UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                  FORM 10-QSB/A
                                (AMENDMENT NO. 1)

         (Mark One)
[X]      QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE
         ACT OF 1934

                For the quarterly period ended September 30, 2006

[_]      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

                  For the transition period from _____ to _____


                         COMMISSION FILE NUMBER 0-25675

                              PATRON SYSTEMS, INC.
        (EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)

            DELAWARE                                             74-3055158
(STATE OR OTHER JURISDICTION OF                                (IRS EMPLOYER
 INCORPORATION OR ORGANIZATION)                              IDENTIFICATION NO.)

5775 FLATIRON PARKWAY, SUITE 230 BOULDER, CO                       80301
  (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                       (ZIP CODE)

                                 (303) 541-1005
                           (ISSUER'S TELEPHONE NUMBER)

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [_]

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

State the number of shares outstanding of each of the issuer's classes of common
equity,  as of the latest  practicable  date:  14,462,260 shares of common stock
outstanding as of November 13, 2006.

Transitional Small Business Disclosure Format (Check one): Yes [_] No [X]


<PAGE>


                              PATRON SYSTEMS, INC.

                         FORM 10-QSB/A QUARTERLY REPORT
                       ----------------------------------

                                TABLE OF CONTENTS


PART I - FINANCIAL INFORMATION                                              PAGE

ITEM 1.  FINANCIAL STATEMENTS ...............................................  4

Condensed Consolidated Balance Sheet at September 30, 2006 (unaudited).......  4
Condensed Consolidated Statements of Operations for the Three and
  Nine Months Ended September 30, 2006 (unaudited)...........................  5
Condensed Consolidated Statement of Stockholders' (Deficiency)
  Equity for the Nine Months Ended September 30, 2006 (unaudited)............  6
Condensed Consolidated Statements of Cash Flows for the
  Nine Months Ended September 30, 2006 and September 30, 2005 (unaudited)....  7
Notes to Condensed Consolidated Financial Statements (unaudited).............  8

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS................................. 37


PART II - OTHER INFORMATION

ITEM 6.  EXHIBITS.............................................................51

SIGNATURES................................................................... 52


                                       2
<PAGE>


                                EXPLANATORY NOTE

Patron Systems,  Inc. is filing this Amendment No. 1 to its Quarterly  Report on
Form 10-QSB (the "Form  10-QSB") for the  quarterly  period ended  September 30,
2006 filed with the  Securities  and Exchange  Commission  on November 14, 2006.
This filing amends and restates our previously reported financial statements for
the nine months ended  September  30, 2006 to reflect the  determination  by the
Company that, during the three months ended March 31, 2006, it had recorded 1) a
net loss of $858,213 on the settlement of various liabilities under its creditor
and claimant  liabilities  restructuring  program when it should have recorded a
net gain of approximately $906,987, 2) excess non-cash interest of $358,000 with
respect to a conversion  option that became  effective  under two of its Interim
Bridge Financing III notes and 3) charged,  as interest expense,  a $285,050 fee
paid  to  the  placement  agent  in  its  Series  A  Preferred  stock  financing
transaction  that should  have been  recorded  as a  reduction  of the  offering
proceeds.  For the three months ended June 30, 2006, the Company  recorded a net
gain of $371,616 on the settlement of various liabilities under its creditor and
claimant  liabilities  restructuring  program when it should have recorded a net
gain of  approximately  $965,381.  For the nine months ended September 30, 2006,
the Company recorded a reduction in the net loss of $3,002,015 ($0.61 per share)
and a  corresponding  reduction  in  accumulated  deficit  of  $3,002,015  and a
reduction  of  additional  paid in  capital  of  $3,002,015.  The  nature of the
adjustments  required in the  creditor and  claimant  liabilities  restructuring
relate to an  overvaluation  of the Series A-1  preferred  shares  issued in the
exchange  offer  offset  by  gains on the  extinguishment  of  liabilities  that
originated in connection with obligations to issue or repurchase stock.

This Amendment No. 1 amends and restates the following  items of our Form 10-QSB
as described above: (i) Part I, Item 1 - Financial Statements; (ii) Part I, Item
2 -  Management's  Discussion and Analysis of Result of Operations and Financial
Condition; and (iii) Part II, Item 6 - Exhibits.

All  information in our Form 10-QSB,  as amended by this Amendment No. 1, speaks
as to the date of the  original  filing of our Form  10-QSB for such  period and
does not reflect any  subsequent  information  or events except as noted in this
Amendment No. 1. All information contained in this Amendment No. 1 is subject to
updating and  supplementing as provided in our reports,  as amended,  filed with
the  Securities  and Exchange  Commission  subsequent to the date of the initial
filing of our Form 10-QSB.


                           FORWARD LOOKING STATEMENTS

The following discussion and explanations should be read in conjunction with the
financial  statements  and  related  notes  contained  elsewhere  in  this  Form
10-QSB/A.  Certain  statements  made in  this  discussion  are  "forward-looking
statements" within the meaning of the Private  Securities  Litigation Reform Act
of 1995.  Forward-looking  statements can be identified by  terminology  such as
"may,"  "will,"  "should,"  "expects,"  "intends,"  "anticipates,"   "believes,"
"estimates,"  "predicts,"  or "continue" or the negative of these terms or other
comparable  terminology.  Because  forward-looking  statements involve risks and
uncertainties,  there are important  factors that could cause actual  results to
differ  materially  from those  expressed  or  implied by these  forward-looking
statements.  Although Patron Systems believes that expectations reflected in the
forward-looking  statements are reasonable,  it cannot guarantee future results,
performance  or  achievements.  Moreover,  neither  Patron Systems nor any other
person  assumes  responsibility  for the  accuracy  and  completeness  of  these
forward-looking  statements.  Patron  Systems  is  under no duty to  update  any
forward-looking  statements  after  the  date of this  report  to  conform  such
statements to actual results.


                                       3
<PAGE>


PART I - FINANCIAL INFORMATION

ITEM 1   FINANCIAL STATEMENTS

                      PATRON SYSTEMS, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEET
                                   (unaudited)

                                                             SEPTEMBER 30, 2006
ASSETS                                                          (As Restated)
                                                             ------------------
Current Assets
  Cash ....................................................  $           60,156
  Accounts receivable, net ................................             222,722
  Other current assets ....................................              58,004
                                                             ------------------
     Total current assets .................................             340,882

Property and equipment, net ...............................             193,543
Intangible assets, net ....................................           1,436,767
Goodwill ..................................................           9,510,716
                                                             ------------------
     Total assets .........................................  $       11,481,908
                                                             ==================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
  Accounts payable ........................................  $          659,030
  Accrued payroll and related expenses ....................             551,930
  Accrued interest ........................................             592,179
  Demand note payable .....................................             312,556
  Bridge notes payable ....................................           1,519,975
  Notes payable (to creditors of acquired business,
    including $554,202 to related parties) ................             799,982
  Expense reimbursements due to officers and stockholders .               4,458
  Other current liabilities ...............................             555,043
  Accrued registration rights penalty .....................              90,488
  Deferred revenue ........................................             223,880
                                                             ------------------
     Total current liabilities ............................           5,309,521

Commitments and contingencies

Stockholders' Equity
  Preferred stock, par value $0.01 per share,
    75,000,000 shares authorized, Series A convertible:
    2,160 shares authorized; 964 shares issued and
    outstanding ...........................................                  10
    liquidation preference of $6,334,337
    Series A-1 convertible:  50,000,000 shares authorized;
    no shares outstanding .................................                --
  Common stock, par value $0.01 per share, 150,000,000
    shares authorized, 14,462,260 shares issued
    and outstanding .......................................             144,627
  Additional paid-in capital ..............................          94,466,946
  Deferred compensation ...................................                --
  Accumulated deficit .....................................         (88,439,196)
                                                             ------------------
     Total stockholders' equity ...........................           6,172,387
                                                             ------------------
     Total liabilities and stockholders' equity ...........  $       11,481,908
                                                             ==================

           See notes to condensed consolidated financial statements.


                                       4
<PAGE>

<TABLE>
                      PATRON SYSTEMS, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)
<CAPTION>
                                                           NINE MONTHS ENDED                THREE MONTHS ENDED
                                                             SEPTEMBER 30,                    SEPTEMBER 30,
                                                      ----------------------------    ----------------------------
                                                          2006
                                                      (AS RESTATED)       2005            2006            2005
                                                      ------------    ------------    ------------    ------------
<S>                                                   <C>             <C>             <C>             <C>
Revenue ...........................................   $    857,570    $    184,300    $    276,825    $     93,457
                                                      ------------    ------------    ------------    ------------

Cost of Sales
  Cost of products/services .......................         39,580           2,003           9,683            --
  Amortization of technology ......................         99,980         280,855          44,936         133,124
                                                      ------------    ------------    ------------    ------------
    Total cost of sales ...........................        139,560         282,858          54,619         133,124
                                                      ------------    ------------    ------------    ------------
  Gross profit (loss) .............................        718,010         (98,558)        222,206         (39,667)
                                                      ------------    ------------    ------------    ------------

Operating Expenses
  Salaries and related expenses ...................      3,700,443       2,306,118       1,252,255       1,229,681
  Consulting expense (non-employee stock based
    compensation) .................................           --         1,239,083            --           286,208
  Professional fees ...............................      1,105,500         932,250         219,603         278,867
  General and administrative ......................      1,011,459       1,251,659         389,884         494,173
  Amortization of intangibles .....................         92,440          69,691          30,813          30,814
  Stock based penalties under accomodation
    agreements ....................................           --           745,500            --           118,500
  Stock based penalty under collateralized
    financing arrangement .........................          8,560          78,247           3,314          16,145
  Loss on intrinsic value of put right ............           --          (300,000)           --          (300,000)
  Loss on collateralized financing arrangement ....           --           366,193            --              --
  Loss/(gain) associated with settlement agreements     (2,452,909)       (343,571)       (580,541)         45,532
                                                      ------------    ------------    ------------    ------------
     Total operating expenses .....................      3,465,493       6,345,170       1,315,328       2,199,920

Operating loss ....................................     (2,747,483)     (6,443,728)     (1,093,122)     (2,239,587)

Other Income (Expense)
  Interest income .................................          2,770          19,250             809            --
  Loss on sale of property and equipment ..........           (125)           (544)           --              (544)
  Interest expense ................................     (1,125,449)    (12,355,249)        (64,564)    (10,158,714)
                                                      ------------    ------------    ------------    ------------
     Total other income (expense) .................     (1,122,804)    (12,336,543)        (63,755)    (10,159,258)
                                                      ------------    ------------    ------------    ------------
Loss from continuing operations before income taxes     (3,870,287)    (18,780,271)     (1,156,877)    (12,398,845)

  Income taxes ....................................           --              --              --              --
                                                      ------------    ------------    ------------    ------------
Loss from continuing operations ...................     (3,870,287)    (18,780,271)     (1,156,877)    (12,398,845)
                                                      ------------    ------------    ------------    ------------

Loss from discontinued operations .................       (104,962)     (1,129,751)           --          (278,877)
Loss on disposal of discontinued operations .......        (75,920)           --              --              --
                                                      ------------    ------------    ------------    ------------
                                                          (180,882)     (1,129,751)           --          (278,877)
                                                      ------------    ------------    ------------    ------------

Net loss ..........................................     (4,051,169)    (19,910,022)     (1,156,877)    (12,677,722)

Preferred stock dividend ..........................       (246,968)           --          (122,184)           --
                                                      ------------    ------------    ------------    ------------
Net loss available to common stockholders .........   $ (4,298,137)   $(19,910,022)   $ (1,279,061)   $(12,677,722)
                                                      ============    ============    ============    ============


Net Loss Per Share - Basic and Diluted
  - Continuing operations .........................   $      (0.83)   $      (9.84)   $      (0.12)   $      (6.05)
  - Discontinued operations .......................          (0.04)          (0.59)           --             (0.13)
                                                      ------------    ------------    ------------    ------------
  - Total Net Loss per share available to
      common stockholders .........................   $      (0.87)   $     (10.43)   $      (0.12)   $      (6.18)
                                                      ============    ============    ============    ============

Weighted Average Number of Shares Outstanding
   - Basic and diluted ............................      4,945,846       1,909,483      10,490,543       2,049,970
                                                      ============    ============    ============    ============
</TABLE>

           See notes to condensed consolidated financial statements.


                                       5
<PAGE>


<TABLE>
                      PATRON SYSTEMS, INC. AND SUBSIDIARIES
      CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' (DEFICIENCY) EQUITY
                  FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006
                                   (UNAUDITED)
<CAPTION>
                                                      SHARES OF      PAR VALUE      SHARES OF       PAR VALUE
                                                      SERIES A       SERIES A       SERIES A-1      SERIES A-1      SHARES OF
                                                      PREFERRED      PREFERRED      PREFERRED       PREFERRED        COMMON
                                                        STOCK          STOCK          STOCK           STOCK           STOCK
                                                     ------------   ------------   ------------    ------------    ------------
<S>                                                          <C>    <C>             <C>            <C>               <C>
Balance - December 31, 2005 ......................           --     $       --             --      $       --         1,978,655
Reclassification of deferred
  compensation upon adoption of FAS 123 (R) ......           --             --             --              --              --

Issuance of Series A Preferred Stock to investors             964             10           --              --              --
Issuance of warrants in connection with bridge
  loan extension - extension warrants ............           --             --             --              --              --
Conversion option penalty incurred upon default
  of Bridge Financing III ........................           --             --             --              --              --
Cancellation of stock repurchase obligations
  due to former officer ..........................           --             --             --              --              --
Issuance of Series A-1 Preferred stock in
  settlement of debt .............................           --             --       36,993,054         369,930         (98,626)
Issuance of shares in connection with
  anti-dilution provision ........................           --             --             --              --           251,175
Amortization of deferred compensation ............           --             --             --              --              --
Conversion of Preferred Series A-1 to common stock           --             --      (36,993,054)       (369,930)     12,331,056
Net Loss .........................................           --             --             --              --              --
                                                     ------------   ------------   ------------    ------------    ------------

 BALANCE - SEPTEMBER 30, 2006 (AS RESTATED) ......            964   $         10           --      $       --        14,462,260
                                                     ============   ============   ============    ============    ============
<CAPTION>
                                                                      ADDITIONAL                        COMMON
                                                       PAR VALUE        PAID IN                          STOCK        ACCUMULATED
                                                         COMMON         CAPITAL         DEFERRED       REPURCHASE       DEFICIT
                                                         STOCK       (AS RESTATED)    COMPENSATION     OBLIGATION    (AS RESTATED)
                                                      ------------    ------------    ------------    ------------    ------------
<S>                                                   <C>             <C>             <C>             <C>             <C>
Balance - December 31, 2005 ......................    $     19,787    $ 65,601,272    $     (7,500)   $ (1,300,000)   $(84,388,027)
Reclassification of deferred
  compensation upon adoption of FAS 123 (R) ......            --            (7,500)          7,500            --              --

Issuance of Series A Preferred Stock to investors             --         4,535,440            --              --              --
Issuance of warrants in connection with bridge
  loan extension - extension warrants ............            --            48,129            --              --              --
Conversion option penalty incurred upon default
  of Bridge Financing III ........................            --           192,000            --              --              --
Cancellation of stock repurchase obligations
  due to former officer ..........................            --         1,300,000            --         1,300,000            --
Issuance of Series A-1 Preferred stock in
  settlement of debt .............................            (983)     22,245,869            --              --              --
Issuance of shares in connection with
  anti-dilution provision ........................           2,512          (2,512)           --              --              --
Amortization of deferred compensation ............            --           307,629            --              --              --
Conversion of Preferred Series A-1 to common stock         123,311         246,619            --              --              --
Net Loss .........................................            --              --              --              --        (4,051,169)
                                                      ------------    ------------    ------------    ------------    ------------

 BALANCE - SEPTEMBER 30, 2006 (AS RESTATED) ......    $    144,627    $ 94,466,946    $       --      $       --      $(88,439,196)
                                                      ============    ============    ============    ============    ============
<CAPTION>


                                                           TOTAL
                                                       (AS RESTATED)
                                                        ------------
<S>                                                     <C>
Balance - December 31, 2005 ......................      $(20,066,968)
Reclassification of deferred
  compensation upon adoption of FAS 123 (R) ......            (7,500)

Issuance of Series A Preferred Stock to investors          4,535,450
Issuance of warrants in connection with bridge
  loan extension - extension warrants ............            48,129
Conversion option penalty incurred upon default
  of Bridge Financing III ........................           192,000
Cancellation of stock repurchase obligations
  due to former officer ..........................         2,600,000
Issuance of Series A-1 Preferred stock in
  settlement of debt .............................        22,614,816
Issuance of shares in connection with
  anti-dilution provision ........................              --
Amortization of deferred compensation ............           307,629
Conversion of Preferred Series A-1 to common stock              --
Net Loss .........................................        (4,051,169)
                                                        ------------

 BALANCE - SEPTEMBER 30, 2006 (AS RESTATED) ......      $  6,172,387
                                                        ============

</TABLE>

           See notes to condensed consolidated financial statements.


