other economic, competitive, governmental, regulatory and technical factors affecting Wizzard's and FAB’s operations, products, services and prices.


Accordingly, results actually achieved may differ materially from expected results in these statements.  Forward-looking statements speak only as of the date they are made.  Wizzard and FAB do not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect events or circumstances occurring after the date of such statements.


Company Overview


Retail and Wholesale


FAB conducts their retail and wholesale business through their flagship stores. They currently operate two flagship stores in downtown Beijing. Each of the stores covers over 3,000 square meters of floor area. Their product offerings include CDs, VCDs, DVDs, blu-ray, books, mobile phones accessories, cameras, etc.


Celebrity signing events are the major driver to their retail and wholesale in the stores. FAB’s stores have been used as the most important venue for Chinese music and movie stars to meet their fans. FAB flagship stores host such events at least once a week. Those events not only promote sales of audio-video products but also increase their brand recognition.


FAB Kiosk Network


In 2008, FAB developed and started to launch their proprietary self-service kiosk (“FAB kiosk”) which allows customers to stream music and movies to their storage devices and mobile phones instantly via USB or Bluetooth access. FAB kiosks can also serve as a multi-function platform. Adapting to different deploying environments, different features can be added on to the kiosk, such as, to display commercial and public information, to print commercial vouchers and sales coupons, process payment of utility bills, etc.


The standard FAB kiosks have the following features:

·

The user can review and select a variety of licensed music, movies, mobile phone ringtones and games from a touch screen.

·

The user can stream the selected content or titles to different kinds of portable devices, such as, MP3, MP4, memory cards, hard disks, flash disks, mobile phones.

·

The transmission speed is 10 times higher than downloading through the internet and mobile network.

·

Low cost to the consumer - as low as RMB 1 per item versus more than RMB 10 for a disk.

·

Payment can be made in various ways - coins, Beijing Metro-Cards, FAB membership cards and Debit Cards.

·

Commercial advertisements are displayed on the top LED screen.

·

Eye-catching color and models that attract pedestrian’s attention.


FAB kiosks network consists of FAB outlets and standalone kiosks. They promote and deploy their kiosks through FAB’s licensing program and different joint-marketing programs, such as, the joint program with the Tourist Bureau of Beijing Municipal Government, the program with Beijing Red-Cross Society, etc. In those joint-marketing programs, they offer to carry and broadcast their counterpart’s information at no charge while leveraging its influence to increase customer’s awareness and acceptance to their kiosks. With FAB’s licensing program they use the financial resource from a private sector and get their kiosk network deployed quickly.  By implementation of those programs in the last two years, FAB has successfully installed 3,954 kiosks at high-traffic indoor locations throughout Beijing, such as, office buildings, shopping malls, retail shops and airports. A digital content distribution network has been established through the programs.  


FAB licensing program is a merchant program that binds the FAB and each small investor or vendor. Under this program and associated contract, both licensor and lincensee take their joint-business obligations as follows:




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1.

The licensee pays for FAB Kiosk and other equipment and fixtures while the licensor (FAB Media) is responsible for the complete set-up of each FAB outlet from the location selection to construction or conversion, remodeling and equipment installation.

2.

All FAB outlets will be owned by the licensee, but supervised by a designated management company – Beijing Huzhong Culture Co., Ltd (“Huzhong Culture”) in accordance with FAB’s distinctive business formats.

3.

FAB kiosks are linked to the server station through the internet to remain updated. Such maintenances are operated by Huzhong Culture.

4.

In the operation process, the revenue generated from the advertisements on the Kiosks network and FAB membership card are sold in each FAB outlet and distributed among FAB Media, Huzhong Culture and the licensee in the following way:

1)

The licensee receives 20% of the sales revenue of FAB membership cards and 20% of advertisement fees.

2)

FAB Media receives 70% of the sales revenue of FAB membership cards and 70% of advertisement fees.

3)

Huzhong Culture receives 10% of the sales revenue of FAB membership cards and 10% of advertisement fees.


Since January 2011, the FAB decided to expand the program in major tier-one and tier-two cities in China. In order to establish the FAB kiosks network effectively, one agent is exclusively authorized to assist them in developing new licensees in each city. As of 2011 annual reporting date, FAB has accumulated 30 agents and 1,114 licensees in several provinces in China (excluding Beijing).  

FAB has established the e-commercial portal www.fab123.com.  Both pre-paid members and one-time users can navigate through the website to buy or rent digital entertainment products and have online trial experience with licensed audio and video products. So far, this distribution channel is still in the trial operation and no substantial revenue has been generated from this channel.


FABs website supports online payment with credit cards and debit cards issued by major banks in China as well as payment through thirdparty online payment agents. Once they have verified the orders placed by their customers, there are three different ways of delivery: (i) FAB can arrange delivery of products purchased online to customers’ registered or appointed address; (ii) customers may choose to download contents online; (iii) customers can collect goods at FAB’s flagship stores or licensing outlets.


The internet is increasingly a key channel to promote and sell their products and services and to provide customers with an easy, user friendly and accessible way to manage their services and access support whilst reducing costs for FAB. They intend to continue expanding online sales through marketing activities and expect that customers will contribute significantly to their revenue.


FAB membership program


In order to retain customers and increase cross-sales, they have successfully launched their client retention program, FAB membership program, since 2008. This program entitles their customers to download digital contents from FAB kiosks at a lower cost than non-member customers. They also give extra bonus points to the members for purchasing in FAB flagship stores. The bonus points can later be exchanged for non-cash gifts. The FAB membership program is designed to encourage repeat transactions in FAB kiosks and FAB outlets. It has proven to be an effective customer retention program. Currently they offer five kinds of membership cards. The details of the program are described in the following table:


Name of membership card

Price($)

Monthly maximum downloads

Valid Period

Business

15

40

3 months

Silver

30

40

12 months

Gold

45

60

12 months

Platinum

60

80

12 months

Diamond

75

500

12 months


Suppliers and Customers


FAB’s suppliers are mainly audio-visual products publishers and FAB kiosks manufacturers who provide physical and digital audio-visual products as well as FAB kiosks. FAB obtains audio-visual products and contents through direct purchases. They are committed to provide licensed audio-visual products and digital contents to their customers.


FAB’s customers vary for each of their business segments. For their wholesale and retail business, customers include individual consumers and culture and audio-video product retailers such as Beijing Aohua Daheng Trading Co., Ltd, Beijing Dangdang Information Technology Co., Ltd, and Beijing Book Building.




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For their FAB kiosks network operation, customers mainly consist of licensees, advertisers, and individual consumers including 333,632 active FAB members and many one-time users. They continually seek different ways to deliver their products.


Competitive Strengths


FAB believes its historical success and future prospects are attributable to the following competitive strengths:


·

Brand recognition in China’s digital entertainment products retail market


FAB is a distributor in China’s digital entertainment products retail market. They have two flagship stores in China that are located in the heart area of Beijing each covering over 3,000 square meters of floor area. Through strategic alliance with famous media and entertainment companies, their flagships stores have been chosen in China to have celebrity/fan signing events. They distribute entertainment products to other large-scale culture and audio-visual products retailers such as Dangdang.com, Sohu, and Beijing Books Building.


·

Two effective revenue-driven programs: FAB licensing program and FAB membership program


FAB has established two effective revenue-driven programs: FAB membership program and FAB licensing program. Through revenue sharing agreements between licensees and FAB, they have established over 900 licensing outlets located in office buildings, shopping malls, retail stores, etc. In addition, they have increased their pre-paid customer base by 26% through their membership program. By leveraging the two programs, they have achieved dramatic revenue growth with a high margin.


·

Three well–established and integrated distribution channels: FAB flagship stores, FAB kiosks network, and FAB internet portal


FAB distributes their products and services through three complementary channels: FAB flagship stores, FAB kiosks network and internet portal. FAB kiosks have been proven to be e an effective revenue-generating channel and media platform. Adapting to different deploying environments, different features can be added on to the kiosk, such as, to display commercial and public information, to print commercial vouchers and sales coupons or to process payments of utility bills, etc. Their internet portal enables them to see e-commerce and online contents sales with constant improving features and functionality. By combining the three channels, they are able to achieve cross-sales and improve profitability considerably.  


·

Experienced and highly motivated management team with proven track records and global vision.


FAB’s management team consists of members who are highly experienced in China’s entertainment products industry. Mr. Zhang Hongcheng, founder and Chairman, has over 20 years of experience in the industry. As one of the most famous entrepreneurs in the industry, Mr. Zhang has been elected to be the Chairman of China Anti-Piracy Alliance. Mr. Wang Songshan and Mr. Lei Ming, the president and vice president, have over 30 and 20 years of working experience in the industry, respectively. Management aims to take FAB public in the global financial market and offer ultimate experiences to its customers.


Objective and Growth Strategy


FAB’s objective is to continue to enhance their position as a leading digital entertainment product and service provider in China. They are committed to providing the best products and shopping experiences to their customers through their flagship stores, FAB kiosks network and internet offerings. They intend to achieve this objective by implementing the following strategies:


Get access to each regional market of China by opening one or two FAB flagship stores in the region’s center city, such as, Chengdu, Guangzhou, Shanghai, etc.


FAB intends to expand their operation from Beijing to China’s major regional markets. To implement this, they plan to open to one or two FAB flagship stores in the region’s center city such as, Chengdu, Guangzhou, Shanghai, etc. FAB seeks to capitalize on the opportunities for consolidation in China’s fragmented and inefficient audio-visual industry by selectively exploring opportunities to acquire other audio-visual businesses. The expansion will enable them to expand their product offerings, customer base and distribution network.


Follow with the deployment of FAB kiosks network through FAB licensing program.


Over the past several years, FAB has significantly increased FAB kiosks network through their licensing program. The licensing program has been proven to be an effective method to generate revenue for both licensees and FAB through




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revenue sharing agreements. They will follow the business model in major tier-one and tier- two cities in China. They aim to install 30,000 kiosks across the country by 2015.


·

Expand FAB internet platform


FAB continues to enhance their online distribution platform by making their websites more intuitive and easier to use with more functions. Currently, their internet portal enables customers to buy or rent their audio and video products. FAB will improve their website so that customers will be able to view online contents or stream to their devices. They believe they will benefit from the increasing adoption of internet commerce among consumers by attracting additional customers and migrating existing customers to their websites, thereby lowering operating costs.


·

Improve FAB membership system management and expand their loyal customer base


FAB plans to continue to improve their membership management system to enhance operating efficiency. In addition to members’ names, address and contact information, their updated membership management system will enable them to have more market information, such as customer needs and market trends, as well as providing customized service to their customers. They believe the continuous improvement of their membership management system will allow them to improve services quality and attract more customers.


Enhance FAB brand recognition in the nationwide market


FAB seeks to strengthen consumer awareness of their brand in the nationwide market by pursuing an aggressive marketing strategy based on online and offline marketing strategies, including traditional media advertising, affiliations with government authorities, well-known brands and institutions. They also seek to increase penetration among their target customers by increasing FAB membership card distribution using publications.


Continue to explore new opportunities in digital market by selective acquisitions


Online video viewing has become increasingly popular in China driven by internet technology. FAB intends to expand their operation by entering into online video market. Their website has enabled customers to view trail movies before placing their orders. They expect to aggressively enter into the market by acquisitions of well-established online video providers.


Critical Accounting Policies and Estimates (FAB)


Revenue Recognition - Product revenue is recognized when title to the product has transferred to customers in accordance with the terms of the sale; the sales price to the customer is fixed or determinable, and collectability is reasonably assured. Revenues are recorded net of applicable sales taxes.  FAB derives revenue from retail sales, wholesales of merchandise inventory, and FAB kiosk sales. Revenue from FAB kiosk sales includes download service revenue, membership card revenue, advertisement revenue and licensing revenue.


Revenue from retail sales and wholesales is recognized at the point-of-sale. Download service revenue is recognized when substantially all material services or conditions relating the sales have been performed or satisfied, and FAB has no obligation to refund any payment (cash or otherwise) received. Membership card revenue is amortized over the life of the membership period, membership cards with par value of RMB 100 have an expiration period of three months, and par value of RMB 200, 300, 400 and 500 have an expiration period of twelve months. Advertisement revenue is recognized over the contract period which usually expires within four months. Licensing revenue is amortized ratably over the term of the agreement which is generally five years long.


Accounts Receivable – Accounts receivable consist of balances due from wholesale customers. Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible amounts. FAB does periodical reviews to determine whether the outstanding amounts are collectible. If the collectability of the balances becomes doubtful, an allowance is established for possible uncollectible balances.


Advances to Suppliers - Advances to suppliers represent payments made in advance for goods and services to be received.  FAB makes advances to audiovisual products publishers in order to maintain long-term relationships with the vendor. In addition, FAB is required to pay the FAB kiosks manufacturer in advance.


Inventory - Inventory is recorded at the lower of cost or market, using the first-in, first-out (“FIFO”) method. FAB estimates net realizable value based on current market value and inventory aging analyses. FAB writes down inventories for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventories and their estimated market values based upon certain assumptions about future demand and market conditions. As of September 30, 2011 and 2010, inventory consists of finished goods, and no reserve for slow-moving or obsolete inventory is considered necessary.




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Foreign Currency Translation - FAB principally operates in the PRC and its functional currency is the Chinese currency RMB. The reporting currency of FAB is the US dollar. FAB does not enter into any transactions denominated in foreign currencies. The financial statements of FAB are translated into United States dollars using the year-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses and historical rates for equity. Translation adjustments resulting from translating the local currency financial statements into U.S. dollars are included in comprehensive income. The cumulative translation adjustment was included as an item of accumulated other comprehensive income/ loss) in the shareholders’ equity section of the balance sheet.


Results of Operations


Year Ended September 30, 2011 Compared to Year Ended September 30, 2010


FAB derives its revenue from the sale of culture and audio-visual products, and service revenues.  These revenues are generated via wholesale, retail and FAB kiosks network.  


During 2011, FAB recorded revenues of $70.8M, an increase of approximately 27.5%, from revenues of $55.5M in 2010.  The increase was primarily due to the increase in wholesale business. The retail and FAB kiosks network operation also experienced increased revenue during the year.


Gross profit increased to $24.3M in 2011 from $20.3M in 2010, representing an increase of 19.3%.  The increase in gross profit was primarily due to the expansion of FAB kiosks network operation that has a much higher margin than the flagship stores as well as increased sales in the wholesale business.


Total selling, general and administrative expense for 2011 increased by 5.5% to $5.1M from $4.9M in 2010. However, the selling, general and administrative expenses as a percentage of sales decreased 1.6% from 8.8% in 2010 to 7.2% in 2011.  This decrease was primarily due to FAB being able to scale its business without incurring significant increases in administrative expenses.


FAB recorded comprehensive income of $11.7M and $15.3M in 2010 and 2011, respectively. The net margin improved from 21.1% in 2010 to 21.6% in 2011.


Year Ended September 30, 2010 Compared to Year Ended September 30, 2009


FAB derives its revenue from the sale of culture and audio-visual products, and service revenues.  These revenues are generated via wholesale, retail and FAB kiosks network.  


During 2010, FAB recorded revenues of $55.5M, an increase of approximately 42.5%, from revenues of $39.0M in 2009.  The increase was primarily due to the increase in wholesale and FAB kiosks network operation.


Gross profit increase to $20.3M in 2010 from $11.4M in 2009, representing an increase of 78%.  The increase in gross profit was primarily due to the expansion of FAB kiosks network operation that had a much higher margin than the flagship stores.


Total selling, general and administrative expense for 2010 decreased by 8.3% to $4.9M from $5.3M in 2009. However, the selling, general and administrative expenses as a percentage of sales decrease 4.8% from 13.6% in 2009 to 8.8% in 2010.  This decrease was primarily due to a slower growth rate of expense than total revenue, allowing FAB to scale its business without incurring substantial increases in administrative expenses.


FAB recorded comprehensive income of $4.7M and $11.7M in 2009 and 2010, respectively. The net margin improved from 12.2% in 2009 to 21.1% in 2010.


Liquidity and Capital Resources


2011 compared to 2010


Current assets at September 30, 2011 included $13.4M in cash and accounts receivable, an increase of $7.3M from cash and accounts receivable of $6.1M at September 30, 2010.


During fiscal 2011, operating activities provided net cash of $21.7M, as compared to $6.1M in net cash provided by operating activities during 2010.  The net cash provided by operating activities was driven by net income of $14.7M and deferred revenue of $11.0M related to FAB membership cards, and offset by loan receivables of $7.0M.





39




Net cash used in investing activities increased to $6.5M in 2011, versus $2.1M in 2010.  During 2011, FAB purchased $12.1M of property and equipment, offset by repayment of advances to suppliers of $6.9M.  During 2010, FAB made repayments of short-term loans totaling $2.1M.


In 2011, net cash used in financing activities increased to $11.5M, from $3.3M in 2010.  For 2011, FAB made a cash dividend payment of $13.2M versus $5.6M in 2010.  FAB also repaid short-term loans of $4.6M during 2011.  During 2011, FAB received cash from short-term loans of $6.1M versus $4.4M in 2010.

 

At September 30, 2011, FAB had negative working capital of $7.4M, as compared to negative working capital of $2.1M at September 30, 2010.  Driving the negative working capital is $14.9M of deferred revenue for 2011 and $3.5M for 2010.  Deferred revenue was recorded as it relates to the sale of FAB membership cards that have a life of 3 months or 12 months, and 5c kiosks license revenue which is amortized ratably over the term of the agreement which is generally five years long.


2010 compared to 2009


Current assets at September 30, 2010 included $6.1M in cash and accounts receivable, a slight increase from cash and accounts receivable of $6.0M at September 30, 2009.


During fiscal 2010, operating activities provided net cash of $6.1M, as compared to $3.2M in net cash provided by operating activities during 2009.  The net cash provided by operating activities was driven by net income of $11.6M offset by advance to suppliers of $6.8M.


Net cash used in investing activities increased to $2.1M in 2010.  During 2010, FAB made repayments of short-term loans totaling $2.1M.  During 2009, FAB purchased $20K of property and equipment.  


In 2010, net cash used in financing activities increased to $3.3M, from $3.0M in 2009.  For 2010, FAB made a cash dividend payment of $5.6M versus $1.0M in 2009.  FAB also repaid related party loans of $2.9M in 2010 versus $2.3M in 2009.  During 2010, FAB received cash from short-term loans of $4.4M.


At September 30, 2010, FAB had negative working capital of $2.1M, as compared to negative working capital of $1.2M at September 30, 2009.  Driving the negative working capital is $3.5M of deferred revenue for 2010 and $2.2M for 2009.  Deferred revenue was recorded as it relates to the sale of FAB membership cards that have a life of 3 months or 12 month, and 5c kiosks license revenue which is amortized ratably over the term of the agreement which is generally five years long.





40




FAB CONSOLIDATED FINANCIAL STATEMENTS


[fourthrevisedpreliminary_005.gif]


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Shareholder

Digital Entertainment International Limited


We have audited the accompanying consolidated balance sheets of Digital Entertainment International Limited (the “Company”) as of September 30, 2011 and 2010, and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity, 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 consolidated 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 audit 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 the Company as of September 30, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.


/s/Friedman LLP


January 19, 2012

Marlton, New Jersey






41




DIGITAL ENTERTAINMENT INTERNATIONAL LIMITED

CONSOLIDATED BALANCE SHEET

(IN US DOLLARS)


 

September 30

 

2011

2010

 

 

 

Cash

8,401,778

4,395,565

Accounts receivable, net

5,044,078

1,716,523

Advances to suppliers, net

1,357,986

3,672,116

Loan receivable

7,581,005

0

Inventory

3,250,698

3,815,190

Deferred tax asset, current

1,087,070

842,150

Other current assets

141,550

991,303

Total current assets

26,864,165

15,432,847

 

 

 

Property, plant and equipment, net

15,164,534

1,675,077

Deferred tax asset, noncurrent

1,059,393

55,932

Long-term deposits

3,796,504

2,558,660

Long-term advances to suppliers

0

6,791,095

Total assets

46,884,596

26,513,611

 

 

 

Accounts payable

5,644,217

3,689,665

Short-term bank loans

6,265,370

4,483,528

Accrued expenses

1,716,730

883,218

Deferred revenue

14,927,957

3,471,431

Taxes payable

2,202,375

1,818,064

Due to related parties

27,112

665,008

Other payables

1,860,729

318,765

Dividend payable

1,613,333

2,153,588

Total current liabilities

34,257,823

17,483,264

 

 

 

Long-term deposits from customers

2,210,109

1,484,048

Long-term payables

140,971

0

Total Liabilities

36,608,903

18,967,312

 

 

 

Common Stock, $0.13 par value, 10,000 shares authorized and 100 shares issued and outstanding at September, 30, 2011

13

0

Additional paid-in-capital

430,555

263,651

Statutory reserve

131,825

131,825

Accumulated other comprehensive income

706,945

99,221

Retained earnings

9,006,355

7,051,602

Total shareholders’ equity

10,275,693

7,546,299

 

 

 

Total liabilities & shareholder’s equity

46,884,596

26,513,611


See notes to consolidated financial statements





42




DIGITAL ENTERTAINMENT INTERNATIONAL LIMITED

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(IN US DOLLARS)



 

Year Ended September 30,

 

2011

 

2010

 

 

 

 

Total revenues

$    70,852,332

 

$      55,520,738

 

 

 

 

Cost of revenues

46,592,658

 

35,191,894

 

 

 

 

Gross profit

24,259,674

 

20,328,844

 

 

 

 

Selling, general and administrative expenses

5,127,130

 

4,860,659

 

 

 

 

Income from operations

19,132,544

 

15,468,185

 

 

 

 

Other income (expenses)

 

 

 

Interest expense

(185,046)

 

(48,868)

Subsidy income

69,960

 

369,944

Other income

40,726

 

58,760

Total other income (expenses)

(74,360)

 

379,836

 

 

 

 

Income before income taxes

19,058,184

 

15,848,021

 

 

 

 

Provision for income taxes

4,332,747

 

4,275,291

 

 

 

 

Net income

14,725,437

 

11,572,730

 

 

 

 

Other comprehensive income

 

 

 

Foreign currency translation gain

607,724

 

140,490

 

 

 

 

Comprehensive income

$  15,333,161

 

$      11,713,220


See notes to consolidated financial statements





43




DIGITAL ENTERTAINMENT INTERNATIONAL LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(IN US DOLLARS)

YEARS ENDED SEPTEMBER 30, 2011 AND 2010


 

Common Shares

 

Retained earnings

Accumulated

 

 

Number of Shares

Amount

Additional Paid in Capital

Statutory Reserve

Unrestricted

Other Comprehensive Income

Total

 

 

 

 

 

 

Balance, at September 30, 2009

           0

$             0

$       263,651

$    131,825

$ 2,839,725

  $   (41,269)

$ 3,193,932

 

 

 

 

 

 

 

 

Net income

0

0

0

0

11,572,731

0

11,572,731

Dividends declared

0

0

0

0

(7,360,854)

0

(7,360,854)

Foreign currency translation gain

0

0

0

0

0

140,490

140,490

Balance, at September 30, 2010

0

0

263,651

131,825

7,051,602

99,211

7,546,299

 

 

 

 

 

 

 

 

Issuance of common shares

100

13

166,904

0

0

0

166,917

Net income

0

0

0

0

14,725,437

0

14,725,437

Dividends declared

0

0

0

0

(12,770,684)

0

(12,770,684)

Foreign currency translation gain

0

0

0

0

0

607,724

607,724

Balance, at September 30, 2011

100

$          13

$      430,555

$     131,825

$ 9,006,355

$   706,945

$10,275,693

 

 

 

 

 

 

 

 


See notes to consolidated financial statements





44




DIGITAL ENTERTAINMENT INTERNATIONAL LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN US DOLLARS)


 

September 30

 

2011

2010

Cash flows from operating activities

 

 

Net Income

14,725,437

11,572,730

Adjustments to reconcile net income to net cash provided by operating activities

 

 

Depreciation and amortization

620,184

375,543

Provision for (recovery of) doubtful accounts

(975,036)

98,816

Loss on uncollectible rent deposit

118,915

0

Loss on disposal of leasehold improvement

346,770

0

Deferred tax benefit

(1,177,008)

(137,284)

Change in operating asset and liabilities

 

 

Accounts receivable

(2,647,512)

268,179

Loan receivable

(6,713,672)

0

Inventory

712,322

(1,282)

Advances to suppliers

2,885,783

(6,842,079)

Other current assets

67,576

(899,175)

Deferred revenue

11,025,449

1,163,501

Accounts payable

1,735,615

330,301

Taxes payable

289,980

658,856

Accrued expenses

772,546

203,739

Other payable

(38,771)

(667,753)

Net cash provided by operating activities

21,748,578

6,124,092

 

 

 

Cash flows from investing activities

 

 

Repayment of long-term advances to suppliers

6,950,928

0

Payments on construction in progress

(229,453)

0

Purchase of property and equipment

(12,147,224)

(13,890)

Payments for long-term deposits

(1,088,770)

(2,094,724)

Net cash provided by investing activities

(6,514,519

(2,108,614)

 

 

 

Cash flows from financing activities

 

 

Net proceeds from capital contributions

166,917

0

Proceeds from short-term loan

6,1187,734

4,404,093

Proceeds from long-term customer deposits

639,408

820,629

Repayment of related parties loans

(654,183)

(2,939,002)

Repayment of short-term loans

(4,589,051)

0

Dividend paid

(13,209,582)

(5,583,068)

Net cash provided by investing activities

(11,527,757)

(3,297,348)

 

 

 

Effect of exchange rate change on cash

299,911

85,514

 

 

 

Net increase in cash

4,006,213

803,644

Cash, beginning of year

4,395,565

3,591,921

Cash, end of year

8,401,778

4,395,565

 

 

 

Supplemental cash flow disclosure

 

 

Income taxes paid

5,457,796

4,195,695

Interest paid

339,152

85,033

 

 

 

Noncash investing transactions:

 

 

Obligation payable on acquisition of property and equipment

1,685,398

0


See notes to consolidated financial statements





45




DIGITAL ENTERTAINMENT INTERNATIONAL LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1 - ORGANIZATION AND BASIS OF PRESENTATION

Organization

The accompanying consolidated financial statements include the financial statements of Digital Entertainment International Limited (“Digital HK”, or the “Company”); its wholly owned subsidiary, Beijing Dingtai Guanqun Culture Co., Ltd. (“DGC”); Beijing FAB Cultural Media Co., Ltd. (“FAB Media”) and Beijing FAB Digital Entertainment Products Co., Ltd. (“FAB Digital”), which are variable interest entities (“VIEs”) of DGC; and subsidiary of FAB Digital, Beijing Jing Lvtong Travel and Science Technology Co., Ltd. (“JLTST”).


The Company, through its wholly owned subsidiary and its VIEs, is engaged in marketing and distributing various officially licensed digital entertainment products under the “FAB” brand throughout the PRC, including but not limited to audiovisual products such as Compact Discs, Video Compact Discs and Digital Video Disks as well as books, magazines, mobile phone accessories and cameras. The Company’s products and services are primarily distributed through its flagship stores, proprietary “FAB” kiosks and online virtual stores. FAB kiosks, located in high-traffic areas of office buildings, shopping malls, retails stores and airports, are self-service terminals that provide a range of entertainment and business applications.


Digital HK was incorporated under the laws of Hong Kong Special Administrative Region of the People’s Republic of China (“PRC”) in November 2010. It was 85% owned by Universal Entertainment Group Limited (“UEG”), and 15% owned by Eon Capital International Inc. (“ECI”). In June, 2011, ECI agreed to transfer its 15% ownership of Digital HK to UEG at HK$1.00 per share. As of September 30, 2011, Digital HK is wholly owned by UEG.


Digital HK is a holding company and conducts its business through its wholly owned subsidiary, DGC, which is a wholly foreign-owned enterprise (“WFOE”) with limited liability incorporated in the PRC in March 2011. DGC has entered into a series of contractual agreements with the owners of FAB Digital and FAB Media.


FAB Digital was incorporated as a private enterprise in the PRC in September 2003 with a registered capital of 1 million Renminbi (“RMB”). FAB Digital specializes in the distribution of cultural and audio visual products through its two flagship stores in Beijing as well as its online stores. JLTST, which is fully owned by FAB Digital, was incorporated in the PRC in November 2010 with a registered capital of RMB 1 million.


FAB Media was incorporated as a private enterprise in the PRC in April 2008 with a registered capital of RMB 1 million.). FAB Media is primarily engaged in operating and providing proprietary multimedia kiosks for music downloads, information exchange and advertising.


In February and March 2011, a series of contractual arrangements were entered into among DGC, FAB Digital, FAB Media and its individual shareholders. Such arrangements include an Exclusive Service Agreement, a Share Pledge Agreement, an Option Agreement and a Voting Right Proxy Agreement.


Pursuant to these agreements, DGC has the exclusive right to provide to FAB Digital and FAB Media consulting services related to business operation and management. The key terms of these agreements include:

1)

DGC has the sole discretion to make all operating and business decisions for FAB Digital andFAB Media on behalf of the equity owners, including business operations, policies and management, approving all matters requiring shareholder approval;

2)

FAB Digital and FAB Media have agreed to pay all of the operating costs incurred by DGC, and intended to transfer 100% of the income earned to DGC; DGC also has the right to determine the amount of the fees it will receive;

3)

During the term of these agreements, DGC will retain the rights to the intellectual properties if they are created by DGC;

4)

FAB Digital and FAB Media may not enter into any other agreements with any third party to receive consulting service without the prior consent of DGC;

5)

The equity owners pledge their respective equity interests in the FAB Digital and FAB Media as a guarantee for the payment of technical and consulting services fees under the Exclusive Service Agreement;

6)

 The shareholders of FAB Digital and FAB Media have irrecoverably and unconditionally granted DGC or its designee an exclusive option to purchase, to the extent permitted by PRC laws, all or any portion of equity interest of the FAB Digital and FAB Media.


All these contractual agreements obligate DGC to absorb a majority of the risk of loss from FAB Digital and FAB Media’s activities and entitle DGC to receive a majority of its residual returns. In essence, DGC has gained effective control over both FAB Digital and FAB Media. Based on these contractual arrangements, the Company believes that both FAB Digital and FAB Media should be considered as variable interest entities (“VIEs”) under the FASB Accounting Standards Codification (“ASC”) 810, “Consolidation”. Accordingly, management believes that the accounts of these two entities should be consolidated with those of DGC, the primary beneficiary.





46




Digital HK is effectively controlled by the majority shareholders of FAB Digital and FAB Media. Digital HK has 100% equity interest in DGC. Accordingly, DGC, FAB Digital and FAB Media are effectively controlled by the same majority shareholders.