                                       6
<PAGE>

<TABLE>
                   PATRON SYSTEMS, INC. AND SUBSIDIARIES
              CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (unaudited)
<CAPTION>
                                                                NINE MONTHS ENDED
                                                                   SEPTEMBER 30,
                                                           ----------------------------
                                                               2006            2005
                                                           (As Restated)
                                                           ------------    ------------
<S>                                                        <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES
  Net loss from continuing operations ..................   $ (3,870,287)   $(18,780,271)
                                                           ============    ============
  Adjustments to reconcile net loss to
  net cash used in operating activities:
    Depreciation and amortization ......................        236,845         367,974
    Stock based compensation ...........................        307,629       1,239,083
    Non-cash interest expense ..........................        543,439       1,927,374
    Amortization of deferred financing charges .........           --         1,825,606
    Stock options issued to Chief Executive Officer ....           --            16,000
    Penalty warrants issued to bridge note holders .....           --         8,000,000
    Gain associated with settlement agreements .........     (2,452,909)       (389,103)
    Accrued registration penalty .......................          8,560            --
    Loss on disposition of discontinued operations .....         75,920            --
    Loss on sale of fixed assets .......................            125            --
    Reduction in intrinsic value of put right ..........           --          (300,000)
    Stock based penalty under accomodation agreements ..           --           823,747
    Gain on settlement of consulting agreement payable .           --          (228,900)
    Loss on collateralized financing arrangement .......           --           366,194
    Non-cash increase in notes payable to former officer           --            17,399
    Non-cash interest income ...........................           --           (19,250)
    Changes in assets and liabilities:
      Restricted cash escrowed to settle liabilities
      assumed ..........................................        511,691        (517,003)
      Prepaid expenses .................................           --            51,487
      Accounts receivable ..............................          1,422         (32,634)
      Other current assets .............................         18,636         (95,682)
      Accounts payable .................................       (222,911)       (320,797)
      Accrued interest .................................        581,137          12,202
      Deferred revenue .................................       (108,201)         65,267
      Accrued payroll and payroll related expenses .....         24,366      (1,043,209)
      Other current liabilities ........................       (157,401)        394,267
      Consulting agreements payable ....................           --           (50,000)
      Expense reimbursements due to officers and
      stockholders .....................................        (32,335)        (30,521)
      Loss on sale of property and equipment ...........           --               544
      Other accrued expenses ...........................           --            (3,413)
                                                           ============    ============
  Total adjustments ....................................       (663,987)     12,076,632
                                                           ============    ============
NET CASH USED IN CONTINUING OPERATIONS .................     (4,534,274)     (6,703,639)
                                                           ============    ============
NET CASH USED IN DISCONTINUED OPERATIONS ...............       (197,882)     (1,077,769)
                                                           ------------    ------------
NET CASH USED IN OPERATING ACTIVITIES ..................     (4,732,156)     (7,781,408)
                                                           ------------    ------------

CASH FLOWS USED IN INVESTING ACTIVITIES
  Cash payments in purchase business combinations ......           --          (857,633)
  Cash acquired in purchase business combinations ......           --           406,834
  Purchase and development of technology ...............       (396,428)        (92,547)
  Proceeds from sale of fixed assets ...................          1,755           1,500
  Purchase of fixed assets .............................       (133,559)        (43,608)
                                                           ------------    ------------
NET CASH USED IN CONTINUING
  INVESTING ACTIVITIES .................................       (528,232)       (585,454)
                                                           ============    ============
NET CASH USED IN DISCONTINUED
  INVESTING ACTIVITIES .................................        (78,920)        (14,284)
                                                           ------------    ------------
NET CASH USED IN INVESTING ACTIVITIES ..................       (607,152)       (599,738)
                                                           ------------    ------------

CASH FLOWS FROM FINANCING ACTIVITIES
  Expenses repaid to officers and stockholders .........           --          (273,536)
  Payments on settlement of accommodation agreements ...       (125,000)           --
  Deferred financing costs .............................        (54,000)       (627,739)
  Proceed from issuance of Series A Preferred Stock ....      4,355,451            --
  Repayments of amounts due under settlement with
  former officer .......................................           --          (200,000)
  Proceeds from issuance of bridge notes ...............      1,000,000       7,100,000
  Repayments of notes payable ..........................         (7,001)           --
  Proceeds from disposition of discontinued
  operations ...........................................         50,000            --
  Proceeds received in connection with financing
  settlement ...........................................        180,000            --
  Proceeds from issuance of notes, less fees ...........           --         2,543,000
  Repayments of advances from stockholders .............           --           (32,774)
                                                           ------------    ------------
NET CASH PROVIDED BY CONTINUING
  FINANCING ACTIVITIES .................................      5,399,450       8,508,951
                                                           ============    ============
NET CASH USED BY DISCONTINUED
  FINANCING ACTIVITIES .................................           --           (93,483)
                                                           ------------    ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ..............      5,399,450       8,415,468
                                                           ------------    ------------

NET INCREASE IN CASH ...................................         60,142          34,322

CASH, beginning of period ..............................             14          45,901
                                                           ------------    ------------
CASH, end of period ....................................   $     60,156    $     80,223
                                                           ============    ============

Supplemental Disclosures of Cash Flow
  Information:

Cash paid during the period for:
  Interest .............................................   $    285,091    $    527,231
                                                           ============    ============

Supplemental non-cash investing and finanical
activity
    Current tangible assets acquired ...................   $       --      $    300,911
    Non-current tangible assets acquired ...............                      2,756,470
    Current liabilities assumed with acquisitions ......                     (8,379,271)
    Non-current liabilities assumed with
    acquisitions .......................................                       (439,126)
    Intangible assets acquired .........................                      3,101,000
    Goodwill recognized on purchase business
    combinations .......................................                     22,433,752
    Non-cash consideration .............................                    (19,332,500)
    Cash acquired in purchase business
    combinations .......................................                        416,397
                                                           ------------    ------------
     Cash paid to acquire businesses ...................   $       --      $    857,633
                                                           ============    ============

    Liabilities and claims settled in exchange
      for Series A-1 Preferred Stock ...................   $ 24,467,871
</TABLE>

           See notes to condensed consolidated financial statements.


                                       7
<PAGE>


                      PATRON SYSTEMS, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
                               SEPTEMBER 30, 2006

NOTE 1 - BASIS OF INTERIM FINANCIAL STATEMENT PRESENTATION

The accompanying unaudited Condensed Consolidated Financial Statements of Patron
Systems,  Inc. and subsidiaries (the "Company,"  "Patron," "we," "us," or "our")
have been prepared in accordance with accounting  principles  generally accepted
in the United States for interim  financial  information and the instructions to
Form 10-QSB. Accordingly,  they do not include all the information and footnotes
required by accounting  principles  generally  accepted in the United States for
complete  financial  statements.  In the opinion of management,  all adjustments
(which include only normal  recurring  adjustments)  necessary to present fairly
the financial  position,  results of  operations  and cash flows for all periods
presented  have been made.  The results of operations  for the  three-month  and
nine-month  periods ended September 30, 2006 are not  necessarily  indicative of
the operating  results that may be expected for the entire year ending  December
31, 2006.

This Form 10-QSB/A should be read in conjunction  with the Company's  10-KSB for
the year ended December 31, 2005.


NOTE 2 - THE COMPANY

ORGANIZATION AND DESCRIPTION OF BUSINESS

Patron Systems,  Inc. ("Systems") is a Delaware corporation formed in April 2002
to provide  comprehensive,  end-to-end  information security solutions to global
corporations and government institutions.

Pursuant to an Amended and Restated Share Exchange  Agreement  dated October 11,
2002, Combined  Professional  Services ("CPS"),  Systems and the stockholders of
Systems  consummated a share  exchange  ("Share  Exchange").  As a result of the
Share  Exchange,   the  former  stockholders  of  Systems  became  the  majority
stockholders of CPS. Accordingly,  Systems became the accounting acquirer of CPS
and the exchange was accounted for as a reverse merger and  recapitalization  of
Systems.  CPS  subsequently  merged with  Systems,  with Systems  surviving  the
merger. The combined entity continued to use the name Patron Systems, Inc.

ANNUAL MEETING OF STOCKHOLDERS

On July 20,  2006,  the Company  held its annual  meeting of  stockholders.  The
stockholders approved the election of three directors: Mr. Robert Cross to serve
until the annual meeting of  stockholders  in 2007; Mr. Braden Waverley to serve
until the annual meeting of  stockholders  in 2008; and Mr. George  Middlemas to
serve  until the  annual  meeting of  stockholders  in 2009.  Additionally,  the
stockholders  approved the three other  proposals made as part of the 2006 proxy
statement  including  the  adoption  of the  Patron  Systems,  Inc.  2006  Stock
Incentive  Plan  which  provides  for the grant of up to 5.6  million  shares of
common stock  underlying  stock  options and other awards under the plan and the
approval of an  amendment  to the Second  Amended and  Restated  Certificate  of
Incorporation,  as amended, to provide for a 1-for-30 reverse stock split of the
Company's issued and outstanding common stock.

REVERSE STOCK SPLIT AND AMENDMENT TO CERTIFICATE OF INCORPORATION

On July 20, 2006, the Company's stockholders approved an amendment to its Second
Amended and Restated Certificate of Incorporation,  as amended, to provide for a
1-for-30  reverse  stock  split of our  issued  and  outstanding  Common  Stock.
Effective July 31,2006, the Company's Second Amended and Restated Certificate of
Incorporation,  as amended, to provide for a 1-for-30 reverse stock split of our
issued  and  outstanding  Common  Stock  was  declared   effective.   All  share
information included in the accompanying  financial statements and notes thereto
give retroactive effect to the reverse split.


                                       8
<PAGE>


CONSOLIDATION OF SUBSIDIARIES

Effective   September  19,  2006,  we  merged  our   wholly-owned   subsidiaries
Entelagent,  CSSI and  PILEC  into  our  company  through  the  filing  with the
Secretary of State of the States of Delaware and  California,  a Certificate  of
Ownership  and  Merger  merging   Entelagent   Software   Corp.,  (a  California
corporation),  Complete Security Solutions,  Inc., (a Delaware  corporation) and
PILEC Disbursement Company, (a Delaware corporation) into Patron Systems,  Inc.,
(a Delaware corporation).


NOTE 3 - RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

The Company, while undergoing the audit of its consolidated financial statements
for the year ended December 31, 2006, became aware of possible  misstatements in
its unaudited condensed consolidated interim financial statements filed with the
Securities and Exchange  Commission  during the year ended December 31, 2006. On
March 6, 2007, the Company's Board of Directors  determined that certain amounts
reported in its unaudited condensed  consolidated  interim financial  statements
for the quarters ended March 31, 2006, and June 30, 2006, and for the six months
ended June 30,  2006 and nine  months  ended  September  30,  2006  needed to be
restated as described below.

The specific errors that came to management's  attention relate to the Company's
accounting for certain transactions that occurred during the quarter ended March
31, 2006 and the quarter ended June 30, 2006. Upon review of these transactions,
Company  management  discovered  that  the  accounting  for  these  transactions
resulted in a  $2,408,250  overstatement  of its loss for the  quarterly  period
ended March 31, 2006 and a $593,765  overstatement of its loss for the quarterly
period ended June 30, 2006,  which also resulted in an overstatement of the year
to date  losses  in the six and nine  month  periods  ended  June  30,  2006 and
September 30, 2006, respectively.  For the nine months ended September 30, 2006,
a reduction in the net loss of $3,002,015  ($0.61 per share) and a corresponding
reduction in  accumulated  deficit of  $3,002,015  and a reduction of additional
paid in capital of $3,002,015 was recorded.

Specifically,  the Company  recorded  for the three months ended March 31, 2006,
(1) a net loss of $858,213 on the  settlement of various  liabilities  under its
creditor  and  claimant  liabilities  restructuring  program when it should have
recorded a net gain of approximately  $906,987,  (2) excess non-cash interest of
$358,000 with respect to a conversion  option that became effective under two of
its Interim Bridge Financing III notes and (3) charged,  as interest expense,  a
$285,050  fee paid to the  placement  agent  in its  Series  A  Preferred  stock
financing  transaction  that  should have been  recorded  as a reduction  of the
offering  proceeds.  For the three  months  ended  June 30,  2006,  the  company
recorded a net gain of $371,616 on the settlement of various  liabilities  under
its creditor and claimant liabilities  restructuring program when it should have
recorded a net gain of  approximately  $965,381.  The nature of the  adjustments
required in the creditor and claimant liabilities  restructuring in the quarters
ended March 31, 2006 and June 30, 2006, relate to an overvaluation of the Series
A-1  preferred  shares  issued  in the  exchange  offer  offset  by gains on the
extinguishment  of liabilities that originated in connection with obligations to
issue or repurchase stock.

The effect of the  restatement  on the  Company's  previously  issued  unaudited
condensed consolidated interim financial statements is as follows:

                                                       Nine Months ended
                                                      September 30, 2006
                                                 ------------------------------
                                                 As Previously          As
                                                   Reported          Restated
                                                 ------------      ------------
Loss/(Gain) associated
with settlement agreements .................     $    (93,944)     $ (2,452,909)

Interest expense ...........................     $ (1,768,499)     $ (1,125,449)

Net loss from continuing operations ........     $ (6,872,302)     $ (3,870,287)

Net loss available to common
stockholders ...............................     $ (7,300,152)     $ (4,298,137)

Net loss per share- continuing
operations .................................     $      (1.44)     $      (0.83)

Net loss per share - total .................     $      (1.48)     $      (0.87)

Additional paid in capital .................     $ 97,468,961      $ 94,466,946

Accumulated Deficit ........................     $(91,688,179)     $(88,439,196)


                                       9
<PAGE>


NOTE 4 - LIQUIDITY AND FINANCIAL CONDITION

The  accompanying  financial  statements  have been  prepared  assuming that the
Company will  continue as a going  concern.  The Company  incurred a net loss of
$4,051,169  for the nine months  ended  September  30, 2006,  which  includes an
aggregate of $1,172,518 of non-cash charges including the conversion option cost
for bridge note and subordinated note holders,  non-cash  interest expense,  the
amortization  of deferred  compensation  and the charge for stock  option  based
compensation. These non-cash charges are offset by a non-cash gain of $2,452,909
associated with the settlement of outstanding liabilities, claims and litigation
for Series A-1  Preferred  stock.  The  Company  used net cash in its  operating
activities of $4,732,156  during the nine months ended  September 30, 2006.  The
Company's  working  capital   deficiency  at  September  30,  2006  amounted  to
$4,968,639  and the Company is  continuing  to  experience  shortages in working
capital. The Company is also involved in litigation and is being investigated by
the  Securities  and  Exchange  Commission  with respect to certain of its press
releases  and its use of form S-8 to register  shares of common  stock issued to
certain consultants (Note 16). The Company cannot provide any assurance that the
outcome of these matters will not have a material  adverse affect on its ability
to sustain  the  business.  These  matters  raise  substantial  doubt  about the
Company's  ability to continue as a going concern.  The  accompanying  financial
statements  do not include any  adjustments  that may result from the outcome of
this uncertainty.

The Company expects to continue  incurring losses for the foreseeable future due
to the  inherent  uncertainty  that is related to  establishing  the  commercial
feasibility of technological  products and developing a presence in new markets.
The Company's ability to successfully market its software products, grow revenue
and generate cash flows of certain businesses it acquired in 2005 is critical to
the  realization of its business  plan.  The Company raised  $5,640,501 of gross
proceeds  ($5,301,451  net  proceeds  after the  payment of certain  transaction
expenses) in financing  transactions  during the nine months ended September 30,
2006. The Company used $4,732,156 of these proceeds to fund its operations and a
net of $607,152  in  investing  activities.  On January  12,  2006,  the Company
offered its creditors and claimants an agreement to receive Series A-1 Preferred
Stock,  par value $0.01 per share ("Series A-1  Preferred")  for amounts owed to
the holders of the Company's  indebtedness  (including  lenders,  past-due trade
accounts, and employees, consultants and other service providers with claims for
fees,  wages or expenses)  (Note 17). On July 21, 2006,  the Company's  Board of
Directors  approved the  completion  of the  creditor  and claimant  liabilities
restructuring.  A total of  $24,467,871 of debts,  liabilities  and other claims
were settled by the issuance of Series A-1 Preferred Stock. In addition, through
July 21, 2006, the Company settled  $660,493 in claims for $28,140 in cash and a
$32,500  note.  The Company is currently  unable to provide  assurance  that the
acceptance of the claims  settlement will actually improve the Company's ability
to fund the further development of its business plan or improve its operations.

On July 12,  2006,  the Board of  Directors  ratified,  approved and adopted the
indemnification and escrow agreements that the Company has entered into with its
legal counsel,  Stubbs,  Alderton & Markiles,  LLP.  Accordingly,  cash that was
previously held in escrow for general working  capital  purposes,  including the
repayment of outstanding obligations,  under the Company's merger agreement with
Entelagent and the Series A Preferred Stock Financing documents was used to fund
general operating activities.


                                       10
<PAGE>


The  Company is  currently  in the  process of  attempting  to raise  additional
capital and has taken certain steps to conserve its liquidity while it continues
to integrate the businesses  acquired in 2005. Although management believes that
the  Company  has access to capital  resources,  the Company has not secured any
commitments  for additional  financing at this time nor can the Company  provide
any  assurance  that it will be  successful  in its efforts to raise  additional
capital and/or successfully execute its business plan.


NOTE 5 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated  financial  statements  include the accounts of the Company and
its  wholly-owned  subsidiaries,   Entelagent  Software  Corporation,   Complete
Security Solutions,  Inc. and PILEC Disbursement Company, which were merged into
the Company on September  19, 2006.  The accounts of  LucidLine,  Inc. have been
included in  discontinued  operations  through April 18, 2006, the date on which
LucidLine was sold (Note 20). All significant  inter-company  transactions  have
been eliminated.

CASH

The Company  considers  all highly  liquid  securities  purchased  with original
maturities of three months or less to be cash.

CONCENTRATION OF CREDIT RISK

The Company maintains cash with major financial institutions. Cash is insured by
the  Federal  Deposit  Insurance  Corporation  ("FDIC")  up to  $100,000 at each
institution.  From time to time amounts may exceed the FDIC limits. At September
30,  2006 the  uninsured  bank  cash  balances  were  $0.  The  Company  has not
experienced any losses on these accounts.

REVENUE RECOGNITION

The Company derives revenues from the following  sources:  (1) sales of computer
software,  which includes new software licenses and software updates and product
support  revenues and (2) services,  which  include  internet  access,  back-up,
retrieval and restoration services and professional consulting services.

The Company  applies the revenue  recognition  principles  set forth under AICPA
Statement of Position ("SOP") 97-2 "Software Revenue Recognition" and Securities
and  Exchange   Commission  Staff  Accounting   Bulletin  ("SAB")  104  "Revenue
Recognition"  with  respect to its  revenue.  Accordingly,  the Company  records
revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has
occurred,   (iii)  the  vendor's  fee  is  fixed  or   determinable,   and  (iv)
collectability is reasonably assured.

The Company  generates  revenues  through sales of software  licenses and annual
support subscription  agreements,  which include access to technical support and
software  updates  (if  and  when  available).  Software  license  revenues  are
generated  from  licensing the rights to use products  directly to end-users and
through third party service providers.

Revenues from software license agreements are generally recognized upon delivery
of software to the customer.  All of the Company's  software sales are supported
by a written  contract or other evidence of sale  transaction such as a customer
purchase order.  These forms of evidence  clearly  indicate the selling price to
the  customer,  shipping  terms,  payment  terms  (generally 30 days) and refund
policy,  if any. The selling  prices of these products are fixed at the time the
sale is consummated.

Revenue from post-contract customer support arrangements or undelivered elements
are deferred and  recognized at the time of delivery or over the period in which
the services are performed based on vendor specific  objective  evidence of fair
value for such  undelivered  elements.  Vendor  specific  objective  evidence is
typically  based on the price charged when an element is sold  separately or, if
an element is not sold separately, on the price established by


                                       11
<PAGE>


an  authorized  level of  management,  if it is  probable  that the price,  once
established,  will not change before market  introduction.  The Company uses the
residual  method  prescribed in SOP 98-9,  "Modification  of SOP 97-2,  Software
Revenue Recognition With Respect to Certain Transaction" to allocate revenues to
delivered elements once it has established vendor-specific objective evidence of
fair value for such undelivered elements.

Professional  consulting  services  are  billed  based on the number of hours of
consultant   services  provided  and  the  hourly  billing  rates.  The  Company
recognizes revenue under these arrangements as the service is performed.

BUSINESS COMBINATIONS

In accordance with business  combination  accounting,  the Company allocated the
purchase  price of acquired  companies  to the tangible  and  intangible  assets
acquired,  liabilities  assumed,  as well as in-process research and development
based  on their  estimated  fair  values.  The  Company  engaged  a  third-party
appraisal firm to assist  management in  determining  the fair values of certain
assets acquired and liabilities assumed. Such a valuation requires management to
make  significant   estimates  and  assumptions,   especially  with  respect  to
intangible assets.