Therefore, DGC, FAB Digital and FAB Media are considered under common control. The consolidation of DGC, FAB Digital and FAB Media has been accounted for at historical cost and prepared on the basis as if the aforementioned exclusive contractual agreements between DGC and FAB Digital and FAB Media had become effective as of the beginning of the first period presented in the accompanying consolidated financial statements.


2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America (“U. S. GAAP”).


Principles of Consolidation

The consolidated financial statements include the financial statements of Digital HK, DGC, FAB Digital, FAB Media and JLTST. All intercompany transactions and balances have been eliminated upon consolidation.


Use of Estimates

The preparation of consolidated financial statements in conformity with U. S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of property and equipment; the allowance for doubtful accounts; the realization of deferred tax assets, the valuation of inventories, land use right and property, plant and equipment; and accruals for income tax uncertainties and other contingencies when applicable. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.


Risks and Uncertainties

The Company is subject to substantial risks from, among other things, intense competition associated with the industry in general, other risks associated with financing, liquidity requirements, rapidly changing customer requirements, limited operating history, and foreign currency exchange rates.


The Company has significant operating risk in the PRC. The operating results of the Company may be adversely affected by changes in the political and social conditions in the PRC and by changes in Chinese government policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. The Company can give no assurance that those changes in political and other conditions will not result in a material adverse effect upon the Company’s business and financial condition.


Cash

For purposes of the statement of cash flows, the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.


Accounts Receivable

Accounts receivable consist of balances due from wholesale customers. Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible amounts. The Company does periodical reviews to determine whether the outstanding amounts are collectible. If the collectability of the balances becomes doubtful, an allowance is established for possible uncollectible balances.


Advances to Suppliers

Advances to suppliers represent payments made in advance for goods and services to be received. The Company makes advances to audiovisual products publishers in order to maintain long-term relationships with the vendor. In addition, the Company is required to pay the FAB kiosks manufacturer in advance.


Inventory

Inventory is recorded at the lower of cost or market, using the first-in, first-out (“FIFO”) method. The Company estimates net realizable value based on current market value and inventory aging analyses. The Company writes down inventories for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventories and their estimated market values based upon certain assumptions about future demand and market conditions. As of September 30, 2011 and 2010, inventory consists of finished goods, and no reserve for slow-moving or obsolete inventory is considered necessary.





47




Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation and amortization is calculated on the straight-line method over the estimated useful lives of the assets as set out below:


 

Estimated Useful Life

Electronic equipment

5 years

Office furniture and equipment

5 years

Vehicles

5 years

Building

50 years

Leasehold improvements

Shorter of lease terms or estimated useful life


Revenue Recognition

Product revenue is recognized when title to the product has transferred to customers in accordance with the terms of the sale; the sales price to the customer is fixed or determinable, and collectability is reasonably assured. Revenues are recorded net of applicable sales taxes.


The Company derives revenue from retail sales, wholesales of merchandise inventory, and FAB kiosk sales. Revenue from FAB kiosk sales includes download service revenue, membership card revenue, advertisement revenue and licensing revenue.


Revenue from retail sales and wholesales is recognized at the point-of-sale. Download service revenue is recognized when substantially all material services or conditions relating the sales have been performed or satisfied, and the Company has no obligation to refund any payment (cash or otherwise) received. Membership card revenue is amortized over the life of the membership period, membership cards with par value of RMB 100 have an expiration period of three months, and par value of RMB 200, 300, 400 and 500 have an expiration period of twelve months. Advertisement revenue is recognized over the contract period which usually expires within four months. Licensing revenue is amortized ratably over the term of the agreement which is generally five years long.


Cost of Revenues

Cost of revenues consists primarily of costs associated with purchasing, receiving, shipping, inspecting and warehousing products.


Selling, General and Administrative (“SG&A”) Expenses

Included in SG&A expenses are payroll and related costs, store operating costs, occupancy charges, professional and service fees, general operating and overhead expenses and depreciation charges.


Foreign Currency Translation

The Company principally operates in the PRC and its functional currency is the Chinese currency RMB. The reporting currency of the Company is the US dollar. The Company does not enter into any transactions denominated in foreign currencies. The financial statements of the Company are translated into United States dollars using the year-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses and historical rates for equity. Translation adjustments resulting from translating the local currency financial statements into U.S. dollars are included in comprehensive income. The cumulative translation adjustment was included as an item of accumulated other comprehensive income/(loss) in the shareholders’ equity section of the balance sheet.


Comprehensive Income

The Company has adopted ASC 220, “Comprehensive Income”, which establishes standards for reporting and displaying comprehensive income, its components, and accumulated balances in a full-set of general-purpose financial statements. The Company’s accumulated other comprehensive income represents the accumulated balance of foreign currency translation adjustments.


Fair Value of Financial Instruments

ASC 820, “Fair Value Measurement”, defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures.


Fair Value of Financial Instruments

ASC 820, “Fair Value Measurement”, defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures.


The three levels are defined as follows:


Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.




48




Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liabilities, either directly or indirectly, for substantially the full term of the financial instruments.

Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value.


Estimated fair values of the financial instruments were not materially different from their carrying values as presented on the balance sheet. This is attributed to the short maturities of the instruments and that interest rates on the borrowings approximate those that would have been available for loans of similar remaining maturity and risk profile at respective balance sheet dates. The carrying amounts of short-term loans approximate their fair values because the applicable interest rates approximate current market rates.


As of September 30, 2011 and 2010, the Company's financial instruments include cash, accounts receivable, advances to suppliers, inventory, loan receivable, short-term bank loans, accounts payable, deposits from customer, deferred revenues, accrued expenses, taxes payable, dividends payable and due to related parties. The fair values of these financial instruments approximate their carrying amounts due from/to their short-term nature. The carrying value of long-term deposits, advances and payables approximates fair value based on their terms, which represent those available to the Company for similar instruments.


Income Taxes

The Company is subject to the Income Tax Laws of the PRC. It did not generate any taxable income outside of the PRC for the years ended September 30, 2011 and 2010. The Company accounts for income taxes in accordance with ASC 740, “Income Taxes”. ASC 740 requires an asset and liability approach for financial accounting and reporting for income taxes and allows recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain. The components of deferred tax assets are individually classified as current and non-current based on their characteristics.


ASC 740-10-25 prescribes a more-likely-than-not threshold for consolidated financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return. It also provides guidance on the recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, years open for tax examination, accounting for income taxes in interim periods and income tax disclosures. There are no material uncertain tax positions as of September 30, 2011 and 2010, respectively. All tax returns since inception are subject to examination by tax authorities.


Value Added Taxes

The Company is subject to a value added tax (“VAT”) for selling merchandise. The applicable VAT rate is 17% for products sold in the PRC. The amount of VAT liability is determined by applying the applicable tax rate to the invoiced amount of goods sold (output VAT) less VAT paid on purchases made with the relevant supporting invoices (input VAT). Under the commercial practice of the PRC, the Company pays VAT based on tax invoices issued. The tax invoices may be issued subsequent to the date on which revenue is recognized, and there may be a considerable delay between the date on which the revenue is recognized and the date on which the tax invoice is issued. In the event that the PRC tax authorities dispute the date on which revenue is recognized for tax purposes, the PRC tax office has the right to assess a penalty based on the amount of the taxes which are determined to be late or deficient, and will be expensed in the period if and when a determination is made by the tax authorities that a penalty is due.


Recent Accounting Pronouncements

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. ASU 2011-04 expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively. This guidance will be effective for the Company beginning January 1, 2012. The Company anticipates that the adoption of this standard will not materially affect its consolidated financial statements.


In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”. ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statements of changes in equity. ASU 2011-05 requires that all non-owner changes in shareholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is to be applied retrospectively. This guidance will be effective for the Company beginning January 1, 2012. The Company anticipates that the adoption of this standard will not change the presentation of its consolidated financial statements.


3 - ADVANCES TO SUPPLIERS


Advances to suppliers as of September 30, 2011 and 2010 consist of the following:




49







 

September 30,

 

2011

 

2010

Advances to suppliers

$

1,359,564

 

$

10,907,735

Allowance for doubtful accounts

 

(1,578)

 

 

(444,524)

Advances to suppliers, net

 

1,357,986

 

 

10,463,211

Current portion

 

(1,357,986)

 

 

(3,672,116)

Advances to suppliers - long-term

$

-

 

$

6,791,095


The Company reviews the advances to suppliers periodically to determine whether the carrying value has become impaired. The Company considers the assets to be impaired if facts and circumstances indicate that the collectability of the services or materials become doubtful. The Company uses the aging method to estimate the allowance for uncollectible balances. Historically if the Company cannot receive goods within 270 days, the possibility of collectability is rare. As a result, the company’s policy is to provide 100% allowance.


The valuation allowance is adjusted to the amount computed as a result of the aging method. Whenever facts subsequently become available to indicate that the allowance provided requires an adjustment, then the adjustment will be classified as a change in estimate. The allowances of doubtful accounts were $1,578 and $444,524 for the years ended September 30, 2011 and 2010, respectively. During the year ended September 30, 2011, the Company recovered $ 453,445 of previously reserved doubtful account balances.


The long-term advances to suppliers consist mainly of a prepayment to Beijing Yide Real Estate Development Co., LTD (“YIDE”) for land purchase and building construction. In May 2011, the contract with YIDE was terminated, and the prepayment was fully refunded.


4 - ACCOUNTS RECEIVABLE


Accounts receivable as of September 30, 2011 and 2010 consist of the following:

 

September 30,

 

2011

 

2010

Accounts receivable

$

5,044,078

 

$

2,226,120

Allowance for doubtful accounts

 

-

 

 

(509,597)

Accounts receivable, net

$

5,044,078

 

$

1,716,523


Currently, the Company grants credit to customers with well-established credit history with a term of six to twelve months while the Company generally requests other customers to pay either in advance or upon delivery. For past due receivables, the Company usually provides full provision. During the year ended September 30, 2011, the Company recovered $ 521,591 of previously reserved doubtful account balances.


5 - PROPERTY AND EQUIPMENT


Property and equipment and their related accumulated depreciation are as follows:

 

September 30,

 

2011

 

2010

Electronic equipment

$

1,207,738

 

$

809,390

Office furniture and equipment

 

114,389

 

 

93,653

Vehicles

 

56,094

 

 

53,521

Building

 

12,530,739

 

 

-

Leasehold improvements

 

2,752,229

 

 

1,764,783

 

 

16,661,189

 

 

2,721,347

Less: Accumulated depreciation

 

(1,731,606)

 

 

(1,046,270)

 

 

14,929,583

 

 

1,675,077

Construction in process

 

234,951

 

 

-

Total property, plant and equipment, net

$

15,164,534

 

$

1,675,077


In April 2011, the Company purchased a building for $12,237,468 (RMB 80,000,000). As of the date of this report, the Company has not received the related property ownership certificate and the land use right certificate. Management of the Company estimate these certificates will be obtained in the first half of 2012, and the building is used for operations since April 2011. As a result, depreciation expense on the building has been recorded.


Construction-in-progress included leasehold improvements in progress at a newly leased location for a new flagship store. This new store is currently under remodeling and is not in operation. No depreciation is provided for construction-in-progress until the assets are placed into service. Depreciation expense for the years ended September 30, 2011 and 2010 was $620,184 and $375,543, respectively.





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6 - LONG-TERM DEPOSITS


Deposits include no-piracy sales guaranty deposits made to product licensors by FAB Digital and rent deposits made to landlords. The deposits for no-piracy sales guaranties are fully refundable when FAB Digital decides to terminate the license agreements with the licensors to sell their products. The rent deposits are also fully refundable at the end of the lease term.


7 - LOANS RECEIVABLE


Loans receivable consists of the following:

 

September 30,

 

2011

 

2010

Beijing Yirun Baiyuan Trading Co., Ltd.

$

6,312,360

 

$

-

Beijing Long Xingtang Advertising Co., Ltd.

 

1,268,645

 

 

-

Total loan receivable

$

7,581,005

 

$

-


In 2011, the Company entered into various loan arrangements providing credit lines to unrelated third parties with no maximum borrowing levels and a maximum term of six months plus options to renew. Interest is at 10% per annum. The interest receivables imputed on the outstanding loan receivable were $121,266 and $0 for the year ended September 30, 2011 and 2010, respectively.


8 - SHORT-TERM BANK LOANS


Short-term bank loans consist of the following:

 

September 30,

 

2011

 

2010

Loan from China Development Bank

$

4,699,027

 

$

4,483,528

Loan from China Merchants Bank

 

1,566,343

 

 

-

Total short-term bank loans

$

6,265,370

 

$

4,483,528


Short-term bank loans are primarily used for working capital needs. On March 23, 2011, FAB Digital entered into a new loan agreement with China Merchants Bank (“CMB”) for a one-year term loan (due March 31, 2012) in the amount of RMB 10,000,000 (approximately $1.5 million).


The loan has a variable interest rate based on the one year benchmark rates of similar loans published by the People’s Bank of China plus 30 basis points, adjustable on a monthly basis. The loan was guaranteed and collateralized by the video product copyrights of FAB Digital, and the software copyrights and personal house property owned by the Chief Executive Officer.


The loan from China Development Bank (“CDB”) had a one-year term due May 24, 2011 which was fully repaid. On June 10, 2011, FAB Digital entered into another loan agreement with CDB for a one-year term loan due June 14, 2012 in the amount of RMB 30,000,000 (approximately $4.7 million). The loan has a variable interest rate based on the one year benchmark rates of similar loans published by the People’s Bank of China plus 10 basis points, adjustable on a monthly basis. In connection with the loan agreement, the major shareholders of the FAB Digital entered into a share pledge agreement with Beijing Medium and Small Business Credit Guarantee Company (“CGC”) in which 100% of their respective equity interest in the Company is collateralized, as well as the copyright and trademark of FAB Digital, and the personal house property owned by the Chief Finance Officer. Accordingly, CGC provides commercial guaranty to the loan from CDB.


9 - RELATED-PARTY TRANSACTIONS


The table below sets forth the related parties and their affiliation with the Company:


                  Related Parties

Affiliation with the Company

Hongxiang Audio & Video Products Co., Ltd.

Affiliated Company controlled by

Mr. Zhang Hongcheng

Guangdong Endless Culture Co., Ltd.

Affiliated Company controlled by

Mr. Zhang Hongcheng





51




Amounts due to related parties are as follows:

 

September 30,

 

2011

 

2010

Loans from related parties

 

 

 

Hongxiang Audio & Video Products Co., Ltd.

$

-

 

$

29,890

Guangdong Endless Culture Co., Ltd.

 

27,112

 

 

635,118

Total due to related parties

$

27,112

 

$

665,008


From time to time, employees of the related parties may perform certain business functions for the Company and vise versa. For the year ended September 30, 2011 and 2010, Guangdong Endless Culture Co., Ltd. (“GEC”) paid $101,633 and $38,268, respectively to the employees of the Company as compensation expenses for services rendered to GEC and not included in the Company’s consolidated financial statements. The Company paid $79,221 and $50,381, respectively to the employees of GEC as compensation for services rendered to the Company. The amounts are included in the Company’s consolidated financial statements.


The Company has eight business locations, and two of them are subleased from GEC. In March 2008, GEC entered into a lease agreement with Xidan Joy City on behalf of FAB Media for a term of eight-year from April 2008 to March 2016. Subsequently, FAB Media entered into a sublease agreement with GEC. The average monthly rent expense is $47,420. FAB Media paid the rental and promotion expense to Xidan Joy City directly.


In May 2011, GEC entered into another lease agreement with Guoson Mall on behalf of FAB Digital for a term of five-year period from May 2011 to August 2016. The average monthly rent expense is $ 66,169; the promotion expense and property management fees are $ 1,361 and $ 20,004 per month respectively. FAB Digital paid the rental and promotion expense to Guoson Mall directly.


Future minimum annual rental payments due for Xidan Joy city and Guoson Mall are as follows:


Fiscal Year

Rental Commitments

2012

$1,658,252

2013

1,658,252

2014

1,658,252

2015

1,658,252

2016

1,187,650

Total

$7,820,658


10 - CASH DIVIDENDS


In February 2010, the Board of Directors of both FAB Media and FAB Digital declared and approved a total of $7,360,854 (RMB 50,141,000) cash dividends to their shareholders. $5,583,068 (RMB 38,031,000) and $2,197,429 (RMB 14,410,000) were paid in 2010 and 2011, respectively.


In March, 2011, the Board of Directors of FAB Digital declared and approved and declared a total of $5,670,417 (RMB 37,245,000) cash dividends to its shareholders according to their relative percentage, of which $5,728,082 (RMB 37,245,000) was subsequently paid.


In September, 2011, the Board of Directors of FAB Media also declared and approved and declared a total of $7,050,960 (RMB 45,000,000) cash dividends to their shareholders, of which $5,429,269 (RMB 34,700,000) was subsequently paid.


11 - STATUTORY RESERVE


The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after-tax net income.


Such appropriation may cease if the balance of the fund is equal to 50% of the entities’ registered capital or shareholders’ equity. The Company has reserved $131,825 at both September 30, 2011 and 2010 since the amount has reached the statutory limit of 50% of the registered capital.


12 - INCOME TAXES


The Company was incorporated in Hong Kong in November 2010, and did not earn any income that was derived in Hong Kong for the years ended September 30, 2011 and 2010 and therefore was not subject to Hong Kong income tax.





52




DGC, FAB Digital and JLTST were organized under the laws of the People’s Republic of China (“PRC”) which are subject to Enterprise Income Tax (“EIT”) on the taxable income as reported in their respective statutory financial statements adjusted in accordance with the Enterprise Income Tax Law. Pursuant to the PRC Income Tax Laws, DGC, FAB Digital and JLT are subject to EIT at a statutory rate of 25%.  FAB Media was qualified as a High and New Technology Enterprise in Beijing High-Tech Zone in December 24, 2010, and was entitled to a preferential tax rate of 15% for three years from January 2011 to December 2013.


The Company files income tax returns with both the National Tax Bureau and the Local Tax Bureaus in the PRC. All tax returns of the Company since inception are subject to tax examination by tax authorities.


The Company recognized a deferred tax asset in the amount of $ 2,146,463 and $ 898,082 at September 30, 2011 and 2010, respectively. Deferred tax assets represent deductible temporary differences arising from deferred revenue and the allowance for doubtful accounts. The components of deferred tax assets are as follows:

 

September 30,

 

2011

 

2010

Deferred tax assets

 

 

 

Allowance for doubtful accounts

$

395

 

$

238,530

Deferred revenue

 

2,146,068

 

 

659,552

Total deferred tax assets

$

2,146,463

 

$

898,082


Classification on consolidated balance sheets

- Deferred tax assets, current

$

1,087,070

$

842,150

- Deferred tax assets, non-current

 

1,059,393

 

55,932


Income tax expense (benefit) consists of:

 

Year Ended September 30,

 

2011

 

2010

Current income tax

$

5,509,755

 

$

4,412,575

Deferred income tax benefit

 

(1,177,008)

 

 

(137,284)

 

$

4,332,747

 

$

4,275,291


The following table reconciles PRC statutory rates to the Company’s effective tax rate for the years ended September 30, 2011 and 2010:


 

2011

2010

Statutory income tax rate

25%

25%

Exemption rendered by local tax authorities

-5%

0%

Nondeductible expenses – permanent differences

3%

2%

Effective tax rate

23%

27%


Taxes payable consist of the following as of September 30, 2011 and 2010:


 

September 30,

 

2011

 

2010

VAT payable

$

484,187

 

$

339,807

Income tax payable

 

1,183,157

 

 

1,077,996

Business tax payable

 

385,294

 

 

314,107

Other

 

149,737

 

 

86,151

Total taxes payable

$

2,202,375

 

$

1,818,061


13 - SUBSIDY INCOME


As an incentive for cultural creative industry development, FAB Media received a special grant for a carton project from Finance Bureau of Eastern District of Beijing, amounting to $69,960 as subsidy income for the year ended September 30, 2011.


As an incentive for selling genuine entertainment products, the Company received a special grant from the Management Committee of Yonghe Garden, Eastern District of Beijing, amounting to $369,944 as subsidy income for the year ended September 30, 2010.


14 - LEASE AND RENTAL COMMITMENTS


The Company conducts all of its retail sales and corporate operations in leased facilities. Rent expense under non-cancellable operating leases for the Company’s flagship stores and warehouses was as follows:





53







 

Year Ended September 30,

 

2011

 

2010

FAB Media

$

650,825

 

$

1,065,244

FAB Digitial

 

1,286,631

 

 

1,029,600

Total rent expense

$

1,937,456

 

$

2,094,844


The Company recognizes fixed minimum rent expense on non-cancellable leases on a straight-line basis over the term of leases, and records the difference between the rental expense paid and the amounts due under the leases as a rent liability or asset. Rent liability in the amount of $1,716,730 and $159,784 at September 30, 2011 and 2010, respectively, is included in accrued expenses.


Future minimum annual rental payments due under these non-cancellable operating leases are as follows:


Fiscal Year

Rental Commitments

2012

$1,862,666

2013

1,709,355

2014

1,658,252

2015

1,658,252

2016

1,187,650

Total

$8,076,175


15 – CONCENTRATIONS


Major Customers and Suppliers

For the years ended September 30, 2011 and 2010, no individual customer accounted for more than 10% of the total revenues, no single customer accounted for more than 10% of total outstanding accounts receivable.


For the year ended September 30, 2011, no individual suppliers accounted for more than 10% of the Company’s purchases, no single vendor accounted for more than 10% of total outstanding accounts payable. For the year ended September 30, 2010, four vendors accounted for 48% of the Company’s total purchases, individually accounting for 15%, 13%, 10% and 10%. Two vendors accounted for 24% of the total outstanding accounts payable, individually accounting for 13% and 11%.


16 - SEGMENT INFORMATION


ASC 280, “Segment Reporting”, establishes standards for reporting information about operating segments on a basis consistent with the Company's internal organizational structure as well as information about geographical areas, business segments and major customers in financial statements for details on the Company's business segments.


The Company is engaged in distribution of digital entertainment products and services. The Company's chief operating decision maker (“CODM”) has been identified as the CEO who reviews the financial information of separate operating segments when making decisions about allocating resources and assessing performance of the group. Based on management's assessment, the

Company has determined that it has three operating segments which are wholesale, retail and FAB kiosks.


The following table present summary information by segment for the years ended September 30, 2011 and 2010, respectively:


 

Year Ended September 30, 2011

 

Wholesale Retail


FAB

Revenue from Kiosks


Consolidated

Revenues

$44,745,502

$9,731,922

$16,374,908

$70,852,332

Cost of revenues

37,027,596

7,261,104

2,303,958

46,592,658

Gross profit

7,717,906

2,470,818

14,070,950

24,259,674

Depreciation and Amortization

155,491

404,204

60,489

620,184

Total capital expenditures

7,712,006

2,977,182

3,143,434

13,832,622

Total assets

23,991,074

13,560,563

9,332,959

46,884,596




54





 

Year Ended September 30, 2010

 

Wholesale Retail


FAB

Revenue from Kiosks


Consolidated

Revenues

$31,937,150

$7,822,811

$15,760,777

$55,520,738

Cost of revenues

25,549,720

5,354,537

4,287,637

35,191,894

Gross profit

6,387,430

2,468,274

11,473,140

20,328,844

Depreciation and Amortization

236,217

101,021

38,305

375,543

Total capital expenditures

8,737

3,736

1,417

13,890

Total assets

16,677,061

7,132,161

2,704,389

26,513,611


17- CONTINGENCY


In August 9, 2011, Wizzard Software Corporation (“WSC”), a Colorado corporation, executed a Memorandum of Understanding with Digital HK to acquire 100% of the outstanding shares of Digital HK. In return for 100% of the outstanding shares of Digital HK, Wizzard will issue 49% of its outstanding shares at the time of the closing to Digital HK and two new seats on the Board of Directors. The transaction, which is expected to close in February 2012, is subject to substantial due diligence, approvals by each company’s shareholders, the satisfaction of customary closing conditions and regulatory approvals both in the U.S. and China. As of the date of this report, due diligence is approaching the completion stage.


The Labor Contract Law of the People’s Republic of China requires employers to assure the liability of the severance payments if employees are terminated and have been working for the employers for at least two years prior to January 1, 2008. The employers will be liable for one month for severance pay for each year of the service provided by the employees. Based on management estimate, the probability of payment is remote.


In April 2010, FAB Media filed suit against Beijing Times Square Development Company in the Beijing Xicheng District People’s Court, alleging breach of contract of an agreement entered into with the defendants in 2008 and seeking damages of $281,942 (RMB1,800,000). As of the date of the report, the lawsuit remains pending.


18 - SUBSEQUENT EVENTS


On December 27, 2011, Mr. Wang Gang and Mr. Zhang Hongcheng entered into a share transfer agreement. Pursuant to the agreement, Mr. Wang Gang, one of the major shareholders of FAB Media, agreed to transfer his 60% equity interest of FAB Media to Mr. Zhang Hongcheng. As of the date of this report, Mr. Zhang Hongcheng and Mr. Ma Jiliang are the owners of FAB Media, with the percentage of ownership of 60% and 40%, respectively.


These consolidated financial statements were approved by management and available for issuance on January 19, 2012. In accordance with ASC 855, the Company evaluated subsequent events through the date these consolidated financial statements were issued.


THE SPIN-OFF


As a condition to the Closing of the Agreement, the Company is to complete the “spin-off” of its home healthcare operations through a special dividend to its stockholders as a separate public corporation.  The Agreement provides that UEG shall not be deemed a stockholder of the Company for purposes of the spin-off and shall not be entitled to participate therein.  The spin-off will be subject to the prior approval of Proposal 3 of this Proxy Statement, and the Company’s Board of Directors will set a record date for determining which stockholders are eligible to participate in the spin-off , which record date will be prior to the date of the Closing of the Agreement.   Only stockholders of record as of the spin-off record date will be entitled to participate in the spin-off.  


Our home healthcare operations are conducted by our wholly-owned subsidiary Interim Healthcare of Wyoming, Inc., a Wyoming corporation (“Interim”).  Interim operates principally in the home healthcare and healthcare staffing services industries in Wyoming and Montana.  We acquired all of Interim’s issued and outstanding shares on September 8, 2005, in a transaction accounted for as a purchase.


The spin-off will be achieved through the distribution of all of Interim’s capital stock to our stockholders of record as of the record dated on a pro rata basis, with each Company stockholder to receive one share of Interim common stock for each share of Wizzard that he/she/it holds on such record date.  Our stockholders will not need to relinquish any shares of Wizzard common stock or provide any other consideration for their shares of Interim.  Immediately after the completion of the spin-off, each of our stockholders will continue to hold both his/her/its shares of Wizzard and an equal number of shares of Interim.  Interim will continue to operate its existing businesses after the completion of the spin-off and the spin-off will not affect the number of outstanding shares of Wizzard or any rights of Wizzard’s stockholders, although it may affect the market price of its common stock.  We expect that approximately 11,500,000 shares of Interim common stock will be distributed to our stockholders in connection with the spin-off, although the actual number of




55




shares to be so distributed will be determined as of the spin-off record date.  No fractional shares will be distributed as part of the spin-off.


The completion of the spin-off will be subject to approval of Proposal 3 at the Annual Meeting and to final approval by the Company’s Board of Directors.  In addition, Interim will need to file a Registration Statement on Form 10 (the “Form 10”) with the SEC and the spin-off will be subject to the prior effectiveness of the Form 10.  The Form 10 will include detailed information about Interim and its financial history, capitalization, the spin-off and related matters.  Our Board of Directors reserves the right to amend, modify or abandon the spin-off at any time before the distribution date of the Interim shares.


Interim Healthcare of Wyoming, Inc., the wholly-owned subsidiary through which the Company conducts its home healthcare operations, has filed a Registration Statement on Form S-1 for the registration of the Interim shares that are to be issued to the Company’s stockholders in connection with the spin-off.  The completion of the spin-off will be subject to the SEC’s declaration of effectiveness of such registration statement, and neither the Company nor Interim can provide any assurance as to when or if this will occur.  In addition, prior to the closing of the Share Exchange Agreement, certain registrations and applications for transfer of intellectual property relating to the business of the PRC entities from Mr. Zhang or its affiliates to the PRC entities under Chinese law must have been submitted or made to the PRC governments.


With the execution of the Agreement, the Company has made a business decision to continue to concentrate its efforts on the media business.  Our Board of Directors believes that the separation of Interim will facilitate this process due to the substantially different focus of its home healthcare operations.  Because each of these businesses is so different from the other, each requires management to pursue significantly different operating and business strategies.  As a result, management and our Board of Directors believe that our home healthcare operations are likely to divide management’s attention from the Company’s focus on media, particularly after the Closing of the Acquisition.  The spin-off will allow our management to concentrate on the media business and will allow management of Interim to concentrate on home healthcare.  Our Board of Directors believes that separate companies may create more long-term value for the stockholders of each corporation than if both the media business and the home healthcare business were conducted through the current combined entity.


There is currently no public market for Interim’s common stock.  Following the completion of the spin-off, we expect that quotations for Interim’s common stock will be available on OTCBB.  We expect that trading of Interim’s shares will commence on or about the distribution date of the Interim shares.  We can not predict that any established public market will develop for Interim’s common stock or what its market price may be.  Nor can we predict what effect, if any, the spin-off may have on the market price for Wizzard’s common stock.


The shares of Interim common stock that are distributed to our stockholders will be freely transferable, with the exception of shares that are received by persons who may be deemed to be “affiliates” under the Securities Act of 1933, as amended (the “1933 Act”).  Persons who may be deemed to be affiliates of Interim after the spin-off will include persons or entities that control, are controlled by, or are under common control with Interim.  These persons will be able to sell their Interim shares only pursuant to an effective registration statement under the 1933 Act or an exemption from the registration requirements of the 1933 Act, such as Section 4(1) thereof or Rule 144 promulgated thereunder.


We intend the spin-off to be a tax-free dividend to our stockholders.  The following is a summary of certain material U.S. federal income tax consequences to Wizzard, the holders of Wizzard’s common stock, Interim and the holders of Interim’s common stock following the spin-off. This summary does not discuss all tax considerations that may be relevant to stockholders in light of their particular circumstances.  Nor does it address the consequences to stockholders subject to special rules under the U.S. federal income tax laws, such as stockholders subject to the alternative minimum tax, tax-exempt entities, non-resident alien individuals, foreign entities, foreign trusts and estates and beneficiaries thereof, stockholders who acquire shares as compensation for services, banks, insurance companies, other financial institutions, traders in securities that use mark-to-market accounting, and dealers in securities or commodities. In addition, this summary does not address any state, local or foreign tax consequences. This summary is based upon provisions of the Internal Revenue Code of 1986, amended (the “Code”), and regulations, rulings and judicial decisions, as of the date hereof. Those authorities may be changed, perhaps retroactively, so as to result in U.S. federal income tax consequences different from those summarized below.