Management makes estimates of fair value based upon  assumptions  believed to be
reasonable.  These estimates are based on historical  experience and information
obtained from the management of the acquired  companies.  Critical  estimates in
valuing certain of the intangible  assets include but are not limited to: future
expected  cash  flows  from  license  sales,  maintenance  agreements,  customer
contracts and acquired  developed  technologies;  expected  costs to develop the
in-process  research and development  into  commercially  viable  products;  the
acquired  company's brand awareness and market position,  as well as assumptions
about the  period of time the  acquired  brand will  continue  to be used in the
combined  company's product  portfolio;  and discount rates. These estimates are
inherently  uncertain  and  unpredictable.  Assumptions  may  be  incomplete  or
inaccurate,  and  unanticipated  events and  circumstances  may occur  which may
affect  the  accuracy  or  validity  of such  assumptions,  estimates  or actual
results.

ACCOUNTS RECEIVABLE

The  Company  adjusts  its  accounts  receivable  balances  that it  deems to be
uncollectible.  The  allowance  for  doubtful  accounts  is the  Company's  best
estimate  of the amount of  probable  credit  losses in the  Company's  existing
accounts receivable.  The Company reviews its allowance for doubtful accounts on
a monthly basis and  determines  the allowance  based on an analysis of its past
due  accounts.  All  past  due  balances  that  are  over 90 days  are  reviewed
individually  for  collectability.  Account balances are charged off against the
allowance  after all means of collection  have been  exhausted and the potential
for recovery is considered remote.

PROPERTY AND EQUIPMENT

Property and  equipment is stated at cost.  Depreciation  is computed  using the
straight-line  method over the estimated  useful lives of the assets  (generally
three to five  years).  Maintenance  and  repairs  are  charged  to  expense  as
incurred; cost of major additions and betterments are capitalized. When property
and equipment is sold or otherwise disposed of, the cost and related accumulated
depreciation  are eliminated from the accounts and any resulting gains or losses
are reflected in the statement of operations in the period of disposal.

GOODWILL

The Company  accounts for  Goodwill and  Intangible  Assets in  accordance  with
Statement  of  Financial   Accounting  Standards  ("SFAS")  No.  141,  "Business
Combinations"  and SFAS No. 142,  "Goodwill and Other Intangible  Assets." Under
SFAS No. 142,  goodwill and intangibles that are deemed to have indefinite lives
are no longer amortized but,  instead,  are to be reviewed at least annually for
impairment.  Application  of the goodwill  impairment  test  requires  judgment,
including  the   identification   of  reporting  units,   assigning  assets  and
liabilities  to reporting  units,  assigning  goodwill to reporting  units,  and
determining the fair value.  Significant judgments required to estimate the fair
value of  reporting  units  include  estimating  future cash flows,  determining
appropriate discount rates and other assumptions. Changes in these estimates and
assumptions  could  materially  affect the  determination  of fair value  and/or
goodwill  impairment for each reporting unit. The Company  recorded  goodwill in
connection  with the  Company's  acquisitions  described  in Note 6 amounting to
$22,440,412. The Company's annual impairment review


                                       12
<PAGE>


of goodwill resulted in goodwill impairment charges totaling $12,929,696 for the
year ended  December 31, 2005 (Note 6) resulting  in  $9,510,716  in goodwill at
September 30, 2006.

LONG LIVED ASSETS

The Company periodically reviews the carrying values of its long lived assets in
accordance  with SFAS 144,  "Long  Lived  Assets"  when  events  or  changes  in
circumstances would indicate that it is more likely than not that their carrying
values may exceed their  realizable  value and records  impairment  charges when
necessary. The Company's review of the carrying values of its long lived assets,
which principally consist of amortizable  intangibles from acquired  businesses,
resulted in an impairment  charge of $1,705,455  for the year ended December 31,
2005 (Note 9). Amortizable intangible assets continue to be amortized over their
estimated  useful  lives.  The Company  evaluated  the  carrying  amounts of its
goodwill and  intangible  assets as of September  30, 2006 and  determined  that
impairment charges are not necessary.

USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS

In preparing  financial  statements in  conformity  with  accounting  principles
generally  accepted in the United  States of America,  management is required to
make estimates and  assumptions  that affect the reported  amounts of assets and
liabilities and the disclosure of contingent  assets and liabilities at the date
of the  financial  statements  and revenue  and  expenses  during the  reporting
period.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The  carrying  amounts  reported  in  the  balance  sheet  for  cash,   accounts
receivable,  accounts payable accrued  expenses,  advances from stockholders and
all note obligations  classified as current  liabilities  approximate their fair
values based on the short-term maturity of these instruments.

PREFERRED STOCK

The Company  applies the guidance  enumerated  in SFAS No. 150  "Accounting  for
Certain  Financial  Instruments  with  Characteristics  of both  Liabilities and
Equity"  and EITF Topic  D-98  "Classification  and  Measurement  of  Redeemable
Securities,"  when determining the  classification  and measurement of preferred
stock.  Preferred shares subject to mandatory redemption (if any) are classified
as liability  instruments and are measured at fair value in accordance with SFAS
150. All other  issuances of preferred  stock are subject to the  classification
and  measurement   principles  of  EITF  Topic  D-98.  Accordingly  the  Company
classifies  conditionally  redeemable  preferred shares (if any), which includes
preferred  shares that  feature  redemption  rights  that are either  within the
control of the holder or subject to redemption  upon the occurrence of uncertain
events not solely  within the Company's  control,  as temporary  equity.  At all
other  times,  the Company  classifies  its  preferred  shares in  stockholders'
equity.

The Company's  preferred shares do not feature any redemption  rights within the
holders  control or  conditional  redemption  features not within the  Company's
control as of September 30, 2006.  Accordingly  all issuances of preferred stock
are presented as a component of stockholders equity.

CONVERTIBLE INSTRUMENTS

The Company  evaluates  and  accounts  for  conversion  options  embedded in its
convertible  instruments  in  accordance  with  SFAS  No.  133  "Accounting  for
Derivative  Instruments  and  Hedging  Activities"  ("SFAS  133") and EITF 00-19
"Accounting  for Derivative  Financial  Instruments  Indexed to, and Potentially
Settled in, a Company's Own Stock" ("EITF 00-19").

SFAS 133 generally  provides three criteria that, if met,  require  companies to
bifurcate conversion options from their host instruments and account for them as
free standing  derivative  financial  instruments in accordance with EITF 00-19.
These  three  criteria   include   circumstances   in  which  (a)  the  economic
characteristics and risks of the embedded derivative  instrument are not clearly
and  closely  related  to the  economic  characteristics  and  risks of the host
contract,  (b) the hybrid instrument that embodies both the embedded  derivative
instrument and the host contract is not remeasured at fair value under otherwise
applicable generally accepted accounting principles with changes in


                                       13
<PAGE>


fair value reported in earnings as they occur and (c) a separate instrument with
the same terms as the  embedded  derivative  instrument  would be  considered  a
derivative instrument subject to the requirements of SFAS 133. SFAS 133 and EITF
00-19 also provide an exception to this rule when the host  instrument is deemed
to be conventional (as that term is described in the implementation  guidance to
SFAS 133 and  further  clarified  in EITF 05-2  "The  Meaning  of  "Conventional
Convertible Debt Instrument" in Issue No. 00-19).

The Company  accounts for convertible  instruments  (when it has determined that
the  embedded  conversion  options  should  not be  bifurcated  from  their host
instruments)  in accordance  with the  provisions of EITF 98-5  "Accounting  for
Convertible  Securities with Beneficial  Conversion Features," ("EITF 98-5") and
EITF  00-27  "Application  of EITF  98-5 to  Certain  Convertible  Instruments."
Accordingly,  the Company records when necessary  discounts to convertible notes
for the intrinsic value of conversion options embedded in debt instruments based
upon the  differences  between the fair value of the underlying  common stock at
the commitment date of the note  transaction and the effective  conversion price
embedded in the note. Debt discounts under these arrangements are amortized over
the term of the related debt to their earliest date of  redemption.  The Company
also  records  when  necessary  deemed  dividends  for the  intrinsic  value  of
conversion  options  embedded in  preferred  shares  based upon the  differences
between the fair value of the underlying  common stock at the commitment date of
the note transaction and the effective conversion price embedded in the note.

The  Company  evaluated  the  conversion  option  embedded  in  its  convertible
instruments  during each of the reporting  periods presented and has determined,
in accordance with the provisions of these statements, that it does not meet the
criteria requiring bifurcation of these instruments.

The  Company  determined  that the  conversion  option  embedded in its Series A
Convertible  Preferred  Stock, par value $0.01 per share ("Series A Preferred"),
is not a free standing derivative in accordance with the implementation guidance
provided in paragraph 61 (l) of Appendix A to SFAS 133.

STOCK BASED COMPENSATION

Prior to January 1, 2006, the Company accounted for employee stock  transactions
in  accordance  with  Accounting   Principles   Board  ("APB")  Opinion  No.  25
"Accounting  for Stock Issued to  Employees."  The Company  applied the proforma
disclosure   requirements   of  SFAS  No.  123   "Accounting   for   Stock-Based
Compensation."

Effective  January 1, 2006,  the Company  adopted  SFAS No.  123R  "Share  Based
Payment." This statement is a revision of SFAS Statement No. 123, and supersedes
APB Opinion No. 25, and its related implementation guidance. SFAS 123R addresses
all forms of share based payment  ("SBP") awards  including  shares issued under
employee  stock  purchase  plans,  stock  options,  restricted  stock  and stock
appreciation  rights.  Under  SFAS  123R,  SBP  awards  result in a cost that is
measured at fair value on the awards' grant date,  based on the estimated number
of  awards  that  are  expected  to  vest.  The  Company  adopted  the  modified
prospective  method with respect to accounting for its transition to SFAS 123(R)
and  measured   unrecognized   compensation   cost  as  described  in  Note  19.
Accordingly,  the  Company  recognized  in salaries  and related  expense in the
statement  of  operations,  $307,629  and  $62,705  for the fair  value of stock
options expected to vest during the nine and three month periods ended September
30, 2006, respectively.

In  the  current  quarter  we  have  reclassified   certain  components  of  our
stockholders' equity section to reflect the elimination of deferred compensation
arising from unvested share-based  compensation  pursuant to the requirements of
Staff Accounting Bulletin No. 107, regarding  Statement of Financial  Accounting
Standards No.  123(R),  "Share-Based  Payment." This deferred  compensation  was
previously  recorded  as an  increase  to  additional  paid-in  capital  with  a
corresponding  reduction to stockholders' equity for such deferred compensation.
This  reclassification has no effect on net income or total stockholders' equity
as  previously  reported.  The Company  will  record an  increase to  additional
paid-in capital as the share-based payments vest.

For the nine and three months ended  September 30, 2005, the Company applied APB
Opinion No. 25,  "Accounting  for Stock Issued to  Employees." As required under
SFAS  No.  148,  "Accounting  for  Stock-based  Compensation  -  Transition  and
Disclosure,"  the following  table  presents  pro-forma net income and basic and
diluted earnings per share as if the fair value-based method had been applied to
all awards during that period.


                                       14
<PAGE>


<TABLE>
<CAPTION>
                                                      NINE MONTHS ENDED     THREE MONTHS ENDED
                                                      SEPTEMBER 30, 2005    SEPTEMBER 30, 2005
                                                      ------------------    ------------------
<S>                                                   <C>                   <C>
Net Loss, as reported .............................   $      (19,910,022)   $      (12,677,722)
Stock-based employee compensation cost, under fair
   value accounting ...............................             (375,000)             (225,000)
                                                      ------------------    ------------------
Pro-forma net loss under fair value method ........   $      (20,285,022)   $      (12,902,722)
                                                      ==================    ==================

Net loss per share - basic and diluted, as reported   $           (10.43)   $            (6.18)

Net loss per share - basic and diluted, proforma ..   $           (10.62)   $            (6.29)
</TABLE>

The fair  value of all  awards  was  estimated  at the date of grant  using  the
Black-Scholes   option  pricing  model  with  the  following   weighted  average
assumptions:  risk fee interest rate: 3.44% to 4.05%;  expected  dividend yield:
0%; expected option life: 3 to 4 years; volatility: 87% to 125%.

COMMON STOCK PURCHASE WARRANTS

The Company  accounts for the issuance of common stock purchase  warrants issued
with  registration  rights in  accordance  with the  provisions  of EITF  00-19,
"Accounting  for Derivative  Financial  Instruments  Indexed to, and Potentially
Settled in, a Company's Own Stock."

Based on the  provisions  of EITF 00-19,  the Company  classifies  as equity any
contracts that (i) require physical  settlement or net-share  settlement or (ii)
gives the  company a choice of  net-cash  settlement  or  settlement  in its own
shares (physical settlement or net-share settlement).  The Company classifies as
assets  or  liabilities  any  contracts  that (i)  require  net-cash  settlement
(including a requirement  to net cash settle the contract if an event occurs and
if  that  event  is  outside  the  control  of the  company)  or (ii)  give  the
counterparty a choice of net-cash  settlement or settlement in shares  (physical
settlement or net-share settlement).

INCOME TAXES

The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes."  SFAS No.  109  requires  the  recognition  of  deferred  tax assets and
liabilities  for both the expected  impact of differences  between the financial
statements and tax basis of assets and  liabilities  and for the expected future
tax benefit to be derived from tax loss and tax credit carry forwards.  SFAS No.
109 additionally  requires the establishment of a valuation allowance to reflect
the likelihood of realization of deferred tax assets.

NET LOSS PER SHARE

Basic  net loss  per  common  share  is  computed  by  dividing  net loss by the
weighted-average  number of common shares outstanding during the period. Diluted
net loss per common share also  includes  common stock  equivalents  outstanding
during the period if dilutive.  Diluted net loss per common share,  if required,
would be computed by dividing net loss by the weighted-average  number of common
shares outstanding  without an assumed increase in common shares outstanding for
common stock equivalents; as such common stock equivalents are anti-dilutive.

As a result of the  consummation of the Share Exchange  described in Note 2, the
Company  included 40,001 stock options with an exercise price of $0.30 per share
that  it  issued  to  certain  employees  during  2002  in  its  calculation  of
weighted-average number of common shares outstanding for all periods presented.

Net loss per  common  share  excludes  the  following  outstanding  options  and
warrants as their effect would be anti-dilutive:


                                       15
<PAGE>


                                                            SEPTEMBER 30
                                                   -----------------------------
                                                      2006               2005
                                                   ----------         ----------
Options ..................................            463,970            373,020
Warrants .................................          1,339,306            321,852
Series A Preferred Stock .................          2,008,567               --
Series A-1 Preferred Stock ...............         12,331,018               --
Convertible Notes ........................             66,557               --
                                                   ----------         ----------
                                                   16,209,418            694,872
                                                   ==========         ==========

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December  2004,  the FASB issued SFAS No.  153,  "Exchanges  of  Non-monetary
Assets"  (SFAS  153).  SFAS 153  amends  APB  Opinion  No. 29 to  eliminate  the
exception for non-monetary  exchanges of similar  productive assets and replaces
it with a general  exception  for exchanges of  non-monetary  assets that do not
have commercial  substance.  A non-monetary exchange has commercial substance if
the future cash flows of the entity are  expected to change  significantly  as a
result  of  the  exchange.   The  provisions  of  SFAS  153  are  effective  for
non-monetary  asset exchanges  occurring in fiscal periods  beginning after June
15, 2005.  Earlier  application is permitted for  non-monetary  asset  exchanges
occurring in fiscal periods beginning after December 16, 2004. The provisions of
this  statement  are  intended be applied  prospectively.  The  adoption of this
pronouncement  did  not  have  a  material  effect  on the  Company's  financial
statements.

In May 2005, the Financial  Accounting Standards Board ("FASB") issued Statement
of  Financial  Accounting  Standards  No.  154,  "Accounting  Changes  and Error
Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS
154"). This Statement replaces APB Opinion No. 20, Accounting Changes,  and FASB
Statement No. 3, Reporting  Accounting Changes in Interim Financial  Statements,
and changes the requirements for the accounting for and reporting of a change in
accounting  principle.  This  Statement  applies  to all  voluntary  changes  in
accounting  principle.  It also  applies to changes  required  by an  accounting
pronouncement  in the unusual instance that the  pronouncement  does not include
specific  transition   provisions.   When  a  pronouncement   includes  specific
transition provisions, those provisions should be followed.

APB Opinion No. 20 previously required that most voluntary changes in accounting
principle be  recognized  by including in net income of the period of the change
the  cumulative  effect  of  changing  to the  new  accounting  principle.  This
Statement  requires  retrospective   application  to  prior  periods'  financial
statements of changes in accounting  principle,  unless it is  impracticable  to
determine  either the  period-specific  effects or the cumulative  effect of the
change. When it is impracticable to determine the period-specific  effects of an
accounting  change  on one or more  individual  prior  periods  presented,  this
Statement requires that the new accounting  principle be applied to the balances
of assets and  liabilities as of the beginning of the earliest  period for which
retrospective  application is practicable and that a corresponding adjustment be
made  to  the  opening  balance  of  retained  earnings  (or  other  appropriate
components of equity or net assets in the  statement of financial  position) for
that  period  rather  than being  reported  in an income  statement.  When it is
impracticable  to  determine  the  cumulative  effect  of  applying  a change in
accounting principle to all prior periods,  this Statement requires that the new
accounting  principle  be applied as if it were adopted  prospectively  from the
earliest date  practicable.  This Statement is effective for accounting  changes
and  corrections  of errors made in fiscal years  beginning  after  December 15,
2005. The adoption of this  pronouncement  did not have a material effect on the
Company's financial statements.

On  June  29,  2005,  the  EITF  ratified  Issue  No.  05-2,   "The  Meaning  of
'Conventional  Convertible Debt Instrument' in EITF Issue No. 00-19, `Accounting
for Derivative  Financial  Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock.'" EITF Issue 05-2 provides guidance on determining  whether
a convertible debt instrument is  "conventional"  for the purpose of determining
when an issuer is required to bifurcate a conversion  option that is embedded in
convertible  debt in accordance  with SFAS 133.  Issue No. 05-2 is effective for
new  instruments  entered into and  instruments  modified in  reporting  periods
beginning after June 29, 2005. The adoption of this pronouncement did not have a
material effect on the Company's financial statements.


                                       16
<PAGE>


In September 2005, the EITF ratified Issue No. 05-4, "The Effect of a Liquidated
Damages Clause on a Freestanding  Financial Instrument Subject to EITF Issue No.
00-19,   'Accounting  for  Derivative  Financial  Instruments  Indexed  to,  and
Potentially  Settled in, a Company's Own Stock.'" EITF 05-4 provides guidance to
issuers as to how to account for registration  rights agreements that require an
issuer to use its "best efforts" to file a registration statement for the resale
of equity  instruments and have it declared  effective by the end of a specified
grace period and, if applicable,  maintain the effectiveness of the registration
statement  for a  period  of  time or pay a  liquidated  damage  penalty  to the
investor.  The Company is currently in the process of evaluating the effect that
the adoption of this pronouncement may have on its financial statements.