If a partnership (or other entity treated as a partnership) holds Wizzard or Interim common stock, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership. If you are a partner of a partnership holding Wizzard or Interim common stock, you should consult your tax advisors.


All stockholders should consult their own tax advisors concerning the specific tax consequences of the spin-off of Interim common stock to holders of Wizzard common stock in light of their particular circumstances. This summary is not intended to be, nor should it be construed to be, legal or tax advice to any particular investor.





56




Wizzard has not obtained a ruling from the IRS that the spin-off will qualify as a tax-free transaction under Section 355 of the Code and a tax-free reorganization under Section 368(a)(1)(D) of the Code. On the basis of Wizzard’s position and opinion only and assuming that Wizzard common stock is a capital asset in the hands of a Wizzard stockholder on the distribution date:

 

 

 

holders of Wizzard common stock should not recognize any income, gain or loss as a result of the receipt of shares of Interim common stock in the spin-off;

 

 

holders of Wizzard common stock should apportion the tax basis of their Wizzard common stock between such Wizzard common stock and Interim common stock received in the spin-off in proportion to the relative fair market values of such stock at the time of the spin-off;

 

 

the holding period for Interim common stock received in the spin-off by holders of Wizzard common stock should include the period during which such holders held the Wizzard common stock with respect to which the spin-off was made; and

 

 

neither Interim nor Wizzard should recognize gain or loss as a result of the spin-off.

If the distribution were not to qualify as a tax-free spin-off, each Wizzard stockholder receiving shares of Interim common stock in the spin-off would be treated as if such stockholder had received a distribution in an amount equal to the fair market value of Interim common stock received, which would result in (1) a taxable dividend to the extent of such stockholder’s pro rata share of Wizzard’s current and accumulated earnings and profits, (2) a reduction in such stockholder’s basis in Wizzard common stock to the extent the amount received exceeds such stockholder’s share of earnings and profits and (3) a taxable gain to the extent the amount received exceeds the sum of the amount treated as a dividend and the stockholder’s basis in the Wizzard common stock. Any such gain would generally be a capital gain if the Wizzard common stock is held as a capital asset on the distribution date. In addition, Wizzard would recognize a taxable gain to the extent the fair market value of Interim common stock distributed in the spin-off exceeded its tax basis in such common stock.





57





[fourthrevisedpreliminary_006.jpg]

     4397 South Albright Drive, Salt Lake City, UT 84124

    (801) 277-2763 Phone • (801) 277-6509 Fax


REPORT OF INDEPENDENT

REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors

INTERIM HEALTHCARE OF WYOMING, INC.

Pittsburgh, Pennsylvania 15213


We have audited the accompanying balance sheets of Interim Healthcare of Wyoming, Inc. as of December 31, 2011, 2010 and 2009, and the related statements of operations, stockholders' equity and cash flows for the years ended December 31, 2011, 2010 and 2009. 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 standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits 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, and audit of its internal controls over financial reporting for the years ended December 31, 2011, 2010 and 2009.  Our audit included consideration of internal controls 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 controls over financial reporting for the years ended December 31, 2011, 2010 and 2009.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.


In our opinion, based on our audit, the financial statements audited by us present fairly, in all material respects, the financial position of Interim Healthcare of Wyoming, Inc. as of December 31, 2011, 2010 and 2009 and the results of their operations and their cash flows for the years ended December 31, 2011, 2010 and 2009, in conformity with generally accepted accounting principles in the United States of America.



/s/ Gregory & Associates, LLC


May 4, 2012

Salt Lake City, Utah






58




INTERIM HEALTHCARE OF WYOMING, INC.

 BALANCE SHEETS

 

 

December 31, 2011

 

December 31, 2010

 

December 31, 2009

 

Interim Statement of Financial Position

 

 

 

 

 

 

   CURRENT ASSETS:

 

 

 

 

 

 

     Cash

535,145

 

205,907

 

345,814

 

     Accounts receivable

382,137

[1]

281,867

[2]

272,351

[2]

     Prepaid expenses

15,349

 

14,863

 

5,485

 

     Deferred tax asset, current

20,377

 

21,721

 

21,289

 

          Total current assets

953,008

 

524,358

 

644,939

 

 

 

 

 

 

 

 

   PROPERTY AND EQUIPMENT, net

4,275

 

9,599

 

18,875

 

   GOODWILL

1,189,661

 

1,920,486

 

1,920,486

 

   DEFERRED TAX ASSET,  NET

84,587

 

0

 

0

 

               Total assets

2,231,531

 

2,454,443

 

2,584,300

 

 

 

 

 

 

 

 

   CURRENT LIABILITIES:

 

 

 

 

 

 

     Accounts payable

49,976

 

20,477

 

12,660

 

     Accrued expenses

87,209

 

32,175

 

53,608

 

          Total current liabilities

137,185

 

52,652

 

66,268

 

 

 

 

 

 

 

 

DEFERRED TAX LIABILITY, NET

0

 

111,257

 

100,408

 

 

 

 

 

 

 

 

               Total liabilities

137,185

 

163,909

 

166,676

 

 

 

 

 

 

 

 

   STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

     Common stock

1

[3]

1

[3]

1

[3]

     Additional paid-in capital

1,585,190

 

1,433,940

 

1,576,833

 

     Retained Earnings

509,155

 

856,593

 

840,790

 

          Total stockholders' equity

2,094,346

 

2,290,534

 

2,417,624

 

               Total liabilities and stockholders' equity

2,231,531

 

2,454,443

 

2,584,300

 


[1] net of $20,200 allowance

[2] net of $34,200 allowance

[3] $.001 par value, 50,000 shares authorized, 1,000 shares issued and outstanding


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





59




INTERIM HEALTHCARE OF WYOMING, INC.

 STATEMENTS OF OPERATIONS

 

 

Year ended

 

December 31, 2011

 

December 31, 2010

 

December 31, 2009

Interim Statement of Operations

 

 

 

 

 

   REVENUE

 

 

 

 

 

          Total Revenue

3,425,721

 

3,099,090

 

2,904,782

 

 

 

 

 

 

   COST OF GOODS SOLD

 

 

 

 

 

          Total Cost of Goods Sold

2,305,789

 

2,089,811

 

1,979,984

 

 

 

 

 

 

   Gross Profit

1,119,932

 

1,009,279

 

924,798

   OPERATING EXPENSES

 

 

 

 

 

     Selling expenses

61,889

 

61,019

 

62,378

     General and administrative

306,348

 

349,430

 

318,793

     Salaries, wages and related expenses

550,027

 

561,617

 

562,960

     Consulting fees

13,899

 

11,397

 

23,930

     Impairment of goodwill

730,825

 

0

 

0

          Total Operating Expenses

1,662,988

 

983,463

 

968,061

   LOSS FROM OPERATIONS

(543,056)

 

25,816

 

(43,263)

 

 

 

 

 

 

   OTHER INCOME (EXPENSE):

 

 

 

 

 

     Interest income

261

 

440

 

1,741

     Interest expense

(447)

 

(1,297)

 

(86)

     Other income (expense)

1,304

 

1,260

 

938

          Total Other Income (Expense)

1,118

 

403

 

2,593

   INCOME(LOSS) BEFORE INCOME TAXES

(541,938)

 

26,219

 

(40,670)

   CURRENT INCOME TAX EXPENSE (BENEFIT)

0

 

0

 

0

   DEFERRED INCOME TAX EXPENSE (BENEFIT)

(194,500)

 

10,416

 

(13,281)

   NET INCOME(LOSS) AVAILABLE TO COMMON SHAREHOLDERS

(347,438)

 

15,803

 

(27,389)

 

 

 

 

 

 

 

 

 

 

 

 

   BASIC INCOME (LOSS) PER COMMON SHARE

(347.44)

 

15.80

 


(27.39)

   BASIC WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

1,000

 

1,000

 

1,000

   DILUTED INCOME (LOSS) PER COMMON SHARE -

(347.44)

 

15.80

 


(27.39)

   DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

1,000

 

1,000

 

1,000



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




60





INTERIM HEALTHCARE OF WYOMING, INC.

STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31 2011, 2010 AND 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Common Stock

 

Paid In

 

Retained

 

Shares

 

Amount

 

Capital

 

Earnings

Balance at December 31, 2008

1,000

$

1

$

1,955,595

$

868,179

 

 

 

 

 

 

 

 

Distribution to Owner (Parent)

0

 

0

 

(378,762)

 

0

 

 

 

 

 

 

 

 

Net loss for the year ended December 31, 2009

0

 

0

 

0

 

(27,389)

 

 

 

 

 

 

 

 

Balance at December 31, 2009

1,000

$

1

$

1,576,833

$

840,790

 

 

 

 

 

 

 

 

Distribution to Owner (Parent)

0

 

0

 

(142,892)

 

0

 

 

 

 

 

 

 

 

Net income for the year ended December 31, 2010

0

 

0

 

0

 

15,803

 

 

 

 

 

 

 

 

Balance at December 31, 2010

1,000

$

1

$

1,433,941

$

856,593

 

 

 

 

 

 

 

 

Investment by Owner

0

 

0

 

151,249

 

0

 

 

 

 

 

 

 

 

Net loss for the year ended December 31, 2011

0

 

0

 

0

 

(347,438)

 

 

 

 

 

 

 

 

Balance at December 31, 2011

1,000

$

1

$

1,585,190

$

509,155

 

 

 

 

 

 

 

 

 

 

 

 


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

 




61




INTERIM HEALTHCARE OF WYOMING, INC.
STATEMENTS OF CASH FLOWS


 

December 31,

2011

 

December 31, 2010

 

December 31, 2009

Interim Statement of Cash Flows

 

 

 

 

 

   Cash Flows from Operating Activities

 

 

 

 

 

     Net income (loss)

 (347,438)

 

15,803

 

 (27,389)

     Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

 

 

 

          Change in deferred tax assets and liabilities

 (194,500)

 

10,416

 

(13,281)

          Change in allowance for doubtful accounts

 (14,000)

 

0

 

0

          Depreciation and amortization expense

5,325

 

9,275

 

12,682

          Impairment of goodwill

730,825

 

0

 

0

          Change in assets and liabilities:

 

 

 

 

 

               Increase (Decrease) Accounts receivable

 (86,270)

 

 (9,516)

 

256,549

               Increase (Decrease) Prepaid expenses

3,357

 

 (11,696)

 

 (188)

               (Increase) Decrease Accounts payable

29,499

 

7,817

 

 (25,733)

               (Increase) Decrease Accrued expense

55,034

 

 (21,432)

 

 (27,755)

               (Increase) Decrease Deferred revenue

 (3,843)

 

2,318

 

 (24,151)

                    Net Cash Provided by Operating Activities

177,989

 

2,985

 

150,734

 

 

 

 

 

 

   Cash Flows from Investing Activities:

 

 

 

 

 

     Purchase of property & equipment

0

 

0

 

0

                    Net Cash Used in Investing Activities

0

 

0

 

0

 

 

 

 

 

 

   Cash Flows from Financing Activities:

 

 

 

 

 

     Payments (to)/from Wizzard Software

151,249

 

 (142,892)

 

 (378,762)

                    Net Cash Used in Financing Activities

151,249

 

 (142,892)

 

 (378,762)

 

 

 

 

 

 

   Net Increase (Decrease) in Cash

329,238

 

 (139,907)

 

 (228,028)

   Cash at Beginning of Period

205,905

 

345,814

 

573,842

   Cash at End of Period

535,144

 

205,907

 

345,814

   Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

     Cash paid during the periods for:

 

 

 

 

 

          Interest

447

 

1,297

 

86

          Income taxes

0

 

0

 

0

   Supplemental Disclosures of Non-Cash Investing and Financing

     Activities:

   For the Years Ended December 31, 2011, 2010 and 2009

         None


The accompanying notes are an integral part of these financial statements

  




62




INTERIM HEALTHCARE OF WYOMING, INC.

NOTES TO FINANCIAL STATEMENTS


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization – Interim Healthcare of Wyoming, Inc. ["Interim"], a Wyoming corporation and a wholly owned subsidiary of Wizzard Software Corporation, was organized on September 30, 1991.  Interim operates primarily in the home healthcare and healthcare staffing services in Wyoming and Montana.  On September 8, 2005, Wizzard Software Corporation purchased all of the issued and outstanding shares of Interim Healthcare of Wyoming, Inc. ["Interim"], a Wyoming corporation, in a transaction accounted for as a purchase.  On April 3, 2007, Interim purchased the operations of Professional Personnel, Inc., d.b.a., Professional Nursing Personnel Pool [“PNPP”].


Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Management made assumptions and estimates for determining reserve for accounts receivable, obsolete inventory and in determining the impairment of definite life intangible assets and goodwill.  Actual results could differ from those estimated by management.


Reclassification – The financial statements for the period ended prior to December 31, 2011 have been reclassified to conform to the headings and classifications used in the December 31, 2011 financial statements.


Cash and Cash Equivalents – The Company considers all highly liquid investments with an original maturity date of three months or less when purchased to be cash equivalents.  At December 31, 2011, the Company had no cash balances in excess of federally insured limits.


Accounts Receivable - Accounts receivable consist of trade receivables arising in the normal course of business. At December 31, 2011 and 2010, the Company has an allowance for doubtful accounts of $20,200 and $34,200, respectively, which reflects the Company's best estimate of probable losses inherent in the accounts receivable balance. The Company determines the allowance based on known troubled accounts, historical experience, and other currently available evidence. During the years ended December 31, 2011, 2010 and 2009, the Company adjusted the allowance for bad debt by $14,000, $0 and $0, respectively.


Depreciation - Depreciation of property and equipment is provided on the straight-line method over the estimated useful lives.


Leases - The Company accounts for leases in accordance with Accounting Standards Codification (“ASC”) Topic 840, (formerly Statement of Financial Accounting Standards SFAS No. 13 "Accounting for Leases").  Leases that meet one or more of the capital lease criteria of standard are recorded as a capital lease, all other leases are operating leases.


Goodwill and Definite-life intangible assets - The Company accounts for Goodwill and definite-life intangible assets in accordance with the provisions of Statement of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles Goodwill and Other. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of Topic 350.  Impairment losses arising from this impairment test, if any, are included in operating expenses in the period of impairment.  Topic 350 requires that definite intangible assets with estimable useful lives be amortized over their respective estimated useful lives, and reviewed for impairment in accordance with Topic 360, criteria for recognition of an impairment of Long-Lived Assets.


Loss Per Share - The Company computes loss per share in accordance with FASB ASC Topic 260 Earnings Per Share, which requires the Company to present basic earnings per share and diluted earnings per share when the effect is dilutive (see Note 7).


Income Taxes - The Company accounts for income taxes in accordance with FASB ASC Topic 740 Accounting for Income Taxes.  This topic requires an asset and liability approach for accounting for income taxes (see Note 5).


Advertising Costs - Advertising costs are expensed as incurred and amounted to $31,040, $32,703 and $50,199 for the period ending December 31, 2011, 2010 and 2009, respectively.


Fair Value of Financial Instruments - The Company accounts for fair value measurements for financial assets and financial liabilities in accordance with FASB ASC Topic 820. The authoritative guidance, which, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as the exit price, representing the amount that would either be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for




63




considering such assumptions, the guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

Level 1. Observable inputs such as quoted prices in active markets for identical assets or liabilities;

Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.