In September 2005, the FASB ratified the Emerging  Issues Task Force's  ("EITF")
Issue No. 05-7,  "Accounting for Modifications to Conversion Options Embedded in
Debt Instruments and Related Issues," which addresses  whether a modification to
a  conversion  option that  changes its fair value  affects the  recognition  of
interest  expense for the associated debt instrument  after the modification and
whether a borrower should recognize a beneficial  conversion feature, not a debt
extinguishment if a debt modification  increases the intrinsic value of the debt
(for example,  the modification  reduces the conversion price of the debt). This
issue is effective for future modifications of debt instruments beginning in the
first interim or annual  reporting period beginning after December 15, 2005. The
adoption of this  pronouncement  did not have a material effect on the Company's
financial statements.

In September 2005, the FASB also ratified the EITF's Issue No. 05-8, "Income Tax
Consequences of Issuing Convertible Debt with a Beneficial  Conversion Feature,"
which  discusses  whether the  issuance of  convertible  debt with a  beneficial
conversion  feature  results in a basis  difference  arising from the  intrinsic
value of the  beneficial  conversion  feature on the  commitment  date (which is
recorded in the stockholders'  equity for book purposes,  but as a liability for
income tax purposes),  and, if so, whether that basis  difference is a temporary
difference  under FASB  Statement No. 109,  "Accounting  for Income Taxes." This
Issue should be applied by retrospective  application  pursuant to Statement 154
to all  instruments  with a beneficial  conversion  feature  accounted for under
Issue 00-27  included in financial  statements for reporting  periods  beginning
after  December 15,  2005.  The  adoption of this  pronouncement  did not have a
material effect on the Company's financial statements.

In February 2006, the FASB issued SFAS No. 155,  "Accounting  for Certain Hybrid
Financial  Instruments - an amendment of FASB  Statements No. 133 and 150." SFAS
No. 155 (a) permits fair value remeasurement for any hybrid financial instrument
that contains an embedded  derivative that otherwise would require  bifurcation,
(b) clarifies that certain  instruments  are not subject to the  requirements of
SFAS 133, (c)  establishes a requirement  to evaluate  interests in  securitized
financial assets to identify  interests that may contain an embedded  derivative
requiring  bifurcation,  (d) clarifies  what may be an embedded  derivative  for
certain  concentrations  of credit  risk and (e)  amends  SFAS 140 to  eliminate
certain  prohibitions  related to  derivatives  on a qualifying  special-purpose
entity.  SFAS 155 is  applicable  to new or modified  financial  instruments  in
fiscal years beginning after September 15, 2006,  though the provisions  related
to fair value accounting for hybrid financial instruments can also be applied to
existing instruments.  Early adoption, as of the beginning of an entity's fiscal
year, is also permitted, provided interim financial statements have not yet been
issued.  We are  currently  evaluating  the potential  impact,  if any, that the
adoption of SFAS 155 will have on our consolidated financial statements.

In March 2006,  the FASB issued  Statement  of  Financial  Accounting  Standards
("SFAS") No. 156,  Accounting for Servicing of Financial  Assets (SFAS No. 156).
SFAS No. 156 amends SFAS No. 140  "Accounting  for  Transfers  and  Servicing of
Financial Assets and  Extinguishments of Liabilities," to require all separately
recognized  servicing assets and servicing  liabilities to be initially measured
at  fair  value,  if  practicable.  SFAS  No.  156  also  permits  servicers  to
subsequently  measure each separate class of servicing assets and liabilities at
fair value rather than at the lower of cost or market.  For those companies that
elect to measure their servicing assets and liabilities at fair value,  SFAS No.
156 requires  the  difference  between the carrying  value and fair value at the
date of adoption to be recognized as a cumulative  effect adjustment to retained
earnings as of the  beginning  of the fiscal year in which the election is made.
SFAS No. 156 is effective for the first fiscal year  beginning  after  September
15, 2006. We are currently  evaluating  the potential  impact,  if any, that the
adoption of SFAS 156 will have on our consolidated financial statements.

In  July  2006,   the   Financial   Accounting   Standards   Board  issued  FASB
Interpretation  No.  48,  Accounting  for  Uncertainty  in  Income  Taxes.  This
Interpretation  prescribes a recognition threshold and measurement attribute for
the financial  statement  recognition and measurement of a tax position taken or
expected to be taken in a tax return.


                                       17
<PAGE>


This  Interpretation  also provides guidance on  derecognition,  classification,
interest  and  penalties,   accounting  in  interim  periods,   disclosure,  and
transition.  The  Interpretation  is effective for fiscal years  beginning after
December 15,  2006.  We have not yet  completed  our analysis of the impact this
Interpretation will have on our financial condition, results of operations, cash
flows or disclosures.

In September 2006, the FASB issued Statement of Financial  Accounting  Standards
No. 157, Fair Value Measurements ("SFAS 157"). This Standard defines fair value,
establishes  a  framework  for  measuring  fair  value  in  generally   accepted
accounting  principles and expands  disclosures  about fair value  measurements.
SFAS 157 is effective for financial statements issued for fiscal years beginning
after  November 15, 2007 and interim  periods  within those  fiscal  years.  The
adoption of SFAS 157 is not expected to have a material  impact on the Company's
financial position, results of operations or cash flows.

Other  accounting  standards  that have been  issued or  proposed by the FASB or
other standards-setting  bodies that do not require adoption until a future date
are not  expected  to  have a  material  impact  on the  consolidated  financial
statements upon adoption.


NOTE 6 - BUSINESS COMBINATIONS

On February 25, 2005, the Company acquired  Complete  Security  Solutions,  Inc.
("CSSI") and LucidLine,  Inc.  ("LucidLine")  in separate  merger  transactions.
Additionally,  on March 30, 2005, the Company acquired Entelagent Software Corp.
("Entelagent") in a merger transaction. The Company accounted for these business
combinations  in  accordance  with the  provisions of SFAS 141  "Accounting  for
Business Combinations."

In connection with these three merger  transactions,  the Company paid, $200,000
in cash, 496,667 shares of common stock with a fair market value of $12,665,000,
subordinated  promissory notes in the aggregate  principal amount of $4,500,000,
warrants to purchase  up to 75,001  shares of common  stock which were valued at
$1,912,500.   Direct  expenses   incurred  by  the  Company  to  complete  these
transactions  amounted  to  $912,663.  The  total  purchase  price for the three
companies amounted to $20,190,133.

The allocation of the purchase price was based upon a valuation  study performed
by an independent outside appraisal firm. The purchase price allocation resulted
in the allocation of $3,101,000 to intangible  assets,  including  $2,570,000 to
developed  technology  and  $190,000 to  in-process  research  and  development.
Additionally,  the  purchase  price  allocation  resulted in the  allocation  of
$22,440,412 to goodwill.

The Company  performed its annual  impairment test of goodwill at its designated
valuation date of December 31, 2005 in accordance  with SFAS 142. As a result of
these tests, the Company determined that the recoverable amount of goodwill with
respect  to its  business  amounted  to  $9,510,716.  Accordingly,  the  Company
recorded a goodwill  impairment charge in the amount of $12,929,696 for the year
ended  December  31,  2005.  Additionally,   after  reevaluating  the  resources
available to the Company, the strategic direction of the business as well as the
revised  business  plans and  financial  projections,  the  Company,  during the
quarter ended December 31, 2005, recorded a $1,705,455 charge for the impairment
of  the  developed  technology  assets  acquired  in  the  CSSI  and  Entelagent
acquisitions.  The  remaining  amount  of  goodwill  and  intangible  assets  is
presented net of such impairment charges recorded during the year ended December
31,  2005.  There have been no new  developments  since  December 31, 2005 which
would give rise to an impairment charge.

On April 18, 2006,  the Company  entered into a Stock  Purchase  Agreement  with
Walnut Valley,  Inc.  pursuant to which the Company sold all of the  outstanding
shares  of  LucidLine,  Inc.  As a  result,  LucidLine  has  been  treated  as a
discontinued operation in these financial statements (Note 20).


NOTE 7 - OTHER CURRENT ASSETS

Other current assets consist of the following:


                                       18
<PAGE>


                                                              SEPTEMBER 30, 2006
                                                              ------------------
Prepaid expenses ..........................................   $           27,365
Deposits ..................................................               30,639
                                                              ------------------
  Other current assets ....................................   $           58,004
                                                              ==================

NOTE 8 - PROPERTY AND EQUIPMENT

                                                             SEPTEMBER 30, 2006
                                                             ------------------
Computers ................................................   $          234,136
Furniture and fixtures ...................................               31,962
Leasehold improvements ...................................                4,490
                                                             ------------------
    sub-total ............................................              270,588
less: accumulated depreciation ...........................              (77,045)
                                                             ------------------
    Property and equipment, net ..........................   $          193,543
                                                             ==================

Depreciation  expense  amounted to $44,425 and $25,491 for the nine months ended
September 30, 2006 and 2005, respectively.

NOTE 9 - INTANGIBLE ASSETS

The  components of  intangible  assets as of September 30, 2006 are set forth in
the following table:

                                                             SEPTEMBER 30, 2006
                                                             ------------------
Developed technology .....................................   $        2,570,000
Customer relationships ...................................              180,000
Trademarks and tradenames ................................              161,000
In-process research and development ......................              920,815
                                                             ------------------
                                                                      3,831,815
Amortization and impairment charge .......................           (2,395,048)
                                                             ------------------
   Intangible assets, net ................................   $        1,436,767
                                                             ==================

The  amortization of intangible  assets will result in the following  additional
expense by year:

                                                                    INTANGIBLE
YEARS ENDED DECEMBER 31,                                           AMORTIZATION
                                                                   ------------
2006 ........................................................      $     85,398
2007 ........................................................           367,070
2008 ........................................................           379,501
2009 ........................................................           310,666
2010 ........................................................           180,016
2011 ........................................................           101,686
2012 ........................................................            12,430
                                                                   ------------
                                                                    $  1,436,767
                                                                    ============

During the year ended  December  31,  2005,  the Company  recorded a  $1,705,455
charge for the  impairment of the developed  technology  assets  acquired in the
CSSI and Entelagent acquisitions (Note 6).


                                       19
<PAGE>


The Company  classifies  amortization of developed  technology as a component of
cost of sales and  amortization  of customer  relationship  and  trademarks  and
tradenames as a component of general and  administrative  expense.  Amortization
expense  amounted to $192,420 and  $342,483 for the nine months ended  September
30,  2006 and 2005,  respectively.  Included  in these  amounts is  $99,980  and
$272,792 for the nine months ended  September  30, 2006 and 2005,  respectively,
which is classified as cost of sales.


NOTE 10 - DEMAND NOTES PAYABLE

Through  December 31, 2004, the Company borrowed an aggregate amount of $695,000
from several  unrelated  parties.  At September 30, 2006,  all of the notes were
settled in the creditor and claimant liabilities restructuring. Interest expense
on the notes amounted to $20,750 and $52,125 for the nine months ended September
30, 2006 and 2005, respectively.

The remaining demand note at September 30, 2006,  which amounts to $312,556,  is
payable to Lok Technology and is secured by  Entelagent's  accounts  receivable,
which  approximate  $86,000  and  $106,000  at  September  30,  2006  and  2005,
respectively.  The note bears interest at 15% per annum. Interest on this demand
note  amounted  to $35,163  for the nine  months  ended  September  30, 2006 and
$23,442 for nine months ended  September  30, 2005.  As described in Note 16, on
May 4, 2006, the Company became aware of a complaint that Lok Technologies, Inc.
had filed in the Superior Court of California, County of Santa Clara on or about
March 30, 2006  against  the  Company,  Entelagent  Software  Corp.  and unnamed
defendants.

As of September 30, 2006,  $743,500 of the Demand Notes have been surrendered as
payment for Series A-1  Preferred  stock as part of the  creditor  and  claimant
liabilities restructuring (Note 17).


NOTE 11 - BRIDGE NOTES PAYABLE

INTERIM BRIDGE FINANCING I

On February 28, 2005, the Company completed a $3,500,000 financing (the "Interim
Bridge Financing I") through the issuance of 10% Senior  Convertible  Promissory
Notes (the "Bridge I Notes") and warrants to purchase up to 58,348 shares of the
Company's  common stock  ("Bridge I  Warrants").  The warrants  have a term of 5
years and an exercise price of $21.00 per share. The aggregate fair value of the
Bridge I Warrants amounts to $1,487,500.  Prior to final maturity,  the Bridge I
Notes may be  converted  into  securities  that would be  issuable  at the first
closing of a subsequent  financing  by the  Company,  for such number of offered
securities that could be purchased for the principal amount being converted. The
Bridge I Notes  had an  initial  term of 120 days  (due on June 28,  2005)  with
interest at a  contractual  rate of 10% per annum and featured an option for the
Company to extend the term for an additional 60 days to August 27, 2005.

In accordance with APB 14, "Accounting for Convertible Debt and Debt Issued with
Stock Purchase  Warrants," the Company  allocated  $2,456,140 of the proceeds to
the Bridge I Notes and  $1,043,860  of proceeds  to the Bridge I  Warrants.  The
difference  between  the  carrying  amount  of the  Bridge  I  Notes  and  their
contractual redemption amount was accreted as interest expense to June 28, 2005,
their earliest date of redemption.

On June 28, 2005, the Company elected to extend the contractual maturity date of
the Bridge I Notes for an  additional  60 days to August 27, 2005,  which caused
the  contractual  interest rate to increase to 12% per annum.  In addition,  the
Company was  required to issue the 58,348  additional  warrants  (the  "Bridge I
Extension  Warrants") to purchase such number of shares of common stock equal to
1/60 of a share for each $1.00 of  principal  amount  outstanding.  The Bridge I
Extension  Warrants  have a term of 5 years and an exercise  price of $21.00 per
share.  The  Bridge  I  Extension  Warrants  have  a  fair  value  of  $822,500.
Assumptions  relating  to the  estimated  fair  value of these  warrants  are as
follows: fair value of common stock of $19.50; risk-free interest rate of 4.25%;
expected dividend yield zero percent;  expected warrant life of three years; and
current volatility of 125%.


                                       20
<PAGE>


The  Company  did not redeem the  Bridge I Notes on August  27,  2005 and,  as a
result, the notes  automatically  became convertible into 0.128 shares of common
stock for each $1 of principal then  outstanding in accordance with the original
note agreement. Accordingly, the Company recorded a charge of $3,500,000 in 2005
based  upon  the  intrinsic  value of this  conversion  option  measured  at the
original  issuance date of the note in accordance  with EITF 00-27.  The Company
has filed with the SEC on July 24, 2006 a registration  statement for the resale
of the restricted shares of the Company's common stock issuable upon exercise of
the conversion option that would be issued in this transaction.

Contractual  interest  expense on the Bridge I Notes  amounted to  $123,665  and
$204,167 for the nine months ended  September  30, 2006 and 2005,  respectively,
and is included as a component of interest expense in the accompanying statement
of operations.

As of September 30, 2006,  $3,180,025 of the Bridge I Notes were  surrendered as
payment for Series A-1  Preferred  stock as part of the  creditor  and  claimant
liabilities restructuring (Note 17). With the surrender of the Bridge I Notes in
payment  for  Series  A-1  Preferred  stock  under  the  creditor  and  claimant
liabilities  restructuring,  conversion  options associated with the surrendered
Bridge  I Notes  are no  longer  exercisable  and  have  been  cancelled.  As of
September  30,  2006,  $319,975  of  Bridge  I  notes  remain  outstanding.  The
registration  statement filed on July 24, 2006 includes the resale of the 40,957
restricted  shares of the Company's  common stock  issuable upon the exercise of
the conversion option associated with the Bridge I Notes.

INTERIM BRIDGE FINANCING II

On June 6, 2005,  the Company  completed a $2,543,000  financing  (the  "Interim
Bridge  Financing  II")  through  the  issuance  of (i) 10%  Junior  Convertible
Promissory  Notes (the  "Bridge II Notes")  and (ii)  warrants to purchase up to
42,384  shares of common stock (the "Bridge II  Warrants").  The warrants have a
term of 5 years and an exercise  price of $18.00 per share.  The aggregate  fair
value of the Bridge II Warrants  amounts to  $673,895.  Prior to  maturity,  the
Junior Convertible Promissory Notes may be converted into the securities offered
by the Company at the first  closing of a subsequent  financing for the Company,
for such number of offered  securities  as could be purchased  for the principal
amount being converted.

In accordance with APB 14, the Company  allocated  $2,010,277 of the proceeds to
the Bridge II Notes and  $532,723  of proceeds  to the Bridge II  Warrants.  The
difference  between  the  carrying  amount  of the  Bridge  II Notes  and  their
contractual  redemption  amount is being accreted as interest expense to October
3, 2005, their earliest date of redemption.

The  Bridge II Notes  have an  initial  term of 120 days (due on  various  dates
beginning  October 3, 2005) with interest at 10% per annum and feature an option
for the Company to extend the term for an  additional  60 days to various  dates
beginning  December 2, 2005.  Upon the  extension  of the  maturity  date of the
Bridge II Notes, the contractual  interest rate would increase to 12% per annum,
and the Company  would be required to issue  warrants  (the "Bridge II Extension
Warrants") to purchase such number of shares of the Company's common stock equal
to 1/60th of a share for each $1.00 of principal then outstanding. The Bridge II
Extension  Warrants,  issuable upon extension of the maturity date of the Junior
Convertible Promissory notes, feature a term of 5 years and an exercise price of
$18.00 per share. The Bridge II Extension Warrants have a fair value of $65,388.
Assumptions  relating  to the  estimated  fair  value of these  warrants  are as
follows:  fair value of common stock $2.40;  risk-free  interest  rate of 3.10%;
expected  dividend yield zero percent;  expected warrant life of five years; and
current volatility of 125%. In addition,  if the Bridge II Notes are not paid in
full on or before the extended maturity date, each note becomes convertible into
..128  shares of the  Company's  common  stock for each $1.00 of  principal  then
outstanding.  The  intrinsic  value of this  conversion  option  measured at the
issuance  date of the notes  amounts to  $2,543,000  and would be  recognized as
interest  expense in accordance with EITF 00-27.  The Company has agreed to file
with the SEC, a registration  statement for the resale of the restricted  shares
of its common stock issuable upon exercise of the  conversion  option that would
be issuable in this transaction, on a best efforts basis.

The Company sold these  securities to seven accredited  investors  introduced by
Laidlaw,  placement  agent in the  Interim  Bridge  Financing  II.  The  Company
incurred  $386,027 of fees in connection with this transaction  including a cash
fee of $305,160  and  $80,867  for the fair value of warrants to purchase  4,243
shares of the Company's common stock at an exercise price of $18.00 per share.


                                       21
<PAGE>


The Company  elected to extend the due dates of these notes by an  additional 60
days to various dates beginning  December 2, 2005. In addition,  the Company was
required to issue Bridge II Extension  Warrants to purchase 42,388 shares of the
Company's common stock. The Bridge II Extension Warrants have at term of 5 years
and an exercise price of $18.00 per share.

The  Company  did not redeem the Bridge II Notes on  December  2, 2005 and, as a
result, the notes  automatically  became convertible into 0.128 shares of common
stock for each $1 of principal then  outstanding in accordance with the original
note agreement.  Accordingly,  the Company recorded a charge of $2,543,000 based
upon the  intrinsic  value of this  conversion  option  measured at the original
issuance date of the note in accordance with EITF 00-27.
 The Company has filed with the SEC on July 24,  2006 a  registration  statement
for the resale of the restricted  shares of the Company's  common stock issuable
upon exercise of the conversion option that would be issued in this transaction.