Unless otherwise disclosed, the fair value of the Company’s financial instruments including cash, accounts receivable, prepaid expenses, accounts payable, and accrued expenses approximates their recorded values due to their short-term maturities.


 Revenue Recognition - Revenue is recognized when earned. The Company's revenue recognition policies are in compliance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topics - The Company recognizes revenue from the providing of healthcare services when the services are provided and collection is probable.. The Company's revenue recognition policies are also in compliance with the Securities and Exchange Commission Staff Accounting Bulletin No. 101 and 104.


Recently Enacted Accounting Standards

In December 2010, the FASB issued Accounting Standards Update No. 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (ASU 2010-28).  ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.  In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist.  ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. 


Other recent accounting pronouncements issued by the FASB did not or are not believed by management to have a material impact on the Company’s present or future financial statements.


NOTE 2 - PROPERTY & EQUIPMENT


The following is a summary of property and equipment at:


 


Life

 

December 31,

2011

 

December 31,

2010

 

December 31,

2009

 

 

 

 

 

 

 

 

Furniture, fixtures and equipment

2-10 yrs

$

89,084

$

89,084

$

89,084

 

 

 

89,084

 

89,084

 

89,084

Less: Accumulated depreciation

 

 

(84,809)

 

(79,485)

 

(70,209)

Property & equipment, net

 

    $

4,275

    $

9,599

    $

18,875


Depreciation expense for the periods ended December 31, 2011, 2010 and 2009 was $5,325, $9,276 and $12,682, respectively.


NOTE 3 - GOODWILL / DEFINITE-LIFE INTANGIBLES ASSETS


Impairment - During 2011, Wizzard Software Corporation the parent of the Company performed its annual test of impairment of goodwill by comparing the net carrying value of the intangible asset with the quoted market prices on the NYSE MKT. The Fair value was estimated using the average closing quoted stock price of Wizzard Software Corporation during the fourth quarter of 2011.  Based upon the results of this analysis, it was determined that the goodwill was impaired. The Company recorded an impairment charge of $730,825 as a result of impairment testing.


Goodwill - The following is a summary of goodwill:

 

For the periods ended

 

 

December 31, 2011

 

December 31, 2010

 

December 31, 2009

 

 

 

 

 

 

 

Goodwill at beginning of period

$

1,920,486

  $

1,920,486

  $

1,920,486

Impairment

 

(730,825)

 

-

 

-

Goodwill at end of period

$

1,189,661

  $

1,920,486

  $

1,920,486





64





Goodwill consists of:

 

December 31,

 

December 31,

 

December 31,

 

 

2011

 

2010

 

2009

Interim Healthcare of Wyoming – Casper

$

585,881

  $

945,795

  $

945,795

Interim Healthcare of Wyoming - Billings

 

603,780

 

974,691

 

974,691

Total Goodwill

$

1,189,661

  $

1,920,486

  $

1,920,486

 

 

 

 

 

 

 


NOTE 4 - CAPITAL STOCK


Common Stock - The Company has authorized 50,000 shares of common stock, $0.001 par value. As of December 31, 2011, 2010 and 2009, 1,000 shares were issued and outstanding.  The Company is a wholly owned subsidiary of Wizzard Software Corporation.


NOTE 5 - INCOME TAXES


The Company accounts for income taxes in accordance with FASB ASC Topic 740, Accounting for Income Taxes which requires the Company to provide a net deferred tax asset or liability equal to the expected future tax benefit or expense of temporary reporting differences between book and tax accounting and any available operating loss or tax credit carryforwards.  At December 31, 2011 and 2010, the total of all deferred tax assets was $104,965 and $21,721, respectively, and the total of the deferred tax liabilities was $0 and $111,256, respectively.  The amount of and ultimate realization of the benefits from the deferred tax assets for income tax purposes is dependent, in part, upon the tax laws in effect, the Company’s future earnings, and other future events. The Company anticipates earnings in the near future and the realization of the benefit of the deferred tax assets.


The components of income tax expense (benefit) from continuing operations for the Years ended December 31, 2011, 2010 and 2009 consist of the following:

 

 

For the Years Ended

 

 

December 31

 

 

2011

 

2010

 

2009

Current tax expense:

 

 

 

 

 

 

Federal

$

0

 $

0

 $

0

State

 

0

 

0

 

0

Current tax expense

 

0

 

0

 

0

 

 

 

 

 

 

 

Deferred tax expense (benefit):

 

 

 

 

 

 

Allowance for doubtful accounts

 

5,072

 

0

 

0

Bonus accrual

 

(3,391)

 

189

 

(55)

Vacation accrual

 

(337)

 

(621)

 

(386)

Goodwill – impaired

 

(264,760)

 

0

 

0

Goodwill – tax amortization

 

46,383

 

46,383

 

46,383

Net operating loss carryforward

 

22,533

 

(35,536)

 

(59,223)

Valuation allowance

 

0

 

0

 

0

Subtotal deferred tax expense/(benefit)

 

(194,500)

 

10,416

 

(13,281)

Income tax expense/(benefit)

$

(194,500)

$

10,416

$

(13,281)

 

 

 

 

 

 

 


Deferred income tax expense/(benefit) results primarily from the reversal of temporary timing differences between tax and financial statement income.


A reconciliation of income tax expense at the federal statutory rate to income tax expense at the company’s effective rate is as follows:  

 

 

 

 

 

For the Years Ended December 31,

 

 

2011

 

2010

 

2009

Current deferred tax assets:

 

 

 

 

 

 

Computed tax at the expected statutory rate

$

(184,259)

$

8,915

$

(13,828)

State and local income taxes, net of federal

 

(11,959)

 

640

 

(817)

Other non-deductible expenses

 

1,718

 

861

 

1,363

Change in valuation allowance

 

0

 

0

 

0

Income tax expense/(benefit)

$

(194,500)

$

10,416

$

(13,281)





65




The temporary differences, tax credits and carryforwards gave rise to the following deferred tax asset December 31, 2011 and 2010:

 

 

December 31,

 

December 31,

 

December 31,

 

 

2011

 

2010

 

2009

Current deferred tax assets (liabilities):

 

 

 

 

 

 

Allowance for doubtful accounts

$

6,950

$

12,021

$

12,021

Bonus accrual

 

5,072

 

1,681

 

1,870

Vacation accrual

 

8,356

 

8,019

 

7,398

Valuation allowance

 

0

 

0

 

0

Total current deferred tax assets (liabilities)

 

20,377

 

21,721

 

21,289

 

 

 

 

 

 

 

Long-term deferred tax assets (liabilities):

 

 

 

 

 

 

Excess of goodwill/intangible assets amortization for tax over book

 

12,362

 

(206,015)

 


(159,631)

Net operating loss carryforward

 

72,226

 

94,759

 

59,223

Valuation allowance

 

0

 

0

 

0

Total long-term deferred tax assets (liabilities)

$

84,588

$

(111,256)

$

(100,408)

Net term deferred tax assets (liabilities)

$

104,965

$

(89,535)

$

(79,119)


At December 31, 2011, the company has loss carryforwards totaling $199,000 that begin to expire in the year 2030.


We file U.S. federal, and U.S. states return, we are generally no longer subject to tax examinations for years prior to 2007 for U.S. federal and U.S. states tax returns.


NOTE 6 - LEASES

          

Operating Lease - The Company leases office space in Casper, Wyoming for $4,750 a month through June 2018.  The Company further leases space in Billings, Montana for of $1,406 a month through February 2014.


The future minimum lease payments for non-cancelable operating leases having remaining terms in excess of one year as of December 31, 2011 are as follows:


Year ending December 31

Lease Payments

2012

73,872

2013

73,872

2014

59,812

2015

57,000

2016

57,000

Thereafter

85,500

Total Minimum Lease Payments

$           407,056


Lease expense charged to operations was $73,872, $61,200 and $61,200 for the periods ended December 31, 2011, 2010 and 2009, respectively.


NOTE 7 – INCOME/(LOSS) PER SHARE


The following data shows the amounts used in computing loss per share and the weighted average number of shares of common stock outstanding for the periods presented for the periods ended:


 

 

December 31, 2011

 

December 31, 2010

 

December 31, 2009

Income/(Loss) from continuing operations available to common stockholders (numerator)

$

(347,438)

$

15,803

$

(27,389)

Income/(Loss) available to common stockholders (numerator)

 

(347,438)

 

15,803

 

(27,389)

Weighted average number of common shares outstanding during the period used in loss per share (denominator)

 

1,000

 

1,000

 

1,000





66




NOTE 8 - CONCENTRATION OF REVENUES


For 2011, 2010 and 2009, Medicare and Medicaid reimbursement was 39%, 44% and 43% of revenue, respectively.


NOTE 9 - SUBSEQUENT EVENTS


Subsequent events have been evaluated through the date and time of this report:





Unaudited pro forma combined consolidated financial information


The following unaudited pro forma combine consolidated balance sheet reflects adjustments to Wizzard’s historical consolidated balance sheet as of March 31, 2012.  Also, the unaudited pro forma combined consolidated statement of income reflects adjustments to Wizzard’s historical consolidated statement of operations for the year ended December 31, 2011, and for the three months ended March 31, 2012, to give effect to:


·

The proposed acquisition of Digital HKCo, per the terms of the Share Exchange Agreement signed on April 5, 2012, and the proposed related issuance of 40,591,000 shares of common stock as if both had occurred on January 1, 2011.

·

The proposed spin-off of Interim Healthcare of Wyoming, Inc., a wholly owned subsidiary of Wizzard, as if both had occurred on January 1, 2011.


The acquisition is treated as purchase transactions and, therefore, the purchase price allocation, which is based upon a preliminary estimate of fair market value of the assets acquired, is subject to change as additional information, including the final determination of the Digital HKCo purchase price, becomes available. The unaudited pro forma combined consolidated statements of operations are not necessarily indicative of Wizzard’s actual results of operations assuming the transaction had been completed on January 1, 2011, nor do they purport to represent Wizzard’s results of operations for the future periods.


The unaudited pro forma combined consolidated financial statements should be read in conjunction with the historical financial statements and related notes of Wizzard appearing in the Annual Report.





67




Unaudited pro forma combined consolidated

balance sheet

As of March 31, 2012


 

Historical

 

 

 

 

 

 

Wizzard

March 31, 2012

Digital HKCo. March 31, 2012

Pro forma adjustments(c)

Pro forma adjustments(a)

Pro forma Combined

Offering adjustments

Pro forma as adjusted

 

 

 

(In thousands, except per share data)

 

 

Cash

978

17,800

477

0

18,301

 

18,301

Accounts receivable, net

809

5,369

567

0

5,611

 

5,611

Inventory

0

3,179

0

0

3,179

 

3,179

Deferred tax asset, current

0

1,226

0

0

1,226

 

1,226

Other current assets

62

368

30

0

400

 

400

Total current assets

1,849

27,942

1,074

0

28,717

 

28,717

 

 

 

 

 

 

 

 

PP&E, net

40

15,382

3

0

15,419

 

15,419

Goodwill and Intangibles

12,674

0

1,190

40,296

51,780

 

51,780

Deferred tax asset, noncurrent

0

2,011

0

0

2,011

 

2,011

Long-term deposits

4

3,585

0

0

3,589

 

3,589

Total assets

14,567

48,920

2,267

40,296

101,516

 

101,516

 

 

 

 

 

 

 

 

Accounts payable

611

4,898

32

0

5,477

 

5,477

Short-term loan

0

4,765

0

0

4,765

 

4,765

Accrued expenses

310

1,970

107

0

2,173

 

2,173

Deferred revenue

27

21,716

(1)

0

21,744

 

21,744

Taxes payable

0

2,527

0

0

2,527

 

2,527

Due to related parties

0

29

0

0

29

 

29

Other payables

0

1,727

0

0

1,727

 

1,727

Total current liabilities

948

37,632

138

0

38,442

 

38,442

 

 

 

 

 

 

 

 

Long-term deposits

0

2,401

0

0

2,401

 

2,401

Long-term payables

0

143

0

0

143

 

143

Total Liabilities

948

40,176

138

0

40,986

 

40,986

 

 

 

 

 

 

 

 

Common Stock

9

0

0

41

(b)            50

 

50

APIC

84,858

430

1,631

56,519

(b)   140,176

 

140,176

Statutory reserve

0

132

0

0

132

 

132

Accum comprehensive income

0

899

0

0

899

 

899

Retained earnings

(71,248)

7,283

498

(16,264)

(b)  (80,727)

 

(80,727)

Total shareholders’ equity

13,619

8,744

2,129

40,296

60,530

 

60,530

 

 

 

 

 

 

 

 

Total liabilities & shareholder’s equity

14,567

48,920

2,267

40,296

101,516

 

101,516






68




Unaudited pro forma combined consolidated

statement of operations

For the three months ended March 31, 2012


 

Historical

 

(d)

(a)

 

 

 

Wizzard

March 31, 2011

Digital HKCo. March 31, 2012

Pro forma adjustments(c)

Pro forma adjustments(e)

Pro forma Combined

Offering adjustments

Pro forma as adjusted

 

 

 

(In thousands, except per share data)

 

 

Total revenues

$    1,856

$      20,857

$       1,008

$       0

$    21,705

 

$  21,705

 

 

 

 

 

 

 

 

Cost of sales

968

12,592

669

0

12,891

 

12,891

Operating expense

1,885

1743

246

379

(d)     3,761

 

3,761

Other income(loss)

0

87

1

0

86

 

86

Income Taxes

0

1,001

0

0

1,007

 

1,001

Foreign Currency gain

0

22

0

0

22

 

22

Comprehensive income(loss)

$  (997)

$      5,630

$          94

$      (379)

$     4,160

 

$     4,160

Earnings (loss) per common share:

 

 

 

 

 

 

 

Basic

$    (0.12)

 

 

 

 

 

$       0.09

Diluted

$    (0.12)

 

 

 

 

 

$       0.09

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

Basic

8,192

 

 

 

40,591

(f)

48,783

Diluted

8,192

 

 

 

40,591

 

 48,783









69




Unaudited pro forma combined consolidated

statement of operations

For the year ended December 31, 2011

 

Historical

 

(d)

(a)

 

 

 

Wizzard December 31, 2011

Digital HKCo. September 30, 2011

Pro forma adjustments(c)

Pro forma adjustments(e)

Pro forma Combined

Offering adjustments

Pro forma as adjusted

 

 

 

(In thousands, except per share data)

 

 

Total revenues

$    6,540

$      70,852

$       3,426

$       5,709

$    79,675

 

$     79,675

 

 

 

 

 

 

 

 

Cost of sales

3,475

46,592

2,306

3,178

50,939

 

 50,939

Operating expense

12,659

5,127

1,663

1,452

(d)     17,575

 

17,575

Other income(loss)

(386)

(74)

1

441

(20)

 

(20)

Income Taxes

0

4,333

0

85

4,418

 

4,418

Foreign currency gain

0

607

0

0

607

 

607

Comprehensive income(loss)

$  (9,980)

$      15,333

$       (542)

$      1,435

7,330

 

$     7,330

Earnings (loss) per common share:

 

 

 

 

 

 

 

Basic

$    (1.31)

 

 

 

 

 

$       0.15

Diluted

$    (1.31)

 

 

 

 

 

$       0.15

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

Basic

7,616

 

 

 

40,591

(f)

48,207

Diluted

7,616

 

 

 

40,591

 

 48,207



Notes to the unaudited pro forma combined

consolidated statement of operations


a.