Contractual  interest  expense on the Bridge II Notes  amounted to $117,261  and
$84,767 for the nine months ended September 30, 2006 and 2005,  respectively and
is included as a component of interest expense in the accompanying  statement of
operations.

As of September 30, 2006,  $2,343,000 of the Bridge II Notes were surrendered as
payment for Series A-1  Preferred  stock as part of the  creditor  and  claimant
liabilities  restructuring  (Note 17). With the surrender of the Bridge II Notes
in payment  for Series A-1  Preferred  stock  under the  creditor  and  claimant
liabilities   restructuring,   the  conversion   options   associated  with  the
surrendered  Bridge II Notes are no longer  exercisable and have been cancelled.
As of September  30, 2006,  $200,000 of the Bridge II Notes remain  outstanding.
The  registration  statement  filed on July 24, 2006  includes the resale of the
25,600  restricted  shares  of the  Company's  common  stock  issuable  upon the
exercise of the conversion option associated with the Bridge II Notes.

INTERIM BRIDGE FINANCING III

Beginning on July 1, 2005, and continuing through December 31, 2005, the Company
completed,  through 12 separate fundings,  a $5,234,000  financing (the "Interim
Bridge  Financing  III")  through  the  issuance  of (i) 10% Junior  Convertible
Promissory  Notes (the  "Bridge III Notes") and (ii)  warrants to purchase up to
87,235 shares of common stock (the "Bridge III  Warrants").  The warrants have a
term of 5 years and an exercise  price of $18.00 per share.  Prior to  maturity,
the Junior  Convertible  Promissory  Notes may be converted  into the securities
offered by the Company at the first  closing of a subsequent  financing  for the
Company,  for such number of offered  securities  as could be purchased  for the
principal amount being converted.

In accordance with APB 14, the Company  allocated  $4,645,544 of the proceeds to
the Bridge III Notes and  $587,595 of proceeds to the Bridge III  Warrants.  The
difference  between  the  carrying  amount  of the  Bridge  III  Notes and their
contractual  redemption  amount is being accreted as interest expense to various
dates from November 1, 2005, their earliest date of redemption. Accretion of the
aforementioned discount amounted to $20,909 for the three months ended March 31,
2006 and is  included as a component  of  interest  expense in the  accompanying
statement of operations.

The  Bridge  III Notes had an  initial  term of 120 days (due on  various  dates
beginning October 28, 2005) with interest at 10% per annum and feature an option
for the Company to extend the term for an  additional  60 days to various  dates
beginning  December 28,  2005.  Upon the  extension of the maturity  date of the
Bridge III Notes, the contractual interest rate would increase to 12% per annum,
and the Company  would be required to issue  warrants (the "Bridge III Extension
Warrants") to purchase such number of shares of the Company's common stock equal
to 1/60th of a share for each $1.00 of principal  then  outstanding.  The Bridge
III  Extension  Warrants,  issuable  upon  extension of the maturity date of the
Junior Convertible  Promissory Notes,  feature a term of 5 years and an exercise
price of $18.00 per share. In addition, if the Bridge III Notes were not paid in
full on or before the extended maturity date, each note became  convertible into
0.128 shares of the  Company's  common  stock for each $1.00 of  principal  then
outstanding.  The  intrinsic  value of this  conversion  option  measured at the
issuance date of the notes amounts to $5,234,000 and would have been  recognized
as interest  expense in accordance  with EITF 00-27.  The Company agreed to file
with the SEC, a registration  statement for the resale of the restricted  shares
of its common stock issuable upon exercise of the  conversion  option that would
be issuable in this transaction, on a best efforts basis.


                                       22
<PAGE>


Beginning on October 29,  2005,  the Company  elected to extend the  contractual
maturity  date of the  various  Bridge  III Notes for an  additional  60 days to
various dates beginning December 28, 2005, which caused the contractual interest
rate to increase  to 12% per annum.  In  addition,  during the three month ended
March 31, 2006,  the Company was required to issue  39,917  additional  warrants
(the "Bridge III Extension Warrants"). The aggregate fair value of the warrants,
which  amounted to $48,129 was  recorded  as a deferred  financing  cost and was
being  amortized over the 60-day  extension  period or until March 27, 2006 when
the Bridge III Notes were  surrendered  as payment for the Series A-1  Preferred
stock under the creditor and claimant liabilities restructuring.  The Bridge III
Extension  Warrants  have a term of 5 years and an exercise  price of $18.00 per
share. Assumptions relating to the estimated fair value of these warrants are as
follows:  fair value of common stock $1.95 to $2.40;  risk-free interest rate of
3.10% to 3.44%;  expected dividend yield zero percent;  expected warrant life of
three years; and current volatility of 125%.

The Company did not redeem Bridge III Notes on  contractual  maturity dates that
occurred  through  January  12,  2006 (the date of the Series A-1  creditor  and
claimant  liabilities  restructuring).  As a  result,  $3,400,000  of the  Notes
automatically  became  convertible into 0.128 shares of common stock for each $1
of principal then  outstanding in accordance  with the original note  agreement.
This amounts to a total of 70,400  shares during the three months ended of March
31, 2006.  Accordingly,  the Company recorded a charge of $192,000, in the three
months ended March 31, 2006,  based upon the intrinsic  value of this conversion
option  measured at the original  issuance date of the notes in accordance  with
EITF 00-27. With the surrender of the Bridge III Notes in payment for Series A-1
Preferred stock under the creditor and claimant liabilities restructuring, these
conversion options are no longer exercisable and have been cancelled.

As of  September  30,  2006,  all of the Bridge III Notes  were  surrendered  as
payment for Series A-1  Preferred  stock as part of the  creditor  and  claimant
liabilities restructuring (Note 17).

Contractual interest expense on the Bridge III Notes amounted to $153,036 and $0
for the nine months  ended  September  30, 2006 and 2005,  respectively,  and is
included as a component  of interest  expense in the  accompanying  statement of
operations.

The Company sold these securities to Apex, Northwestern,  and Advanced Equities.
Funding  for the Bridge III Notes  included  the  conversion  of  $1,650,000  of
stockholder advances made during the period March 30, 2005 to June 30, 2005 into
Bridge III Notes.

2006 BRIDGE NOTES

On January 18, 2006, the Company completed a financing of approximately $540,000
in  additional  gross  funds (the "2006  Bridge  Note  Financing")  through  the
issuance of Subordinated  Convertible Promissory Notes (the "2006 Bridge Notes")
in the amount of  $720,001.  The 2006 Bridge Note  agreement  provided for these
notes to automatically convert into the same securities (consisting of shares of
Series A Preferred Stock and warrants to purchase shares of the Company's common
stock)  offered  by the  Company  in  connection  with its  Series  A  Preferred
Financing (as defined  below).  On March 27, 2006 (the date of the first closing
of the Series A Preferred Financing),  the 2006 Bridge Notes were converted into
7.2 Units in the Series A Preferred  Financing  described  below.  The  $180,000
difference between the gross proceeds received upon the original issuance of the
notes and the redemption  amount was recorded as an original  issuance  discount
that was fully expensed during the nine months ended September 30, 2006.

Additionally,  the  Company  paid  Laidlaw & Company  (UK)  Ltd.  (Laidlaw),  as
placement  agent in the  transaction,  a fee of $54,000 in conjunction  with the
2006 Bridge Note  Financing.  This fee was fully  amortized  and  recognized  as
interest expense during the nine months ended September 30, 2006.

INTERIM BRIDGE FINANCING IV

Beginning  on July 18, 2006 and  continuing  through  September  15,  2006,  the
Company  obtained  interim  financing  ("Interim  Bridge Financing IV") totaling
$1,000,000 from Apex. This Interim Bridge  Financing IV  automatically  converts
into  securities  (consisting of shares of Series B Preferred Stock and warrants
to purchase shares of the


                                       23
<PAGE>


Company's  common stock) offered by the Company in connection  with its Series B
Preferred  Financing (see Note 21). On October 13, 2006,  (the date of the first
closing of the Series B Preferred  Financing),  the Interim Bridge  Financing IV
was  converted  into 10 Units in the Series B Preferred  Financing  described in
Note 21 below.


NOTE 12 - RELATED PARTY TRANSACTIONS

EXPENSE REIMBURSEMENTS DUE TO OFFICERS AND STOCKHOLDERS

Certain  stockholders  and  officers  of the Company  have paid  expenses on the
Company's  behalf since its inception,  of which $4,458  remains  outstanding at
September 30, 2006. The amounts  payable to such officers and  stockholders  are
due on demand.

As of September 30, 2006, $135,535 of expense reimbursements were surrendered as
payment for Series A-1  Preferred  stock as part of the  creditor  and  claimant
liabilities restructuring (Note 17).

NOTES PAYABLE TO OFFICERS AND STOCKHOLDERS

As of September 30, 2006, $284,212 of notes payable to officers and stockholders
were  surrendered  as  payment  for Series  A-1  Preferred  stock as part of the
creditor and claimant liabilities restructuring (Note 17).

CONSULTING AGREEMENT PAYABLE

On June 8, 2005,  the Company  negotiated  a  settlement  regarding a consulting
agreement  payable with a related party.  The terms of the settlement  agreement
terminated the prior agreement and reduced the remaining  payments due under the
contract  to  $150,000  including  a  $50,000  payment  that was  made  upon the
execution of the agreement and two additional  $50,000 payments including one to
be made upon the completion of a follow-on-financing  by the Company and one not
later than September 30, 2005.  The $150,000  reduction in payments was recorded
as a reduction of general and  administrative  expense  during the quarter ended
June 30, 2005.  Additionally,  the settlement agreement terminated an obligation
for the Company to issue 3,334 shares of unrestricted  stock. The stock issuable
under this  commitment  was  recorded in 2004 as common  stock issued in lieu of
cash for services in the amount of $78,900. The rescission of the stock issuable
under this arrangement resulted in an additional reduction of $78,900 in general
and administrative expenses during the year ended December, 31, 2005.

The payment due on September 30, 2005 was not made by the Company.  The $100,000
balance due under this  arrangement  has been  surrendered as payment for Series
A-1 Preferred  stock under the creditor and claimant  liabilities  restructuring
described in Note 17.

NOTES PAYABLE (TO CREDITORS OF ACQUIRED BUSINESS)

The notes issued to creditors of Entelagent (in connection  with the acquisition
described  in Note 6) include  $554,202  that is payable to related  parties for
settlements  of accrued  payroll,  notes payable and other  payables that remain
outstanding at September 30, 2006.  The original  amount of these notes amounted
to $2,602,913. Aggregate interest expense on these notes amounted to $74,184 and
$103,901 for the nine months ended September 30, 2006 and 2005, respectively.

During the nine months ended September 30, 2006, $1,795,930 of the notes payable
to creditors of acquired  business  were  surrendered  as payment for Series A-1
Preferred stock under the creditor and claimant liabilities restructuring. As of
September 30, 2006, $799,982 of the notes payable remain outstanding.


                                       24
<PAGE>


NOTE 13 - OTHER CURRENT LIABILITIES

Other current liabilities principally consist of $439,146 of accrued payroll and
sales tax  liabilities  and estimated  penalties that the Company assumed in its
acquisition   of   Entelagent   (Note  6).  The  balance   consists  of  various
miscellaneous other current liabilities.


NOTE 14 - DEFERRED REVENUE

Deferred  revenue at September 30, 2006 includes (1) $153,348 for the fair value
of remaining  service  obligations on maintenance and support  contracts and (2)
$70,532  for  contracts  on which the  revenue  recognition  is  deferred  until
contract  deliverables have been completed.  Included in the contracts for which
revenue recognition has been deferred are two contracts with a value of $468,947
for which $159,321 of revenue has been  recognized and for which the majority of
the remaining revenue is expected to be recorded during 2006.


NOTE 15 - ACCOMMODATION AGREEMENT

In November 2002, the Company entered into a financing  arrangement with a third
party financial institution (the "Lender"),  pursuant to which the Company would
borrow $950,000 under a note to be collateralized by the pledge of 31,667 shares
of registered  stock from five different  stockholders.  In connection with this
arrangement,  the Company  executed a series of  Accommodation  Agreements  with
these stockholders  wherein each stockholder  pledged their shares in return for
the right to receive on or before  November  17,  2003 the return of the pledged
shares,  or replacement  shares in the event of foreclosure,  and one additional
share of common stock for every four shares pledged as compensation. The Company
also agreed to use "best  efforts" to register  these shares with the Securities
and Exchange Commission 12 months from the date of issue.

In December 2002, the Company received  approximately $450,000 of proceeds under
the note and  provided  the  Lender the  pledged  shares.  Since  that date,  no
additional  proceeds were provided by the Lender and repeated attempts were made
by the Company to secure the additional  proceeds.  The Company has  effectively
accounted  for the Lender's  failure to fund the facility and return the pledged
shares  as a  foreclosure  on the  loan  collateral.  Accordingly,  the  Company
recorded a $1,047,728 loss during the year ended December 31, 2002.

On March  13,  2003,  the  Company  issued  40,000  replacement  shares  with an
aggregate fair value of $3,708,000 to the  stockholders who pledged their shares
under  the  Accommodation  Agreements.  Accordingly,  the  Company  recorded  an
additional  loss of $2,210,272  during the year ended  December 31, 2003 for the
difference  between the loss the Company recorded upon the Lender's  foreclosure
of the collateral and the aggregate fair value of the replacement shares.

In  addition,  the  Accommodation  Agreements  provided for the Company to pay a
penalty  in the  event of its  failure  to cause  the  replacement  shares to be
registered  on or before March 31, 2003.  As a result,  the Company has recorded
stock based  penalties for the fair value of 15,000  shares per quarter  through
December 31, 2005.

The total stock-based  penalties  associated with the  Accommodation  Agreements
from April 2003 to December  31, 2005 were  $3,318,975.  An aggregate of 165,000
shares were issuable through  December 31, 2005 under the stock-based  penalties
associated with the Accommodation Agreements.

On March 27, 2006, the Company  entered into an agreement to release and resolve
all  outstanding  claims  between the parties  under the  creditor  and claimant
liabilities restructuring (Note 17).

STOCK PLEDGE ARRANGEMENT

In April 2004, a stockholder  of the Company  entered into a one-year stock loan
financing  arrangement ("Stock Financing Facility") with a third party financial
institution (the "Lender I"),  pursuant to which such  stockholder  committed to
obtain financing for the Company under a credit facility  collateralized  by the
pledge of 22,834 shares


                                       25
<PAGE>


of  registered  stock  (the  "Pledged  Stock")  that  was  pledged  by a  second
stockholder (the "Pledging  Stockholder").  In connection with this arrangement,
the Company  executed an accommodation  agreement with the Pledging  Stockholder
committing to issue 22,834 shares of restricted stock (the "Replacement  Stock")
on April 2, 2005 (the "Termination  Date") in the event of a loss of the Pledged
Stock,  plus a premium of 6,850 shares (the "Premium  Shares") for entering into
the agreement.  The Company also agreed to register  10,000 shares of restricted
stock held by the Pledging  Stockholder (the "Held Stock") within thirty days of
the  agreement  and to use its best  efforts  register  with  the SEC,  both the
Replacement Stock and Premium Stock within 12 months from their date of issue.

The  Company  received  $40,012 of funds but was unable to recover  the  Pledged
Stock on the Termination Date. In addition, due to a delay in registering all of
the  shares  under  this  arrangement,  the  Company  entered  into a  secondary
agreement  with  the  Pledging  Stockholder  providing  for:  (1) the  immediate
issuance of the Replacement  Shares and Premium Shares;  (2) registration of the
Replacement Shares,  Premium Shares and Held Shares; (3) the retroactive accrual
of a penalty  from May 2, 2004  through the date the  registration  statement is
filed  payable in such  number of shares  that is equal to 15% of the Held Stock
(prorated  for each  fraction of a year);  and (4) the accrual of an  additional
penalty from April 2, 2005 through the date the registration  statement is filed
equal to 15% of the  Replacement  Stock and  Premium  Stock  (prorated  for each
fraction of a year).

The Company  recorded a charge of $406,205 for the fair value of the Replacement
Stock and Premium Stock (29,684 shares) issued to the Pledging Stockholder under
this arrangement. Such charge, net of $40,012 of advances received, is presented
as a loss on collateralized  financing arrangement in the accompanying statement
of  operations.  The Company also recorded  charges of $8,560 and $78,247 during
the nine months ended  September  30, 2006 and 2005,  respectively  for the fair
value of 4,497 and 4,353 shares  issuable during the nine months ended September
30, 2006 and 2005, respectively to the Pledging Stockholder as penalties for the
delays in registering the stock.  The charges  associated with the penalties are
included in stock based penalties under collateralized  financing arrangement in
the accompanying statements of operations.


NOTE 16 - COMMITMENTS AND CONTINGENCIES

SEC INVESTIGATION

Pursuant  to  Section  20(a)  of the  Securities  Act and  Section  21(a) of the
Securities Exchange Act, the staff of the SEC (the "Staff"), issued an order (In
the Matter of Patron Systems, Inc. - Order Directing a Private Investigation and
Designating  Officers to Take  Testimony  (C-03739-A,  February 12,  2004)) (the
"Order")  that a  private  investigation  (the "SEC  Investigation")  be made to
determine whether certain actions of, among others, the Company,  certain of its
former officers and directors and others  violated  Section 5(a) and 5(c) of the
Securities Act and/or Section 10 and Rule 10b-5  promulgated  under the Exchange
Act.  Generally,  the Order  provides,  among  other  things,  that the Staff is
investigating (i) the legality of two (2) separate Registration Statements filed
by the Company on Form S-8,  filed on December 20, 2002 and on April 2, 2003, as
amended on April 9, 2003 (collectively, the "Registration Statements"), covering
the  resale  of, in the  aggregate,  145,834  shares of common  stock  issued to
various  consultants  of the Company,  and (ii) whether in  connection  with the
purchase or sale of shares of common  stock,  certain  officers and directors of
the Company and others (a) sold common  stock in  violation  of Section 5 of the
Securities Act and/or, (b) made misrepresentations  and/or omissions of material
facts and/or  employed  fraudulent  devices in  connection  with such  purchases
and/or sales  relating to certain of the  Company's  press  releases  regarding,
among  other  items,   proposed  mergers  and   acquisitions   that  were  never
consummated.  If the SEC brings an action  against the Company,  it could result
in,  among  other  items,  a  civil  injunctive   order  or  an   administrative
cease-and-desist  order being  entered  against the Company,  in addition to the
imposition of a  significant  civil  penalty.  Moreover,  the SEC  Investigation
and/or a subsequent SEC action could affect  adversely the Company's  ability to
have its common stock become  listed on a stock  exchange  and/or  quoted on the
NASD Bulletin  Board or NASDAQ,  the Company  being able to sell its  securities
and/or  have its  securities  registered  with the SEC and/or in various  states
and/or the Company's ability to implement its business plan. The Company's legal
counsel  representing  the Company in such matters has indicated  that while the
SEC  Investigation  is ongoing and the Company has not  received  correspondence
from the SEC  indicating  that the matter is  officially  closed,  the Staff has
indicated  that it does not intend to request  additional  information  from the
Company and that, at


                                       26
<PAGE>


this time,  it does not intend to  recommend  that the SEC bring an  enforcement
action against the Company, its former officers and directors.