The pro forma balance sheet assumes the Digital HKCo acquisition occurred on January 1, 2011.  For purposes of the pro forma balance sheet as of March 31, 2012, Digital HKCo’s historical balance sheet as of March 31, 2012 was combined with Wizzard’s historical balance sheet as of March 31, 2012.  The pro forma balance sheet assumes the spin-off of the Home Healthcare (HHC) subsidiary occurred on January 1, 2011.  For purposes of the pro forma balance sheet as of March 31, 2012, the HHC was removed from Wizzard’s historical balance sheet as of March 31, 2012.


b.

The pro forma statement of operations assumes that the Digital HKCo acquisition occurred on January 1, 2011. For purposes of the pro forma statement of operations for the year ended December 31, 2011, Digital HKCo's historical statements of operations for the year ended September 30, 2011 were combined with Wizzard's historical statement of operations for the year ended December 31, 2011.  For purposes of the pro forma statement of operations for the year ended September 30, 2011, the results of operations of Digital HKCo are from October 1, 2010 to September 30, 2011.  For the purposes of the pro forma statement of operations for the three-month period ended March 31, 2012, Digital HKCo's historical statements of operations for the three-month period ended March 31, 2012 were combined with Wizzard's historical statement of operations for the three-month period ended March 31, 2012.


c.

The pro forma statement of operations assumes the spin-off of the Home Healthcare (HHC) subsidiary occurred on January 1, 2011.  For purposes of the pro forma statement of operations for the year ended December 31, 2011, the HHC was removed from Wizzard’s historical statement of operations for the year ended December 31, 2011. For purposes of the pro forma statement of operations for the three months ended March 31, 2012, the HHC was removed from Wizzard’s historical statement of operations for the three months ended March 31, 2012.


d.

The acquisition of Digital HKCo was accounted for by the purchase method of accounting. The adjustments reflect the incremental amortization of  intangible assets resulting from the acquisition of Digital HKCo as if Wizzard owned Digital HKCo as of January 1, 2011:




70





 

 

Year ended

December 31,

2011

(in thousands)

Year ended

December 31,

2011

Depreciation and Amortization of assets

 

 

 

 

Amortization of non-compete – 5 year life

$

600

$

150

Amortization of trade secrets – 15 year life

 

133

 

33

Amortization of intellectual property – 15 year life

 

200

 

50

Amortization of trademark– 15 year life

 

333

 

83

Amortization of customer relationships - 20 year life

 

250

 

63

 

 

 

 

 

 

$

1,516

$

379


e.

Reflects adjustment to reflect the appropriate quarter of Digital HKCo’s historical statement of operations for the year ended September 30, 2011, the results of operations of Digital HKCo are from October 1, 2010 to September 30, 2011.  


 

 

Historical

 

 

 

 

 

Digital HKCo

 

 

 

 

 

Three month ended

 

 

 

 

 

December 31,

 

 

 

 

 

2011

 

2010

 

 

Net

 

 

 

 

 

 

 

 

Total Revenue

$

21,394

$

15,685

 

$

5,709

 

 

 

 

 

 

 

 

Cost of sales

 

13,751

 

10,573

 

 

3,178

Operating expense

 

1,346

 

1,410

 

 

(64)

Other income (loss)

 

523

 

82

 

 

441

Income Taxes

 

1,288

 

1,203

 

 

85

Comprehensive Income

5,532

2,581

 

2,951


f.

Shares anticipated to be issued in connection with acquisition Digital HKCo assumed to be outstanding for entire periods presented.


RISK FACTORS RELATING TO THE ACQUISITION


Consummation of the Acquisition will result in significant dilution to our stockholders.


At the Closing of the Acquisition, our current stockholders will own, in total, only 51% of the Company’s issued and outstanding shares of common stock.  Furthermore, if the shares of Preferred Stock are converted into common stock upon completion of the applicable Corporate Governance Objectives and Revenue Objectives, the current stockholders’ aggregate position in the Company will be reduced to 22%.  As a result, the holdings of the Company’s current stockholders will be significantly diluted.


UEG may acquire a controlling interest in the Company.


Following the Closing of the Agreement, and if the Corporate Governance Objectives and the Revenue Objectives are met, and UEG converts the Preferred Stock into shares of our common stock, it will own 78% of our total issued and outstanding common shares.  If these events occur, this means that UEG will have the right to make key decisions regarding the Company’s future.


The resale of our common stock by UEG may negatively affect the market price of such stock.


Both the Initial Shares and the shares of common stock to be issued upon conversion of the Preferred Stock will be “unregistered” and “restricted” securities within the meaning of Rule 144 of the SEC. In addition, certain of the shares to be issued under the Agreement will have “piggyback” registration rights that will permit the registration for resale of such shares.  Upon the effectiveness of any registration statement relating thereto and/or the expiration of the six-month holding period mandated by Rule 144 (and, with respect to the Lock-up Shares, the expiration of the lock-up period applicable thereto), these shares may be sold into any market that then exists for our shares of common stock.  Such resales may have a significant depressive effect upon the price thereof.





71




There are risks associated with Digital HKCo’s business structure.


Digital HKCo operates its businesses in China through FAB Digital and FAB Media, respectively. The contractual arrangements with FAB Digital and FAB Media and their respective shareholders provide Digital HKCo with effective control over these companies. As a result of these contractual arrangements, Digital HKCo is considered to be the primary beneficiary of FAB Digital and FAB Media and accordingly, Digital HKCo consolidates the results of operations, assets and liabilities of FAB Digital and FAB Media in its financial statements.  While this is the traditional legal structure for foreign corporations to control businesses in China, these contractual arrangements may not be as effective in providing Digital HKCo with control over FAB Digital and FAB Media as direct ownership of these companies. In addition, FAB Digital and FAB Media or their respective shareholders may breach the contractual arrangements. In any such event, Digital HKCo would have to rely on legal remedies under PRC law. These remedies may not always be effective, particularly in light of uncertainties in the PRC legal system.


Each of the VIE Entities is jointly owned by individuals, including Mr. Zhang. Conflicts of interest between these individuals’ role as shareholders of the VIE Entities and their duties to Digital HKCo may arise. In addition, these individuals are also directors and executive officers of the VIE Entities. PRC laws provide that a director or certain member of senior management owes a fiduciary duty to the company he directs or manages. These individuals must therefore act in good faith and in the best interests of the relevant VIE Entities and must not use their respective positions for personal gain. These laws do not require them to consider best interests of Digital HKCo when making decisions as a director or member of management of the relevant VIE Entities. Conflicts may arise between these individuals’ fiduciary duties as directors and officers of the VIE Entities and Digital HKCo.  We cannot assure you that when conflicts of interest arise, these individuals will act in the best interests of the Company or Digital HKCo or those conflicts of interest will be resolved in favor of the Company or Digital HKCo.


In addition, these individuals may breach or cause the VIE Entities to breach or refuse to renew the existing contractual arrangements that allow Digital HKCo to effectively control the VIE Entities and receive economic benefits from them. If the Company cannot resolve any conflicts of interest or disputes between Digital HKCo and the shareholders of the VIE Entities, the Company would have to rely on legal proceedings, which could result in disruption of the business of Digital HKCo, and there would be substantial uncertainty as to the outcome of any such legal proceedings.


UEG has represented that the ownership structure of Digital HKCo is in compliance with all existing PRC laws and regulations, and each of the VIE Contracts is binding and will not result in any violation of PRC laws or regulations currently in effect.  The Company cannot assure you that the PRC regulatory authorities will ultimately take a view that is consistent with UEG’s representation. If Digital HKCo is found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating of income, revoking Digital HKCo’s business licenses or operating licenses, requiring the Company to restructure the relevant ownership structure or operations, and requiring Digital HKCo to discontinue all or any portion of its business. Any of these actions could cause significant disruption to Digital HKCo’s business operations.


The failure of the FAB Companies to implement and maintain an effective system of internal controls may undermine our ability to accurately report our financial results or to prevent fraud.


Upon the Closing of the Agreement, Digital HKCo will become a wholly-owned subsidiary of Wizzard, and it and its subsidiaries will be subject to the Sarbanes-Oxley Act of 2002.  The SEC, as required under Section 404 of the Sarbanes-Oxley Act, has adopted rules requiring public companies to include a report of management on the effectiveness of these companies' internal control over financial reporting in their annual reports.  Our management may conclude that our internal control over financial reporting is not effective due to the failure of the FAB Companies to cure any identified material weakness and control deficiencies. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may not reach the same conclusion or may issue a report that is qualified if it is not satisfied with our internal control over financial reporting or the level at which our controls are documented, designed, operated or reviewed. In addition, during the course of the evaluation, documentation and testing of our internal control over financial reporting, we may identify other material weaknesses and deficiencies on the part of the FAB Companies that we may not be able to remediate in time to meet the deadline imposed by the SEC for compliance with the requirements of Section 404. If our management or our independent registered public accounting firm concludes that our internal control over financial reporting is not effective, the market price of our common stock may be adversely affected due to a loss of investor confidence in the reliability of our reporting process. We will need to incur significant costs and use significant management and other resources to ensure the FAB Companies’ compliance with Section 404 of the Sarbanes-Oxley Act.





72




If the FAB Companies are unable adequately to protect their intellectual property rights, their businesses may be materially adversely affected.


The FAB Companies’ businesses depend heavily on intellectual property.  The protection of intellectual property rights and brands in the PRC may not be as effective as those in the United States or other countries.  The steps that the FAB Companies have taken to protect their intellectual property may not be effective at preventing its misappropriation.  Any litigation that is necessary to protect these rights may require significant expense and time.

 

Changes in the economic and political policies of the PRC could materially and adversely affect the FAB Companies’ business.


Through the VIE Entities, Digital HKCo conducts substantially all of its business operations in the PRC. As a result, its business, financial condition, results of operations and business prospects depend largely on economic and political developments in the PRC. China's economy differs from the economies of most developed countries in many respects, including the amount of government involvement in the economy, the general level of economic development, growth rates and control of foreign exchange and the allocation of resources. Although the economy of the PRC has experienced significant growth in recent decades, this growth has remained uneven across different periods, regions and among various economic sectors. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. It also exercises significant control over China's economic growth through strategically allocating resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. The PRC government’s future actions and policies may materially affect the Chinese economy and may have a material adverse effect on the FAB Companies’ business.

 

Uncertainties relating to the legal system of the PRC may have a material adverse effect on the FAB Companies.


China has not yet developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations continue to evolve and the limited number and non-binding nature of published decisions concerning them, their interpretation and enforcement involves uncertainties. In addition, the Chinese legal system is based partly on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, the FAB Companies may not be aware of their violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.


International operations are subject to additional risks which could harm our business, operating results, and financial condition.


There are risks inherent in doing business internationally including:

·

trade barriers and changes in trade regulations;

·

difficulties in developing, staffing, and simultaneously managing foreign operations as a result of distance, language, and cultural differences;

·

stringent local labor laws and regulations;

·

longer payment cycles;

·

credit risk and higher levels of payment fraud;

·

restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.;

·

political or social unrest, economic instability, repression, or human rights issues;

·

geopolitical events, including acts of war and terrorism;

·

compliance with U.S. laws such as the Foreign Corrupt Practices Act, and local laws prohibiting bribery and corrupt payments to government officials;

·

antitrust and competition regulations;

·

laws, regulations, licensing requirements, and business practices that favor local competitors or prohibit foreign ownership or investments;

·

different employee/employer relationships, existence of workers’ councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions.

·

different or more stringent user protection, content, data protection, privacy and other laws; and

·

risks related to other government regulation or required compliance with local laws.


Fluctuations in foreign currency exchange rates can affect operating results in U.S. dollar terms.


Revenue generated and expenses incurred by international subsidiaries and equity method investees are often denominated in the currencies of the local countries. As a result, consolidated U.S. dollar financial statements are subject




73




to fluctuations due to changes in exchange rates as the financial results of international subsidiaries and equity method investees are translated from local currencies into U.S. dollars.


There are risks inherent to the FAB Companies’ operations that could significantly impact their ability to continue to execute their business plans and/or generate revenues and profits.


Each of the FAB Company’s faces business risks regarding the following:


·

The ability to secure necessary materials to manufacture its products;

·

The ability to secure licenses and distribution rights for many of its copyrighted products;

·

The ability to secure the necessary licenses from the Chinese government to operate a hi-tech business;  

·

The ability to attract and retain highly skilled employees to develop software and hardware for its Kiosk business;

·

Competition with pirated or copyright infringing products and the Companies’ ability to compete effectively on price with illegal content;

·

The FAB Companies rely on large gatherings of people to promote their business and sell music and other products.  The FAB Companies must be able to secure growth gathering permits or their revenues may be negatively impacted.  


The foregoing risks are in addition to the risks identified under the caption “Risk Factors” of our Annual Report on Form 10-K for the calendar year ended December 31, 2011, and you are urged to read such disclosure in its entirety.


The actual total number of shares issued will be based upon the total outstanding shares at the closing date, and whether or not the revenue and corporate governance objectives are achieved by FAB over approximately a 24 month period.


The following table sets forth certain information as of June 11, 2012, regarding the beneficial ownership of our common stock, if the Share Exchange Agreement is approved:

 

 

 

each person (or group of affiliated persons) who, insofar as we have been able to ascertain, beneficially owned more than 5% of the outstanding shares of our common stock;

  

 

each director;

  

 

each named executive; and

  

 

all directors and executive officers as a group.


We relied on information received from each stockholder as to beneficial ownership, including information contained on Schedules 13D and 13G and Forms 3, 4 and 5.  As of June 11, 2012, there were 8,693,826 shares of common stock outstanding.  As of that date, there were options to purchase 86,844 shares of common stock and warrants to purchase 497,738 shares of common stock.  Upon closing of the Share Exchange Agreement, the Company will issue 11,000,000 shares of Wizzard Software common stock.  Those individuals holding 5% or more of the Company’s common stock after this issuance are listed in the table below.


Name and Address of

Beneficial Owner (1)

  

Amount and Nature of

Beneficial Ownership (2)

 

 

Percent of

Class

 

5% Stockholders:

  

 

 

 

 

 

Christopher Spencer, Chief Executive Officer

  

274,995

(3)

 

1.4%

 

Zhang Hongcheng

  

2,000,455

 

 

10.2%

 

 

 

 

Directors:

  

 

 

 

 

 

Douglas Polinsky

  

16,500

(4)

 

*

 

J. Gregory Smith

  

16,500

(4)

 

*

 

Denis Yevstifeyev

  

16,500

(4)

 

*

 

 

 

 

Executive Officers:

  

 

 

 

 

 

John L. Busshaus, Chief Financial Officer

  

70,557

 (3)

 

*

 

All directors and executive officers as a group (6 persons)

  

2,395,507

 

 

12.2%

 

*

Less than 1%

 (1)

The address of each director and officer is c/o Wizzard Software Corporation, 5001 Baum Blvd.  Suite 770, Pittsburgh, Pennsylvania 15213.

 (2)

The persons named in this table have sole voting and investment power with respect to all shares of common stock reflected as beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such person within sixty (60) days from June 1, 2012, and the total outstanding shares used to calculate each beneficial owner’s percentage includes such shares, although such shares are not taken into account in the calculations of the total number of shares or percentage of outstanding shares. Beneficial ownership as reported does not include shares subject to option or conversion that are not exercisable within 60 days of June 1, 2012.