LEGAL PROCEEDINGS

On January 5, 2006,  Mark P. Gertz,  Trustee in  bankruptcy  for Arter & Hadden,
LLP,  filed an Adversary  Complaint  for Recovery of Assets of the Estate in the
United  States  Bankruptcy  Court  Northern  District of Ohio Eastern  Division,
against  the  Company as  successor  in merger to  Entelagent.  Mr.  Gertz seeks
$32,278 plus  interest  accruing at the  statutory  rate since July 15, 2003 for
services rendered by Arter & Hadden,  LLP to Entelagent.  On September 11, 2006,
the Company entered into a settlement and release  agreement with Mark P. Gertz,
Trustee in  bankruptcy  for Arter & Hadden,  LLP which  calls for the payment of
$32,500 in 13 installments of $2,500.

On May 4, 2006,  Patron  became  aware that Lok  Technologies,  Inc. had filed a
complaint on or about March 30, 2006 against the  Company,  Entelagent  Software
Corp.  and unnamed  defendants in the Superior  Court of  California,  County of
Santa Clara alleging  breach of contract,  breach of duty of good faith and fair
dealing and unjust enrichment and seeking damages, interest, disgorgement of any
unjust  enrichment,  attorneys fees and cost. Prior to receipt of this notice of
litigation,  the Company  had  recorded a liability  of  $320,000  plus  accrued
interest of $159,432. The Company believes that it has defenses to these claims.
The Company cannot  provide any assurance  that the ultimate  settlement of this
claim will not have a material adverse affect on its financial condition.


NOTE 17 - CREDITOR AND CLAIMANT LIABILITIES RESTRUCTURING

On January 12, 2006, the Company issued a Stock Subscription  Agreement & Mutual
Release ("the Original Release") to each creditor and claimant ("Subscriber") of
the Company for purposes of entering  into a final and binding  settlement  with
respect to any and all claims,  liabilities,  demands,  causes of action, costs,
expenses,  attorneys fees, damages,  indemnities,  and obligations of every kind
and  nature  that  the  creditor  and/or  claimant  may have  with  the  Company
("Subscriber  Claims").  Under terms of this agreement,  the Company sold to the
Subscriber and the Subscriber purchased from the Company shares ("Stock") of its
Series A-1 Preferred stock at a price of $0.80 per share. The aggregate purchase
price was equivalent to the value of the Subscriber Claims being settled through
this  settlement  and release.  Subscriber was deemed to have paid for the Stock
through the settlement and release of Subscriber Claims. Each share of Stock was
automatically  convertible into 1/3 share of the Company's common stock upon the
effectiveness  of an amendment to the  Company's  certificate  of  incorporation
which provided for a sufficient number of authorized but unissued and unreserved
shares of the Company's  common stock to permit the conversion of all issued and
outstanding  shares of Series A-1  Preferred.  The Company issued the Series A-1
Preferred shares following the final  determination of the claims and acceptance
by the Company of each  claimant  submitted  Stock  Subscription  Agreement  and
Mutual Release through countersignature thereof.

The Original  Release also  provided that in the event that (a) a bona fide sale
or (series of related  sales) by the Company of equity  interests in the Company
in  an  amount  equal  to  or  in  excess  of  $3,000,000  or  (b)  any  merger,
consolidation,     recapitalization,      reclassification,     reincorporation,
reorganization,  share exchange,  sale of all or substantially all of the assets
of the Company or comparable transaction, was not consummated on or before March
31, 2006 (the "Termination  Date"),  the Stock  Subscription  Agreement & Mutual
Release would terminate and be null and void, the Series A-1 Preferred issued to
Subscriber  would be cancelled  and the  Subscriber  Claims would remain in full
force and effect on their terms.  Each Subscriber agreed not to transfer or sell
any portion of the Stock until the next business day after the Termination Date,
subject  to (i) an  effective  registration  under  the  Securities  Act or in a
transaction  which is otherwise in compliance  with the Securities  Act, (ii) an
effective  registration  under any applicable state  securities  statute or in a
transaction otherwise in compliance with any applicable state securities statue,
and (iii) evidence of compliance  with the applicable  securities  laws of other
jurisdictions.  As  described  below,  the  Company  completed  the sale of $4.8
million in equity securities under the Series A Preferred Financing on March 27,
2006  thereby  eliminating  the  provision  for  automatic  termination  of this
arrangement.

The Company has filed with the  Securities  and Exchange  Commission on July 24,
2006 a registration statement ("Registration  Statement") covering the resale of
the underlying Stock and has agreed to use its best efforts to cause


                                       27
<PAGE>


such  Registration   Statement  to  become  effective  as  soon  as  practicable
thereafter  and in any  event no later  than  180  days  from the date  that the
Company  countersigns each Stock Subscription  Agreement and Mutual Release. The
Company shall keep the Registration  Statement  continuously effective under the
Securities  Act until the  earlier  of (i) the date when all shares of the Stock
have been sold pursuant to the  Registration  Statement or an exemption from the
registration  requirements  of the  Securities  Act, and (ii) two years from the
effective date of the Registration Statement.

Through  July  21,  2006,  the  Company  issued  additional  Stock  Subscription
Agreements & Mutual  Releases ("the  Additional  Release") to several  creditors
that had not signed the January 12, 2006 Original Release by April 30, 2006. The
terms of the  Additional  Release  were  predominantly  the same as the Original
Release  with  the  exception  of  the  120  day   requirement  for  filing  the
Registration Statement.

On July 21,  2006,  the Board of  Directors  authorized  the  completion  of the
Creditor and Claimant  Liabilities  Restructuring  program.  Under this program,
claims  totaling  $24,467,871  were settled for 36,993,054  shares of Series A-1
Preferred  Stock.  The Company recorded net gains with respect to all claims and
liabilities  settled under this program in the aggregate  amount of  $1,853,055.
The Series A-1 Preferred  shares were  automatically  converted into  12,331,056
shares of the  Company's  common stock on July 31, 2006  following the Company's
effectuation of a 1-for-30 reverse stock split.

The following  table  provides a summary of all claims  settled by category with
the (gain) loss recognized on the settlement:

<TABLE>
<CAPTION>
                                              Series A-1                   Fair Value
Settlement Category                          Stock Issued   Claim Amount     of Stock      Gain/(Loss)
------------------------------------------   ------------   ------------   ------------   ------------
<S>                                            <C>          <C>            <C>            <C>
General Creditors ........................     22,246,601   $ 18,072,357   $ 13,283,857   $  4,788,500
Former Officer/Stockholder ...............      1,549,526   $  1,180,991   $    929,716        251,275
Former Non-Executive Chairman ............        315,438   $    254,152   $    252,350          1,802
Stockholders under Accommodation Agreement      3,000,000      2,400,000      2,400,000           --
Mr. Allin and the Allin Dynastic Trust ...      2,500,000      1,317,089      1,500,000       (182,911)
Other Claimants ..........................      7,381,489      1,243,282      4,248,893     (3,005,611)
                                             ------------   ------------   ------------   ------------
                                               36,993,054   $ 24,467,871   $ 22,614,816   $  1,853,055
                                             ------------   ------------   ------------   ------------
</TABLE>

The fair value of the Series A-1 shares issued in  settlements  reached prior to
June 30, 2006 amounted to $0.60 per share, based on a comparison of the features
of these  shares to similar  shares sold in private  placement  transactions  to
unrelated  parties for cash and the trading price of the Company's shares at the
time of the settlements. Series A-1 shares issued in settlements reached in July
2006, which principally  includes the Company's former  non-executive  chairman,
were  valued at $0.80 per share  commensurate  with an  increase  in the trading
price of the Company's  common stock.  These  agreements  effectuated a complete
settlement of these debts,  claims and liabilities and the mutual release of the
parties with respect thereto.

The Company accounted for the  extinguishment of liabilities  payable to general
creditors in accordance  with SFAS 15  "Accounting  by Debtors and Creditors for
Troubled Debt  Restructurings,"  due to the fact that the holders of these notes
granted to Company  concessions  intended to alleviate its  immediate  liquidity
constraints. These concessions that the creditors granted to the Company enabled
it to (a) effectuate their settlement through an exchange of equity instead of a
use of cash and (b) consummate a private  placement of equity  securities  (Note
18) that resulted in an infusion of cash that was needed to sustain operations.

Claimants other than Mr. Allin and the Allin Dynastic Trust that participated in
the  settlement   include  certain  parties  that  were  previously  engaged  in
litigation with the Company  including the Sherleigh  Associates  Profit Sharing
Plan to which the  Company  issued  2,312,500  shares for a  settlement  loss of
$1,387,500,  Richard Linting to whom the


                                       28
<PAGE>


Company issued 1,777,261 shares for a settlement loss of approximately  $773,000
and the holders of the Marie Graul  claim to whom the Company  issued  1,164,461
shares for a settlement loss of approximately $698,000.

On July 31, 2006, following approval by the Company's stockholders,  the Company
amended  its Second  Amended  and  Restated  Certificate  of  Incorporation,  as
amended, to affect a 1-for-30 reverse stock split.

OTHER LIABILITIES SETTLEMENTS

The Company also settled $660,494 of other liabilities for $28,140 in cash and a
$32,500  note  during the nine  months  ended  September  30,  2006 for which it
recorded net gains in the amount of $599,854.

LOSS (GAIN) ASSOCIATED WITH SETTLEMENT AGREEMENTS

During the nine months  ended  September  30, 2006 as part of the  creditor  and
claimant liabilities restructuring, the Company settled a number of disputed and
unresolved  payables  and  outstanding  claims  resulting  in a  total  gain  on
settlement  of  $1,853,055.  Subsequent  to the  settlement  of the creditor and
claimant  liabilities  restructuring for Series A-1 Preferred Stock, the Company
also settled  other claims that  resulted in a gain of $599,854,  resulting in a
net gain on  settlement of  $2,452,909  for the nine months ended  September 30,
2006.

During the nine months  ended  September  30, 2005,  the Company  entered into a
settlement  agreement  with Cook  Associates  to settle all claims  related to a
lawsuit  filed by Cook  Associates  filed against the Company.  This  settlement
resulted in the Company recognizing a gain on settlement of $389,103.

NOTE 18 - SERIES A AND SERIES A-1 PREFERRED STOCK

On March 1, 2006,  the  Company  filed with the  Delaware  Secretary  of State a
Certificate of Designation of  Preferences,  Rights and  Limitations of Series A
Convertible   Preferred  Stock  and  Series  A-1  Convertible   Preferred  Stock
designating  the rights,  preferences and privileges of 2,160 shares of Series A
Convertible  Preferred  Stock and  50,000,000  shares of Series A-1  Convertible
Preferred Stock.

SERIES A PREFERRED STOCK

The Series A Preferred  Stock has a stated value of $5,000 per share and carries
a dividend  of 10% per annum with such  dividend  accumulating  on a  cumulative
basis.  The dividend is payable only (i) at such time as declared payable by the
Board of Directors of the Company or (ii) in the event of  liquidation,  as part
of the liquidation preference amount ("Liquidation Preference Amount").  Accrued
but unpaid  dividends on the Series A Preferred  amount to $246,968 at September
30, 2006.

The Series A Preferred is convertible,  at the option of the holder, into shares
of the Company's  common stock  ("Conversion  Shares") at an initial  conversion
price ("Initial  Conversion Price") of $2.40 per share based on the stated value
of the Series A Preferred,  subject to adjustment  for stock splits,  dividends,
recapitalizations,  reclassifications, payments made to Common Stock holders and
other similar  events and for issuances of additional  securities at prices more
favorable  than the conversion  price at the date of such issuance.  The Company
evaluated  the  conversion  option at the  commitment  date of the  financing in
accordance with APB 14 and EITF 00-27 and determined  that conversion  price was
not beneficial.

The Series A Preferred is mandatorily  convertible  into shares of the Company's
common stock at the Initial  Conversion Price, which is subject to adjustment as
described above, on the date that: (i) there shall be an effective  registration
statement covering the resale of the Conversion Shares, (ii) the average closing
price of the Company's common stock, for a period of 20 consecutive trading days
is at least 250% of the then applicable  Conversion Price, and (iii) the average
daily  trading  volume of the  Company's  common stock for the same period is at
least 8,334 shares.


                                       29
<PAGE>


The  potential  adjustment  to the  conversion  price that would  occur upon the
completion of a subsequent  financing  transaction  on terms more favorable than
that of the  Series  A  Preferred  (if  any) is  considered  to be a  contingent
conversion  price in accordance with EITF 00-27.  Accordingly,  such adjustments
would be measured and accounted for at the effective time of such adjustment, if
any.

The Series A Preferred Liquidation Preference Amount is equal to 125% of the sum
of: (i) the stated  value of any then  unconverted  shares of Series A Preferred
and (ii) any accrued and unpaid dividends thereon. An event of liquidation means
any liquidation,  dissolution or winding up of the Company, whether voluntary or
involuntary,  as well as any change of control of the Company which includes the
sale by the  Company  of  either  (x)  substantially  all its  assets or (y) the
portion of its assets which comprises its core business technology,  products or
services.

SERIES A-1 PREFERRED STOCK

The Series A-1 Preferred Stock has a stated value of $0.80 per share and carries
a non-cumulative  dividend of 5% per annum,  with such dividend payable only (i)
at such time as  declared  payable by the Board of  Directors  of the Company or
(ii) in the event of liquidation,  as part of the liquidation  preference amount
("Series  A-1  Liquidation  Preference  Amount").  The  Series  A-1  Liquidation
Preference  Amount  is equal  to the sum of:  (i) the  stated  value of any then
unconverted  shares of Series  A-1  Preferred  and (ii) any  accrued  and unpaid
dividends thereon. An event of liquidation means any liquidation, dissolution or
winding up of the  Company,  whether  voluntary or  involuntary,  as well as any
change of control  of the  Company  which  includes  the sale by the  Company of
either (x)  substantially  all its assets or (y) the portion of its assets which
comprises its core business technology, products or services.

The Series A-1 Preferred is not  convertible  at the option of the holder.  Each
share of Series A-1 Preferred  automatically  converts into the Company's common
stock, at a conversion price of $2.40 per share based on the stated value of the
Series A-1 Preferred,  upon the  effectiveness  of an amendment to the Company's
certificate  of  incorporation   which  provides  for  a  sufficient  number  of
authorized  shares to permit  the  exercise  or  conversion  of all  issued  and
outstanding shares of Series A Preferred,  Series A-1 Preferred and all options,
warrants and other rights to acquire shares of the Company's common stock.

Through  September 30, 2006, the Company has issued  36,993,054 shares of Series
A-1 Preferred  Stock which converted upon the  effectiveness  of an amendment to
the Company's Second Amended and Restated Certificate of Incorporation to affect
a 1-for-30  reverse stock split,  into 12,331,056  shares of the Company's newly
split common stock.

PRIVATE PLACEMENT OF SERIES A PREFERRED STOCK AND WARRANTS

In  January  2006,  the  Company  initiated  a  proposed  $5,400,000   financing
transaction (the "Series A Preferred  Financing") which would, for each $100,000
Unit  purchased,  result in the  issuance of (i) 20 shares of Series A Preferred
Stock and (ii) warrants ("Investor Warrants") to purchase 13,888.9 shares of the
Company's common stock.  The minimum amount of the Series A Preferred  Financing
was $3,000,000  ("Minimum  Amount") and the maximum amount was $5,400,000.  Apex
agreed to purchase up to  $1,500,000  which would all be  available  to fund the
Minimum  Amount,  provided  however,  in the event that the  Series A  Preferred
Financing was  over-subscribed as to the Minimum Amount,  then for each $1.00 of
such over  subscription  up to $250,000,  the Apex funding  commitment  would be
reduced on a dollar for dollar basis,  down to a minimum  amount of  $1,250,000.
Additionally,  holders of the 2006 Bridge  Notes were  mandatorily  obligated to
exchange  their 2006 Bridge Notes for Units in the Series A Preferred  Financing
upon consummation of the Series A Preferred Financing at the face value of their
2006 Bridge  Notes.  The  issuance of Units to the holders of 2006 Bridge  Notes
counted toward satisfying the Minimum Amount.

The Investor  Warrants have a term of 5 years and an exercise price of $3.00 per
share.  Each Investor Warrant  entitles the holder thereof to purchase  13,888.9
shares  of the  Company's  common  stock  (the  "Warrant  Shares"),  subject  to
anti-dilution provisions similar to those of the conversion rights of the Series
A Preferred.  The Company was obligated to include the Conversion Shares and the
Warrant Shares in the Registration  Statement originally filed on July 24, 2006.
The Conversion Shares and the Warrant Shares have piggyback registration rights.


                                       30
<PAGE>


In  connection  with the Series A  Preferred  Financing,  the  Company  retained
Laidlaw as its  non-exclusive  placement  agent  ("Series A Preferred  Placement
Agent").  Laidlaw received,  in its role as Series A Preferred  Placement Agent,
(i) a cash fee equal to 10% of all gross proceeds,  excluding the Apex proceeds,
delivered at each Closing and (ii) a warrant (the "Agent  Warrants") to purchase
the  Company's  common  stock  equal to 10% times the sum of (x) the  Conversion
Shares to be issued upon  conversion of the shares of Series A Preferred  issued
at each  Closing  and (y) the  number of shares of the  Company's  common  stock
reserved for issuance upon the exercise of the Investor  Warrants issued at each
closing.  The Agent  Warrants  have a term of 5 years and an  exercise  price of
$3.00 per share.  Additionally,  the  Company  shall pay the Series A  Preferred
Placement  Agent a  non-accountable  expense  allowance  of  $25,000.  The Agent
Warrants  have a fair value of $274,393.  Assumptions  relating to the estimated
fair value of these  warrants  are as  follows:  fair  value of common  stock of
$0.80;  risk-free interest rate of 4.52%;  expected dividend yield zero percent;
expected warrant life of five years; and current volatility of 125%.

On March 3, 2006, the investors in the Series A Preferred  Financing agreed to a
modification of the terms of this financing arrangement to waive the requirement
for 100% completion of the creditor and claimant  liabilities  restructuring for
release of the net  proceeds  of the Series A  Preferred  Financing  in order to
allow the Company to proceed with its business plan and to protect the investors
in the Series A Preferred  Financing.  The  modifications  provided  for the net
proceeds  of the Series A Preferred  Financing  to be  deposited  with an escrow
agent whereby funds would be released to the Company to cover payroll,  rent and
other operating costs,  including eligible payables not otherwise subject to the
creditor and claimant liabilities restructuring, on a bi-monthly basis.

On March 27, 2006, the Company consummated the Series A Preferred Financing with
the  closing of funds  totaling  $4,465,501,  resulting  in the  issuance of 893
shares of Series A Preferred Stock and 620,233 common stock purchase warrants to
the  purchasers  of the Series A Preferred  Stock.  This amount was comprised of
$720,001  associated with the conversion of the Bridge Notes,  $895,000 provided
by Apex and  $2,850,500  from parties  made  available by the Series A Preferred
Placement  Agent.  The  Company  also  issued to Laidlaw  198,375  common  stock
purchase warrants, the "Agent Warrants",  as Series A Preferred Placement Agent.
The Investor Warrants have a fair value of $857,908. Assumptions relating to the
estimated  fair value of these  warrants  are as  follows:  fair value of common
stock of $1.71;  risk-free interest rate of 4.52%;  expected dividend yield zero
percent; expected warrant life of five years; and current volatility of 125%.

On April 3, 2006, the Company  consummated an additional closing of the Series A
Preferred  Financing with the closing of funds totaling  $355,000,  resulting in
the  issuance of 71 shares of Series A Preferred  Stock and 49,306  common stock
purchase warrants.

The 964 shares of Series A Preferred Stock  outstanding as of September 30, 2006
are  convertible,  as described  above,  into 2,008,567  shares of the Company's
newly split common stock.

In order to affect the  availability  of these funds to the Company prior to the
completion of the creditor and claimant liabilities restructuring,  the Company,
on March 27, 2006, entered into a post-closing  restricted cash escrow agreement
("Post-Closing  Escrow Agreement") with an escrow agent ("Escrow Agent").  As of
March 27,  2006,  the  Escrow  Agent was  provided  $2,183,026  in net  offering
proceeds. The escrow agent held the funds and made periodic disbursements to the
Company on or after the 15th of each calendar month and on or after the last day
of each calendar month. The Company was required to provide a detailed  schedule
of  the  mid-month,  month-end  and  maximum  monthly  disbursement  amounts  to
substantiate  its request for a release of any funds. The Company cannot provide
assurance  that the  securing  of  additional  funding,  the  completion  of the
creditor and claimant  liabilities  restructuring  program and the acceptance by
individual  creditors  of  the  claims  settlement  will  actually  improve  the
Company's  ability  to fund the  further  development  of its  business  plan or
improve its operations.


                                       31
<PAGE>


NOTE 19 - STOCKHOLDERS' EQUITY

ADDITIONAL SHARES ISSUED UNDER ANTI-DILUTION PROVISION

Effective April 1, 2006, the Company issued 251,175 shares of common stock under
the provisions of an anti-dilution  agreement associated with private placements
of common stock that occurred in March, August and September 2004.

ISSUANCE OF COMMON STOCK PURCHASE WARRANTS

On January 28, 2006 the Company  issued  warrants for 20,000 shares at an $18.00
per share exercise price to Apex in connection with the Interim Bridge Financing
III financing. The aggregate fair value of these warrants amounted to $20,316.

On February 13, 2006 the Company  issued  warrants for 6,000 shares at an $18.00
per share exercise price to Apex in connection with the Interim Bridge Financing
III financing. The aggregate fair value of these warrants amounted to $6,634.

On February 21, 2006 the Company  issued  warrants for 1,250 shares at an $18.00
per share exercise price to Apex in connection with the Interim Bridge Financing
III financing. The aggregate fair value of these warrants amounted to $1,382.

On March 1, 2006 the Company  issued  warrants for 6,417 shares at an $18.00 per
share exercise price to Apex in connection with the Interim Bridge Financing III
financing. The aggregate fair value of these warrants amounted to $10,029.

On March 17, 2006 the Company issued  warrants for 3,750 shares at an $18.00 per
share exercise price to Apex in connection with the Interim Bridge Financing III
financing. The aggregate fair value of these warrants amounted to $5,861.

On March 22, 2006 the Company issued  warrants for 2,500 shares at an $18.00 per
share exercise price to Apex in connection with the Interim Bridge Financing III
financing. The aggregate fair value of these warrants amounted to $3,907.

On March 27, 2006 the Company issued  warrants for 620,233 shares at a $3.00 per
share  exercise  price to the  investors in the Series A Preferred  Financing in
connection  with the Series A  Preferred  Financing.  Additionally,  the Company
issued  198,375  common stock  purchase  warrants at a $3.00 per share  exercise
price to Laidlaw as placement agent in the Series A Preferred Financing.

On April 3, 2006 the Company  issued  warrants for 49,306  shares at a $3.00 per
share exercise price to Apex in connection with Apex's  investment in the Series
A Preferred Financing.

ISSUANCE OF EMPLOYEE STOCK OPTIONS

During the nine months  ended  September  30,  2006,  the Company  issued  stock
options to employees to purchase  139,914 shares.  These options include a grant
to purchase 73,371 shares at $1.65 per share,  with a fair value of $96,850,  to
the Chief  Operating  Officer of the  Company,  Mr.  Braden  Waverley,  upon the
signing of his employment agreement with the Company.  Additionally, the Company
granted options to purchase 26,204 shares at $1.65 per share,  with a fair value
of $34,589,  to Mr. Martin T. Johnson,  the Company's Chief  Financial  Officer,
upon the signing of his employment agreement with the Company. On July 12, 2006,
the Board of Directors approved the grant of 40,339  non-qualified stock options
to 11 individuals.  The exercise price for these options was $1.35,  the closing
price for the Company's common stock on the date of grant, July 12, 2006.

The fair value of the unvested portion of stock options at September 30, 2006 is
$567,512 with a weighted-average remaining vesting period of 3.3 years.


                                       32
<PAGE>


SHARE-BASED COMPENSATION ARRANGEMENTS

The Company,  since its  inception  has granted  non-qualified  stock options to
various employees and non-employees at the discretion of the Board of Directors.
Substantially all options granted to date have exercise prices equal to the fair
value of underlying  stock at the date of grant and terms of ten years.  Vesting
periods range from fully vested at the date of grant to four years.

As described  in Note 5, the fair value of all awards was  estimated at the date
of grant using the Black-Scholes  option pricing model.  Assumptions relating to
the  estimated  fair value of stock  options that the Company  granted  prior to
January 1, 2006 that were accounted for and recorded  under the intrinsic  value
method prescribed under APB 25 are also described in Note 5.

On February 16, 2006, the Company issued an aggregate of 99,575 stock options to
two newly hired  executives  upon signing  their  employment  agreements.  These
options  are  exercisable  at $1.65 per share and have a term of ten years.  The
aggregate fair value of these options amounts to $131,439.  Assumptions relating
to the  estimated  fair  value of these  stock  options,  which the  Company  is
accounting for in accordance with SFAS 123(R) are as follows: risk-free interest
rate of 4.45%;  expected  dividend yield zero percent;  expected  option life of
four years; and current volatility of 125%.

The risk-free  rate is based on the U.S.  Treasury  yield curve in effect at the
time of grant. The Company has not paid dividends to date and does not expect to
pay  dividends  in the  foreseeable  future due to its  substantial  accumulated
deficit and limited capital  resources.  Accordingly,  expected dividends yields
are currently zero.  Historical  cancellations  and forfeitures of stock options
granted  through  December  31,  2004  have  been  insignificant.  However,  the
Company's operations and the nature of its business changed substantially during
2005 with the  acquisition  of  businesses  and the  recruitment  of a new Chief
Operating Officer in 2006.  Accordingly,  the Company considers more recent data
relating to employee turnover rates to be indicative of future vesting. Based on
available  data, the Company has assumed that  approximately  94% of outstanding
options will vest annually.  Deferred  compensation  relating to options granted
through  December  31, 2005 has been  adjusted to reflect  this  assumption.  No
options have been  exercised to date.  The Company  will  prospectively  monitor
employee  terminations,  exercises  and other  factors  that  could  affect  its
expectations  relating to the vesting of options in future periods.  The Company
will adjust its assumptions  relating to its  expectations of future vesting and
the terms of options at such times that  additional  data indicates that changes
in these assumptions are necessary.  Expected volatility is principally based on
the historical volatility of the Company's stock.

A summary of option  activity for the nine months ended September 30, 2006 is as
follows:

<TABLE>
<CAPTION>
                                                                                   WEIGHTED-
                                                                 WEIGHTED-          AVERAGE
                                                                  AVERAGE          REMAINING
                                                                  EXERCISE        CONTRACTUAL
               OPTIONS                           SHARES            PRICE             TERM
------------------------------------------   --------------    --------------   --------------
<S>                                                 <C>        <C>                   <C>
Outstanding at January 1, 2006 ...........          428,022    $        21.09        7.2 years
Granted ..................................          139,914    $         1.56             --
Exercised ................................             --                --               --
Forfeited or expired .....................          (63,965)   $         9.88             --
Outstanding at September 30, 2006 ........          503,971    $        17.09        7.8 years
Exercisable at September 30, 2006 ........          337,853    $        23.31        5.9 years
</TABLE>

At September 30, 2006, the aggregate  intrinsic value of options outstanding and
options  exercisable,  based on the  September  29,  2006  closing  price of the
Company  common  stock  ($2.00  per share)  amounted  to  $68,000  and  $68,000,
respectively.   In  addition  the  table  includes   156,670  fully  vested  and
non-forfeitable  stock  options  outstanding  that it  issued  to  non-employees
through  December 31,  2005.  As of September  30,  2006,  these  options have a
weighted   average  exercise  price  of  $17.39,   weighted  average   remaining
contractual  term of 6.4  years  and an  aggregate  intrinsic  value of $0.  The
Company  did not  enter  into any stock  based  compensation  arrangements  with
non-employees  during the nine months  ended  September  30,  2006.  Stock based
compensation  expense to  non-employees  amounted to $1,239,083  during the nine
months ended September 30, 2005,  including  $708,750  relating


                                       33
<PAGE>


to stock  options  and  $530,333  relating  to  issuances  of  common  stock for
services. All non-employee stock based compensation awards were accounted for in
accordance with the provisions of EITF 96-18.

The weighted-average  grant-date fair value of the 139,914 stock options granted
during the nine months ended September 30, 2006 amounted to $1.25 per share. The
Company  granted 175,513 stock options with a weighted  average  grant-date fair
value of $8.31 per share or a total  fair  value of  $1,471,656  during the nine
months ended September 30, 2005. There have also not been any exercises of stock
options to date.

As of September 30, 2006, there was $567,512 of unrecognized  compensation  cost
related to non-vested share-based compensation arrangements including $1,214,907
for the fair value of stock options that the Company  accounted for under APB 25
through December 31, 2005 and $175,368 for option granted during the nine months
ended  September 30, 2006 that that the Company is accounting  for in accordance
with  SFAS  123(R).   These  costs  are  expected  to  be   recognized   over  a
weighted-average period of 3.3 years.

The total fair value of options  vested  during the nine months ended  September
30, 2006  amounted  to  $321,011.  The Company did not modify any stock  options
granted to employees or non employees under share based payment arrangements. In
addition,  the Company did not capitalize the cost  associated  with stock based
compensation.

2006 PATRON SYSTEMS, INC. STOCK INCENTIVE PLAN

On July 20,  2006,  the  stockholders  of the Company  approved  the 2006 Patron
Systems,  Inc. Stock Incentive Plan (the "2006 Stock Plan"). The 2006 Stock Plan
provides  for the  granting of  incentive  stock  options to  employees  and the
granting of  nonstatutory  stock options to employees,  non-employee  directors,
advisors,  and  consultants.  The 2006  Stock Plan also  provides  for grants of
restricted stock, stock appreciation  rights and stock unit awards to employees,
non-employee directors, advisors and consultants. The 2006 Stock Plan authorizes
and reserves  5,600,000 shares for issuance of options that may be granted under
plan.

In accordance  with the 2006 Stock Plan, the stated  exercise price shall not be
less than 100% and 85% of the estimated fair market value of common stock on the
date of grant for ISO's and NSO's,  respectively,  as determined by the Board of
Directors  at the  date of  grant.  With  respect  to any 10%  stockholder,  the
exercise  price of an ISO or NSO shall  not be less  than 110% of the  estimated
fair market value per share on the date of grant.

Options  issued  under  the 2006  Stock  Plan  have a term up to  ten-years  and
generally become exercisable over a four-year period.

Shares subject to awards that expire  unexercised or are forfeited or terminated
will  again  become  available  for  issuance  under  the 2006  Stock  Plan.  No
participant in the 2006 Stock Plan can receive option grants, restricted shares,
stock  appreciation  rights or stock units for more than 1,500,000 shares in the
aggregate in any calendar year.

As of September 30, 2006, no options have been granted from the 2006 Stock Plan.


NOTE 20 - DISCONTINUED OPERATIONS/ SALE OF LUCIDLINE

LucidLine,  Inc.  ("LucidLine") was a provider of bundled and branded high speed
Internet access and synchronized remote data back-up, retrieval, and restoration
services.  The  acquisition of LucidLine was intended to supply the expertise to
establish  the  homeland  security  architecture,  the  risk  and  vulnerability
assessment evaluation services and the development and operation of the homeland
security data center  solutions  necessary to implement our former business plan
to offer model homeland security architecture with state-of-the-art  prevention,
response  and  information  management  capabilities.  The actual  results  were
substantially  different.  The Company was unable to find any parties interested
in its  homeland  security  data center  solutions,  its risk and  vulnerability
assessment   services  and  its   homeland   security   architecture   business.
Additionally,  LucidLine's  commercial data backup and storage  business was not
growing sufficiently to cover the costs of operating the business.

During the period from the acquisition of LucidLine on February 25, 2005 through
December 31, 2005,  LucidLine  generated revenue of almost $227,000,  incurred a
net loss of  approximately  $1.4 million and used net cash of over


                                       34
<PAGE>


$1.4 million.  For the period from January 1, 2006 to March 31, 2006,  LucidLine
had revenue of nearly $99,000, a net loss of approximately $105,000 and used net
cash of approximately $194,000.  Additionally,  we recognized a loss on disposal
of almost $76,000.

Because of the Company's  precarious  financial position,  the difficulty it was
experiencing in finding  parties  interested in pursuing the concept of homeland
security  compliant data centers and the general lack of government  funding for
municipalities   and   counties  to  address   homeland   security   focused  IT
infrastructure  projects,  the Company  decided in the first  quarter of 2006 to
abandon its focus on the homeland  security  market portion of its business plan
and to streamline its business to focus on enterprise level software and service
solutions designed to help customers create,  manage and apply complex rule sets
that support business policies, enhance work flow processes,  enforce regulatory
compliance,  and  reduce  the time,  cost and  overhead  of  electronic  message
management.

Having made this decision,  the Company's management undertook a thorough review
of all areas of its business, including the revenue, pricing, supplier contracts
and all other aspects of the LucidLine  business  unit, in an attempt to further
cost-reduce the already  cost-reduced  business which had approximately  $65,000
per month in  negative  cash  flow.  While this  effort  reduced  the  potential
negative cash flow to  approximately  $35,000 per month through  additional cost
reductions, price increases and improved contract management, this negative cash
flow would still result in a  substantial  drain on the  Company's  very limited
cash resources.  On the basis of this analysis,  the Company decided to sell the
business to a party who would purchase LucidLine and assume LucidLine's customer
and supplier contract  commitments.  After approaching a number of parties, none
of whom were interested in acquiring a money losing and  significantly  negative
cash flow business,  Walnut Valley,  Inc. agreed to acquire the legal entity and
all of its customer and supplier contract commitments for a substantial discount
from the price the Company  paid in February  2005.  As the Company had found no
other  interested  buyers and would have  incurred a cash cost to  shutdown  the
business  far in excess of $50,000,  the Company  decided to sell the  LucidLine
business to Walnut Valley.

On April 18, 2006,  the Company  entered into a Stock  Purchase  Agreement  with
Walnut Valley,  Inc.,  pursuant to which the Company sold all of the outstanding
shares of LucidLine to Walnut Valley,  Inc. in consideration  for a cash payment
of $25,000 and the  issuance of a  Promissory  Note in the  principal  amount of
$25,000 by Walnut Valley in favor of the Company.  The Company  consummated  the
sale of LucidLine as a strategic  business  transaction  designed to enhance our
long-term profitability and strategic operations,  and to further streamline its
business focus on electronic message management.

The Company sold LucidLine to Walnut Valley, Inc. for an aggregate consideration
of $50,000. In February 2005, the Company paid to LucidLine's  stockholders cash
in the aggregate amount of $200,000 and issued an aggregate of 146,667 shares of
the Company's common stock valued at $3,740,000.


NOTE 21 - SUBSEQUENT EVENTS

PRIVATE PLACEMENT OF SERIES B PREFERRED STOCK AND WARRANTS

On August 29,  2006,  the  Company  initiated  a proposed  $5,000,000  financing
transaction (the "Series B Preferred  Financing") which would, for each $100,000
Unit  purchased,  result in the  issuance of (i) 20 shares of Series B Preferred
Stock and (ii) warrants  ("Investor  Warrants") to purchase Company common stock
in an amount equal to 50% of the  Conversion  Shares.  The minimum amount of the
Series B Preferred  Financing is $3,000,000  ("Minimum  Amount") and the maximum
amount is  $5,000,000.  Apex has agreed to purchase up to $1,000,000  which will
all be available to fund the Minimum Amount, provided however, in the event that
the Series B Preferred  Financing is  over-subscribed  as to the Minimum Amount,
then for each $1.00 of such over subscription up to $2,000,000, the Apex funding
commitment will be increased by $0.333 to a maximum amount of $1,666,667.

The  Investor  Warrants  have a term of 5 years  and an  exercise  price  of the
greater  of i) $2.40 per share or ii) that  price per share  equal to the volume
weighted  average closing price of the Company's common stock for the 10 trading
days prior to the  Closing  date.  Each  Investor  Warrant  entitles  the holder
thereof to purchase up to 50% of the Conversion Shares in Company's common stock
(the "Warrant Shares"),  subject to anti-dilution provisions similar


                                       35
<PAGE>


to those of the  conversion  rights of the Series B  Preferred.  The  Conversion
Shares and the Warrant Shares have piggyback registration rights.

In  connection  with the Series B  Preferred  Financing,  the  Company  retained
Laidlaw & Company  (UK) Ltd. as its  non-exclusive  placement  agent  ("Series B
Preferred  Placement  Agent").  Laidlaw shall  receive,  in its role as Series B
Preferred  Placement  Agent,  (i) a cash fee equal to 13% of all gross proceeds,
excluding the Apex  proceeds,  delivered at each Closing and (ii) a warrant (the
"Agent  Warrants") to purchase the Company's common stock equal to 10% times the
sum of (x) the Conversion  Shares to be issued upon  conversion of the shares of
Series B  Preferred  issued at each  Closing and (y) the number of shares of the
Company's  common stock  reserved for issuance upon the exercise of the Investor
Warrants  issued at each closing.  The Agent Warrants have a term of 5 years and
an  exercise  price of the  greater  of i) $2.40 per share or ii) that price per
share equal to the volume weighted average closing price of the Company's common
stock for the 10  trading  days prior to the  Closing  date.  Additionally,  the
Company shall pay the Series B Preferred  Placement  Agent legal expenses not to
exceed $25,000.

On October 13, 2006, the Company  consummated  the first closing of the Series B
Preferred Financing with the closing of funds totaling  $3,120,966.  This amount
was comprised of $1,040,322  provided by Apex and  $2,080,644  from parties made
available  by the Series B Preferred  Placement  Agent.  As part of this closing
cash fees equal to $280,484 were paid to the Series B Preferred Placement Agent.