  (3)

Includes 20,834 stock options that are vested or will vest within 60 days of June 1, 2012.

  (4)

Includes 4,000 stock options that are vested or will vest within 60 days of June 1, 2012.


The Board of Directors recommends stockholder approval of the Share Exchange Agreement and the issuance of up to 40,591,000 Shares of the Company’s common stock if all revenue and corporate governance objectives are met.  The Board of Directors believes that it is in Wizzard’s best interests to acquire FAB to be able to continue the development of our products and services to bring value to the shareholders of the Company.

 

 Stockholder Approval

 

The affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the annual meeting and entitled to vote is required to approve the Share Exchange Agreement and the issuance of up to 40,591,000 shares of our common stock if all revenue and corporate governance objectives are met thereunder.

  

If this Proposal No. 3 of this proxy is not approved, then Proposals No. 5 and 6 will not be approved.  


Your Board of Directors unanimously recommends a vote FOR the approval of the Share Exchange Agreement and the issuance of up to 40,591,000 shares of our common stock if all revenue and corporate governance objective are met thereunder.



PROPOSAL NO. 4 - RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS

 

The Audit Committee and the Board have appointed Gregory & Associates LLC, certified public accountants, as auditors to examine the financial statements of Wizzard for fiscal 2012 and to perform other appropriate accounting services and are requesting ratification of such appointment by the stockholders. Gregory & Associates LLC audited our financial statements for the calendar year ended December 31, 2012.


A representative from Gregory & Associates LLC is not expected to attend the 2012 Annual Meeting.


Audit and Non-Audit Fees

 

The following table summarizes the fees paid or payable to Gregory & Associates LLC for services rendered for the fiscal years ended December 31, 2011 and 2010. Audit fees include the cost of our annual audit and our subsidiaries including the costs of quarterly reviews, and SEC filings requiring the consents of our independent auditor. Audit-related fees consisted of due diligence work on a potential acquisition. The Audit Committee approved 100% of the fees for both 2011 and 2010.

 

 

  

Fiscal Year
2011

  

Fiscal Year
2010

Audit fees

  

$

96,608

  

$

83,990

Audit-related fees

  

 

  

 

Tax Fees

  

 

  

 

All other fees

  

 

  

 

 

  

 

 

  

 

 

Total

  

$

96,608

  

$

83,990

 

The Audit Committee is informed of and approves all services that Gregory & Associates LLC provides. The Audit Committee pre-approves the annual audit fee, tax services, and non-routine SEC filing reviews, as well as the fees for all large projects that are expected to cost more than $50,000. In addition, it has pre-approved $100,000 for items that relate to routine accounting consultations related to items such as new accounting pronouncements, routine SEC filings requiring consents, and routine tax consultations. Upon performance of such services, the Audit Committee is informed of and approves the matters to which such consultations relate. Upon approval by the Audit Committee, the amount is added back to the pre-approved $100,000.

 




75




The affirmative vote of the holders of a majority of the stockholders’ shares present in person or represented by proxy at the annual meeting and entitled to vote is required.

 

If stockholders do not ratify the appointment of Gregory & Associates LLC, the adverse vote will be considered a directive to the Audit Committee and the Board to select other auditors for the next fiscal year.

 

Your Board of Directors unanimously recommends a vote FOR ratification of Gregory & Associates LLC as Wizzard’s independent auditors.



PROPOSAL NO. 5 - ELECTION OF TWO ADDITIONAL DIRECTORS PER THE TERMS OF THE SHARE EXCAHNGE AGREEMENT SUBJECT TO APPROVAL OF PROPOSAL NO 3 OF THIS PROXY STATEMENT.


This proposal is subject to the approval of Proposal No. 3 of this Proxy Statement by the Company’s shareholders.  Should the shareholders not approve Proposal No.3, this Proposal No. 5 shall be null and void.


Per Section 8.3 of the Share Exchange Agreement, referenced in Proposal No. 3, the Board of Directors of Wizzard will consist of the four directors serving in such capacity prior to execution date of the Agreement and two new members appointed by the FAB Parties prior to or at the Closing.  The FAB Parties will have the right to designate one of the two individuals as Chairman of the Board of Directors at the Closing for a term no less than two years.  At such time, the current Chairman of the Company’s Board of Directors will resign as the Chairman, but remain as a voting member of the Board of Directors.  Terms for the directors shall be for no less than two years from the execution date of the Agreement, subject to shareholders’ approval. The structure of the board of directors at each level of the FAB Companies shall be the same as that of the Wizzard immediately after the Closing.


The names of the nominees, together with certain information about them, are set forth below:

 

Name

  

Age

  

Position with Wizzard

  

Zhang Hongcheng

 

44

 

Director and Chairman

 

Gu JianFen

  

77

  

Director

  

 

Zhang Hongcheng founded and has served as Chairman of FAB since 2003.  Mr. Zhang also founded Guangzhou Hongxiang Culture Co., Ltd. and in 2002 sold the company to Tom.com.. Mr. Zhang has 20 years experience in publishing and distributing Digital Entertainment products in China.  He has served as the Vice President of Guangdong Association of Entrepreneur and Chairman of Anti-Piracy Alliance of China. Mr. Zhang graduated from China -Europe International Business School with an EMBA degree in 2001.


Gu JianFen is one of the most famous Music Composers in China. Ms. Gu currently serves as the Vice-Chairperson of China Musicians Association, Vice Chairperson of Music Copyright Society of China and Council Member of China International Culture Exchange Center. Ms. Gu graduated from Shenyang Conservatory of Music in 1955.  Ms. Gu has composed more than one hundred musical works, and won the "China Gold Record Award", the "Contemporary Youth Favorite Song" award,  the "Award of the Ministry of Culture", and UNESCO's "Asia-Pacific Region Excellent Music Award".


         Neither Mr. Zhang nor Ms. Gu is a party adverse to Wizzard or any of its subsidiaries or has a material interest adverse to Wizzard or any of its subsidiaries.  There are no family relationships between Mr. Zhang, Ms. Gu and any other director, executive officer or person nominated to become a director or executive officer.   During the past five years, neither Mr. Zhang nor Ms. Gu has held any directorships in any company with a class of securities registered pursuant to Section 12 of the Exchange Act or subject to the requirements of Section 15(d) of such Act or any company registered as an investment company under the Investment Company Act of 1940, as amended.  The Board of Directors has determined that Mr. Zhang will not be an independent director of the Company following his election, but that Ms. Gu will satisfy the independence requirements of NYSE MKT.


        As these individuals have not yet served as a member of the board of directors, there is no information to disclose regarding compensation and compensation committee interlocks.  The new directors will be eligible to participate in the compensation plans and stock option plan to the same extent as the current directors.


During the past 10 years, none of the following matters was applicable to either Mr. Zhang or Ms. Gu:


(1) A petition under the Federal bankruptcy laws or any state insolvency law was filed by or against, or a receiver, fiscal agent or similar officer was appointed by a court for the business or property of such person, or any partnership in which he was a general partner at or within two years before the time of such filing, or any corporation or business association of which he was an executive officer at or within two years before the time of such filing;




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(2) Such person was convicted in a criminal proceeding or is a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses);


(3) Such person was the subject of any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining him from, or otherwise limiting, the following activities:


(i) Acting as a futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, floor broker, leverage transaction merchant, any other person regulated by the Commodity Futures Trading Commission, or an associated person of any of the foregoing, or as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company, or engaging in or continuing any conduct or practice in connection with such activity;


(ii) Engaging in any type of business practice; or


(iii) Engaging in any activity in connection with the purchase or sale of any security or commodity or in connection with any violation of Federal or State securities laws or Federal commodities laws;


(4) Such person was the subject of any order, judgment or decree, not subsequently reversed,

suspended or vacated, of any Federal or State authority barring, suspending or otherwise limiting for more than 60 days the right of such person to engage in any activity described in paragraph (f)(3)(i) of this section, or to be associated with persons engaged in any such activity;


(5) Such person was found by a court of competent jurisdiction in a civil action or by the Commission to have violated any Federal or State securities law, and the judgment in such civil action or finding by the Commission has not been subsequently reversed, suspended, or vacated;


(6) Such person was found by a court of competent jurisdiction in a civil action or by the Commodity Futures Trading Commission to have violated any Federal commodities law, and the judgment in such civil action or finding by the Commodity Futures Trading Commission has not been subsequently reversed, suspended or vacated;


(7) Such person was the subject of, or a party to, any Federal or State judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of:


(i) Any Federal or State securities or commodities law or regulation; or


(ii) Any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or


(iii) Any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or


(8) Such person was the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.


Except as indicated below, during the fiscal years ended December 31, 2011 and 2010, there were no transactions, and there are no currently proposed transactions, in which the Company was or is to be a participant and the amount involved exceeds the lesser of $120,000 or one percent of the average of the Company’s total assets at year end for the last two completed fiscal years, and in which either Mr. Zhang or Ms. Gu had or will have a direct or indirect material interest.  Mr. Zhang is the principal stockholder of UEG, which is the sole stockholder of Digital HKCo and which will be entitled to receive all of the common stock and Preferred Stock that Wizzard is to issue under the terms of the Share Exchange Agreement.  We cannot presently estimate the dollar value of the transaction in this regard because:  (i) we will not know the precise number of shares of Wizzard’s common stock to be issued under the Share Exchange Agreement until the Closing thereof; (ii) we cannot accurately predict the market value of our common stock at the Closing; and (iii) all of the common stock and Preferred Stock will be deemed to be “restricted securities” within the meaning of Rule 144 of the SEC, and 50 percent of the Initial Shares will be subject to the terms of a Lock-up Agreement, both of which will justify a substantial discount to the market value of our publicly-traded shares of common stock.


If Proposal No. 3 of this proxy is not approved, this Proposal No. 5 will not be approved.  




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Your Board of Directors unanimously recommends a vote FOR the election of Mr. Zhang and Ms. Gu subject to the approval of Proposal No. 3 of the Proxy



PROPOSAL NO. 6- THE AMENDMENT OF THE COMPANY’S ARTICLES OF INCORPORATION TO CHANGE ITS NAME TO SUCH NAME AS THE COMPANY’S BOARD OF DIRECTORS AND THE FAB PARTIES SHALL DETERMINE, WHICH AMENDMENT SHALL BE SUBJECT TO THE PRIOR CLOSING OF THE SHARE EXCHANGE AGREEMENT.


Under Section 8.2 of the Agreement the Company agreed to change its name to a name to be determined by all parties prior to the Closing, and to request a new symbol from NYSE MKT that is representative of the new name.  The parties have not yet selected such a name, but intend to do so before the Closing.  Subject to approval of this Proposal 6 at the Annual Meeting, immediately following the Closing, the Company will file Articles of Amendment with the Colorado Secretary of State to effectuate this name change.  The parties intend the new name to reflect the business of the Company following the Closing.


If Proposal No. 3 of this proxy is not approved, this Proposal No. 6 will not be approved.  


Your Board of Directors unanimously recommends a vote FOR the amendment of the Company’s Articles of Incorporation to change its name subject to Closing of the Agreement.


YOUR VOTE IS IMPORTANT. WE URGE YOU TO SIGN, DATE AND PROMPTLY RETURN YOUR PROXY CARD SO THAT YOUR SHARES MAY BE VOTED IN ACCORDANCE WITH YOUR WISHES AND THAT THE PRESENCE OF A QUORUM MAY BE ASSURED. THE PROMPT RETURN OF YOUR SIGNED PROXY CARD, REGARDLESS OF THE NUMBER OF SHARES YOU HOLD, WILL AID US IN AVOIDING THE EXPENSE OF ADDITIONAL PROXY SOLICITATIONS. GIVING YOUR PROXY DOES NOT AFFECT YOUR RIGHT TO VOTE IN PERSON AT THE MEETING OR YOUR RIGHT TO RESUBMIT LATER DATED PROXY CARDS.

 

Wizzard Software Corporation

 

By Order of the Board of Directors,

 

/s/ Christopher J. Spencer                

Christopher J. Spencer

Chief Executive Officer




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ANNEX A

WIZZARD SOFTWARE CORPORATION

2012 STOCK OPTION PLAN

 (Subject to Stockholder Approval)


1.

Purpose.  The purpose of the Wizzard Software Corporation 2012 Stock Option Plan is to induce certain designated persons to continue to provide valuable services to Wizzard Software Corporation (the "Company") and to encourage such person to secure or increase on reasonable terms their stock ownership in the Company.  The Board of Directors of the Company believes the Plan is in the best interest of the Company and will promote the success of the Company.  This success will be achieved by encouraging continuity of management and increased incentive and personal interest in the welfare of the Company by those who are primarily responsible for shaping and implementing the long-range plans of the Company.  Certain Options granted under this Plan are intended to be Incentive Stock Options qualified under Section 422 of the Code.  The Plan also permits the grant of Nonqualified Stock Options.


2.

Definitions.  For purposes of this Plan, the following terms shall have the meanings indicated below:


(a)  "Capital Stock" or "Common Stock": any of the Company's authorized but unissued shares of common stock.


(b)  "Code": the Internal Revenue Code of 1986, as amended from time to time.


(c)  "Fair Market Value":  the price per share determined by the Board of Directors at the time any Option is granted.  Fair Market Value of Incentive Stock Options shall be determined consistent with the Code and regulations.


 (d)  "Incentive Stock Option": an option defined in Section 422 of the Code to purchase shares of the Common Stock of the Company.

                                                            

 (e)  "Non-Qualified Stock Option":  an option, not intended to qualify as an Incentive Stock Option as defined in Section 422 of the Code, to purchase Common Stock of the Company.


 (f)  "Option": the term shall refer to a Stock Option granted under this Plan.


 (g)  "Option Agreement": a written agreement pursuant to which the Company grants an Option to an Optionee and sets the terms and conditions of the Option.


 (h)  "Option Date": the date upon which an Option Agreement for an option granted pursuant to this Plan is duly executed by or on behalf of the Company.


(i)  "Option Stock": the Common Stock of the Company (subject to adjustment as described in Section 7) reserved for options pursuant to this Plan, or any other class of stock of the Company which may be substituted therefore by exchange, stock split or otherwise.


(j)  "Optionee":  a person who is eligible to receive an Option under Section 5 of the Plan and to whom an Option has been granted under the Plan.


(k)  "Plan":  this Wizzard Software Corporation 2012 Stock Option Plan effective April 1, 2012, and as amended hereafter from time to time.


(l)  A "Subsidiary":  any corporation in an unbroken chain of corporations beginning with the Company, if, at the time of granting the option, each of the corporations other than the last corporation in the chain owns stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. The term shall include any subsidiaries which become such after adoption of this Plan.


3.

Options Available Under Plan.  An aggregate of 3,000,000 shares of the Company's authorized but unissued shares of Common Stock are hereby made available for grant, and shall be reserved for issuance, under this Plan.  The aggregate number of shares available under this Plan shall be subject to adjustment on the occurrence of any of the events and in the manner set forth in Section 7.  If an Option shall expire or terminate for any reason without having been exercised in full, the unpurchased shares shall (unless the Plan shall have been terminated) become available for other Options under the Plan.


4.

Administration.  The Plan shall be administered by the Board of Directors of the Company.  At all times subject to the authority of the Board of Directors, the Board of Directors may from time to time delegate some or all of its authority under the Plan to a committee consisting of three (3) or more Directors (the "Committee"), and/or obtain assistance or recommendations from such Committee.  If no separate committee is appointed, the Board shall constitute the Committee, and references to the Committee shall include the entire Board of Directors.


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