SERIES B PREFERRED STOCK

The Series B Preferred Stock ("Series B Preferred") has a stated value of $5,000
per share, has no maturity date,  carries a dividend of 10% per annum, with such
dividend  accruing on a  cumulative  basis and payable  only (i) at such time as
declared  payable by the Board of  Directors of the Company or (ii) in the event
of  liquidation,  as part of the  liquidation  preference  amount  ("Liquidation
Preference Amount").  The Liquidation  Preference Amount is equal to 125% of the
sum of:  (i) the  stated  value  of any  then  unconverted  shares  of  Series B
Preferred  and  (ii) any  accrued  and  unpaid  dividends  thereon.  An event of
liquidation  means any  liquidation,  dissolution  or winding up of the Company,
whether  voluntary  or  involuntary,  as well as any  change of  control  of the
Company which includes the sale by the Company of either (x)  substantially  all
its assets or (y) the portion of its assets which  comprises  its core  business
technology,  products or services. The Series B Preferred Stock is junior to the
Series A Preferred Stock with respect to liquidation and dividend rights.

The Series B Preferred is convertible,  at the option of the holder, into shares
of the Company's  common stock  ("Conversion  Shares") at an initial  conversion
price  ("Initial  Conversion  Price)  which  shall be the lesser of i) $2.40 per
share or ii) that price per share equal to the volume  weighted  average closing
price  of the  Company's  common  stock  for the 10  trading  days  prior to the
original issuance date of such shares, based on the stated value of the Series B
Preferred, subject to adjustment for stock splits, dividends, recapitalizations,
reclassifications,  payments  made to Common  Stock  holders  and other  similar
events and for issuances of additional  securities at prices more favorable than
the conversion price at the date of such issuance.

The  Series B  Preferred  is  mandatorily  convertible  at the  then  applicable
conversion price ("Conversion  Price") into shares of the Company's common stock
at the then applicable  Conversion Price on the date that: (i) there shall be an
effective  registration  statement covering the resale of the Conversion Shares,
(ii) the average closing price of the Company's common stock, for a period of 20
consecutive  trading  days is at least  250% of the then  applicable  Conversion
Price,  and (iii) the average daily trading volume of the Company's common stock
for the same period is at least 8,334 shares.

FILING OF FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 2006

On April 10, 2007, the Company filed its Form 10-KSB for the year ended December
31,  2006.  The Form  10-KSB  for the year ended  December  31,  2006  should be
referred to for  additional  subsequent  events which have occurred  between the
original  filing date (November 14, 2006) of the Form 10-QSB for the three month
and nine  month  periods  ended  September  30,  2006 and the filing of the Form
10-KSB on April 10, 2007.


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<PAGE>


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS

                      PATRON SYSTEMS, INC. AND SUBSIDIARIES

           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                            AND RESULTS OF OPERATIONS
                               SEPTEMBER 30, 2006

The following  discussion and analysis  should be read in  conjunction  with the
Annual Report on Form 10-KSB,  including the consolidated  financial statements,
and the related notes  thereto,  for the year ended  December 31, 2005 of Patron
Systems,  Inc.  and  subsidiaries  (collectively  referred to as  "Patron,"  the
"Company," "we," "us," or "our").  Except for historical  information  contained
herein, the matters discussed below are forward-looking statements made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995.  Such  statements  involve  risks and  uncertainties,  including,  but not
limited to, economic,  governmental,  political,  competitive and  technological
factors affecting our operations,  markets,  products,  prices and other factors
discussed  elsewhere  in this  report  and  other  reports  filed by us with the
Securities and Exchange Commission  ("SEC").  These factors may cause results to
differ  materially  from the statements made in this report or otherwise made by
or on our behalf.

OVERVIEW

On February 25, 2005,  we  consummated  the  acquisitions  of Complete  Security
Solutions,  Inc.  ("CSSI") and  LucidLine,  Inc.  ("LucidLine")  pursuant to the
filings of Agreements  and Plans of Merger with the  Secretaries of State of the
States of  Delaware  and  Illinois,  respectively.  On  February  28,  2005,  we
consummated a private placement with accredited  investors in the amount of $3.5
million.  On March 30,  2005,  we  consummated  the  acquisition  of  Entelagent
Software Corp. ("Entelagent") pursuant to the filing of an Agreement and Plan of
Merger with the Secretary of State of the State of California. We merged each of
CSSI,  Entelagent and PILEC Disbursement  Company, a wholly-owned  non-operating
subsidiary  into our  company on  September  19,  2006.  From March 31,  2005 to
December 31, 2005, we borrowed  $3,300,000  from a stockholder,  Apex Investment
Fund V,  LP.  During  the  three  months  ended  September  30,  2005 we  raised
approximately  $3,600,000  in additional  gross funds in five capital  financing
transactions, which includes converting $1,650,000 in advances from stockholders
into  Bridge  Notes.  Net  proceeds  from all of these  transaction  amounted to
$3,594,000,  which were used  principally  to fund  operations and repay certain
liabilities.  We discuss these  transactions  in further  detail in this report.
During the nine months ended  September 30, 2006, we raised  $5,640,501 of gross
proceeds  ($5,301,450  net  proceeds  after the  payment of certain  transaction
expenses)  in  various  financing  transactions.  We used  $5,017,206  of  these
proceeds to fund operations and a net of $607,152 in investing activities.

Our strategic  mission is to solve a set of  enterprise-level  customer problems
associated with electronic  message  management,  whether in the form of e-mail,
eforms or instant messaging. Our software and services solutions are designed to
help our  customers  create,  manage and apply  complex  rule sets that  support
business policies,  enhance work flow processes,  enforce regulatory compliance,
and reduce the time,  cost and  overhead  of  message  management.  Our suite of
products  addresses  e-mail  policy  management,   e-mail  retention   policies,
archiving and eDiscovery,  proactive e-mail  supervision,  and the protection of
messages  and their  attachments  in motion  and at rest.  Our  eforms  solution
enables customers to quickly and easily create forms, capture, share, and manage
data in an industry standard format.

We currently offer software solutions that fit into overall corporate compliance
and data protection initiatives by automatically finding, archiving and applying
persistent  protection  to sensitive  data - beyond  authentication  - whenever,
wherever and however sensitive data is shared, accessed and stored. Additionally
we offer software solutions that support real-time secure  collection,  delivery
and  sharing  of  field-based  report  information.  This  software  allows  law
enforcement  and  public-safety  agencies  to have  real-time  access  to  field
reporting  data  for  use  inside  a  department  or  in a  multi-jurisdictional
information sharing system.


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<PAGE>


CRITICAL ACCOUNTING POLICIES

The  preparation of our  consolidated  financial  statements in conformity  with
accounting  principles  generally  accepted  in the  United  States  of  America
requires management to exercise its judgment.  We exercise considerable judgment
with respect to establishing  sound  accounting  polices and in making estimates
and assumptions  that affect the reported amounts of our assets and liabilities,
our  recognition of revenues and expenses,  and  disclosures of commitments  and
contingencies at the date of the financial statements.

On an ongoing basis, we evaluate our estimates and judgments.  Areas in which we
exercise  significant  judgment include, but are not necessarily limited to, our
valuation of accounts  receivable,  recoverability of long-lived assets,  income
taxes,  equity transactions  (compensatory and financing) and contingencies.  We
have also adopted  certain  polices with respect to our  recognition  of revenue
that we believe are consistent with the guidance  provided under  Securities and
Exchange  Commission  Staff  Accounting  Bulletin No. 104 and estimate values of
delivered and undelivered elements.

We base our  estimates  and  judgments  on a variety  of factors  including  our
historical  experience,  knowledge  of our business  and  industry,  current and
expected  economic  conditions,  the  composition  of our  products,  regulatory
environment,  and in  certain  cases,  the  results of  outside  appraisals.  We
constantly  re-evaluate  our  estimates  and  assumptions  with respect to these
judgments and modify our approach when circumstances indicate that modifications
are necessary.

While we believe that the factors we evaluate provide us with a meaningful basis
for  establishing and applying sound  accounting  policies,  we cannot guarantee
that the  results  will always be  accurate.  Since the  determination  of these
estimates  requires the exercise of judgment,  actual  results could differ from
such estimates.

A  description  of  significant  accounting  polices  that  require  us to  make
estimates and  assumptions  in the  preparation  of our  consolidated  financial
statements are as follows:

ACCOUNTS RECEIVABLE AND REVENUE RECOGNITION

We derive  our  revenues  from the  following  sources:  (1)  sales of  computer
software,  which includes new software licenses and software updates and product
support revenues and (2) professional consulting services.

We apply the revenue  recognition  principles set forth under AICPA Statement of
Position ("SOP") 97-2 "Software Revenue Recognition" and Securities and Exchange
Commission Staff  Accounting  Bulletin  ("SAB") 104 "Revenue  Recognition"  with
respect to its  revenue.  Accordingly,  we record  revenue  when (i)  persuasive
evidence  of an  arrangement  exists,  (ii)  delivery  has  occurred,  (iii) the
vendor's fee is fixed or  determinable,  and (iv)  collectability  is reasonably
assured.

We also accrue unbilled revenue under software  licenses and services  delivered
under  contractual  arrangements  which  provide  for  billings  to be  made  at
intervals that may differ from the periods of delivery or performance.

We generate  revenues  through  sales of software  licenses  and annual  support
subscription agreements,  which include access to technical support and software
updates (if and when  available).  Software  license revenues are generated from
licensing  the rights to use products  directly to end-users  and through  third
party service providers.

Revenues from software license agreements are generally recognized upon delivery
of  software to the  customer.  All of our  software  sales are  supported  by a
written  contract  or other  evidence  of sale  transaction  such as a  customer
purchase order.  These forms of evidence  clearly  indicate the selling price to
the  customer,  shipping  terms,  payment  terms  (generally 30 days) and refund
policy,  if any. The selling  prices of these products are fixed at the time the
sale is consummated.

Revenue from post-contract customer support arrangements or undelivered elements
are deferred and  recognized at the time of delivery or over the period in which
the services are performed based on vendor specific  objective  evidence of fair
value for such  undelivered  elements.  Vendor  specific  objective  evidence is
typically  based on the


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<PAGE>


price charged when an element is sold  separately  or, if an element is not sold
separately, on the price established by an authorized level of management, if it
is probable  that the price,  once  established,  will not change  before market
introduction.  We use the residual method prescribed in SOP 98-9,  "Modification
of SOP 97-2, Software Revenue  Recognition With Respect to Certain  Transaction"
to  allocate   revenues  to   delivered   elements   once  it  has   established
vendor-specific objective evidence of fair value for such undelivered elements.

Professional  consulting  services  are  billed  based on the number of hours of
consultant  services provided and the hourly billing rates. We recognize revenue
under these arrangements as the service is performed.

We adjust our accounts receivable balances that we deem to be uncollectible. The
allowance  for doubtful  accounts is our best estimate of the amount of probable
credit losses in our existing accounts  receivable.  We review our allowance for
doubtful  accounts on a monthly  basis to determine  the  allowance  based on an
analysis of its past due  accounts.  All past due balances that are over 90 days
are reviewed  individually for collectability.  Account balances are charged off
against the allowance  after all means of collection have been exhausted and the
potential for recovery is considered  remote. An allowance for doubtful accounts
is not provided because in our opinion,  all accounts  recorded are deemed to be
collectible.

INCOME TAXES

We are required to determine the aggregate  amount of income tax expense or loss
based upon tax statutes in jurisdictions in which we conduct business. In making
these estimates,  we adjust our results  determined in accordance with generally
accepted  accounting  principles  for items that are treated  differently by the
applicable taxing authorities.  Deferred tax assets and liabilities, as a result
of  these  differences,  are  reflected  on  our  balance  sheet  for  temporary
differences  loss and credit  carry  forwards  that will  reverse in  subsequent
years. We also establish a valuation  allowance against deferred tax assets when
it is more likely than not that some or all of the  deferred tax assets will not
be realized.  Valuation  allowances  are based,  in part,  on  predictions  that
management must make as to our results in future periods.  The outcome of events
could differ over time which would  require us to make changes in our  valuation
allowance.

GOODWILL AND INTANGIBLE ASSETS

We account for Goodwill and  Intangible  Assets in accordance  with Statement of
Financial  Accounting  Standards ("SFAS") No. 141,  "Business  Combinations" and
SFAS No.  142,  "Goodwill  and Other  Intangible  Assets."  Under SFAS No.  142,
goodwill and intangibles  that are deemed to have indefinite lives are no longer
amortized but,  instead,  are to be reviewed at least  annually for  impairment.
Application of the goodwill  impairment  test requires  judgment,  including the
identification of reporting units, assigning assets and liabilities to reporting
units,  assigning  goodwill to reporting  units, and determining the fair value.
Significant  judgments  required to estimate the fair value of  reporting  units
include estimating future cash flows, determining appropriate discount rates and
other  assumptions.  Changes in these estimates and assumptions could materially
affect the  determination  of fair value  and/or  goodwill  impairment  for each
reporting unit. During the year ended December, 31, 2005 we recorded $22,440,212
of  goodwill  in  connection  with  the  acquisitions  of  LucidLine,  CSSI  and
Entelagent.  In  accordance  with SFAS 142, we conducted  our annual  impairment
review of goodwill for the year ended  December 31,  2005,  which  resulted in a
goodwill  impairment  charge of $12,929,696 (Note 6). Intangible assets continue
to be amortized over their estimated useful lives.

We  engaged  an  outside  specialist  to assist us with  performing  our  annual
goodwill  impairment  tests.  These tests were made using a discounted cash flow
model  to  value  the  business.  This  approach  requires  us to  forecast  our
expectation  of  revenues  and cash flows in future  periods and to work with an
independent  specialist on developing assumptions relating to the risk that such
cash flows may or may not materialize in future periods.

SHARE BASED PAYMENTS AND OTHER EQUITY TRANSACTIONS

Prior to January 1, 2006, we accounted for employee stock based  compensation in
accordance with Accounting  Principles  Board ("APB") Opinion No. 25 "Accounting
for Stock Issued to Employees." We applied the proforma disclosure  requirements
of SFAS No. 123 "Accounting for Stock-Based Compensation."


                                       39
<PAGE>


Effective  January 1, 2006, we adopted SFAS No. 123R "Share Based Payment." This
statement is a revision of SFAS  Statement No. 123, and  supersedes  APB Opinion
No. 25, and its related implementation  guidance.  SFAS 123R addresses all forms
of share based payment  ("SBP")  awards  including  shares issued under employee
stock purchase plans,  stock options,  restricted  stock and stock  appreciation
rights.  Under SFAS 123R,  SBP awards  result in a cost that is measured at fair
value on the awards' grant date,  based on the  estimated  number of awards that
are expected to vest. We adopted the modified prospective method with respect to
accounting  for  our  transition  to  SFAS  123(R)  and  measured   unrecognized
compensation cost. Under this method of accounting,  we are required to estimate
the  fair  value  of  share  based  payments  that we make to our  employees  by
developing  assumptions  regarding  expected  holding  terms of  stock  options,
volatility  rates and  expectation  of  forfeitures  and future vesting that can
significantly  impact the amount of compensation  cost that we recognize in each
reporting period.

We are also  required to apply  complex  accounting  principles  with respect to
accounting  for  financing  transactions  that we have  consummated  in order to
sustain our business. These transactions, which generally consist of convertible
debt and equity instruments,  require us to use significant judgment in order to
assess the fair values of these instruments at their dates of issuance, which is
critical to making a reasonable  presentation  of our financing costs and how we
finance our business.

Formulating  estimates  in  any of  the  above  areas  requires  us to  exercise
significant  judgment.  It is at least reasonably possible that the estimates of
the effect on the  financial  statements  of a condition,  situation,  or set of
circumstances  that  existed  at the date of the  financial  statements  that we
considered in formulating our estimates could change in the near term due to one
or more future  confirming  events.  Accordingly,  the actual results  regarding
estimates  of any of the  above  items as they are  presented  in the  financial
statements could differ materially from our estimates.


                              RESULTS OF OPERATIONS

THREE  MONTHS  ENDED  SEPTEMBER  30,  2006  COMPARED TO THE THREE  MONTHS  ENDED
SEPTEMBER 30, 2005.

For the three  months  ended  September  30,  2006,  our  consolidated  revenues
amounted to $276,825  compared to $93,457 for the three months  ended  September
30, 2005.  The  increase is  principally  the result of growth of our  business,
principally with the FormStream product, since the combinations were consummated
with CSSI in February 2005 and Entelagent in March 2005.

Cost of Sales for the three months ended  September 30, 2006 amounted to $54,619
compared to $133,124  for the three  months ended  September  30, 2005.  Cost of
sales during the three months ended  September  30, 2006 and  September 30, 2005
includes $44,936 and $133,124, respectively, associated with the amortization of
developed technology that we acquired from CSSI and Entelagent.

Operating  expenses  amounted to $1,315,328 for the three months ended September
30, 2006 as compared to  $2,199,920  for the three  months ended  September  30,
2005, a reduction of $884,592.  The reduction in operating  expenses includes an
increase  of  approximately  $62,000  for  employee  stock  option  compensation
expense,  approximately $300,000 associated with the reduction in value of a put
right  in  2005  and an  increase  of  approximately  $3,000  associated  with a
stock-based  penalty  under  a  collateralized   financing  arrangement.   These
increases were offset by approximately  $42,000 for reduced salaries  associated
with  an  reduction  in the  number  of  employees,  an  approximately  $286,000
reduction in stock-based  compensation expense,  approximately $59,000 reduction
in legal and  professional  fees  associated  with the work performed in 2005 to
bring the Company's SEC filings into  compliance,  a reduction of  approximately
$104,000 in general and administrative  expense, a $135,000 reduction in expense
associated with 2005 penalties under stock-based accommodation agreements and an
approximately  $625,000  reduction  associated  with gains related to settlement
agreements.

Our  consolidated  loss from operations for the three months ended September 30,
2006  amounted  to  $1,156,877  compared to a loss of  $12,677,722  for the same
period in 2005.  Our loss was reduced as a result of the reductions in operating
expenses and the increased revenues discussed above.

Interest  expense  during the three months ended  September 30, 2006 amounted to
$64,564 as compared to  $10,158,714  for the three  months ended  September  30,
2005. The reduction is principally related to the issuance, in


                                       40
<PAGE>


the three  months  ended  September  30,  2005,  of the Bridge III Notes and the
associated  amortization  of deferred  financing costs and the accretion of debt
discounts  incurred with that  financing not being  incurred in the three months
ended September 30, 2006. Additionally, the interest expense associated with the
outstanding  Acquisition  Notes and the Bridge I, Bridge II and Bridge III Notes
in the three months ended  September 30, 2005 was reduced with the exchange of a
substantial  portion  of  these  notes  for  Series  A-1  Preferred  Stock as of
September 30, 2006.  Non-cash  interest relating to the amortization of deferred
financing  costs and the  accretion  of debt  discounts  during the three months
ended September 30, 2006 amounted to  approximately $0 compared to $1,865,355 in
the same period in 2005.  Amortization  of deferred  finance  charges which have
been  classified as interest  expense was $0 in the three months ended September
30, 2006  compared to  $750,334  in the same period in 2005.  Accretion  of debt
discounts during the three months ended September 30, 2006 were approximately $0
compared to $1,115,021 in the same period in 2005. Interest income, was $809 and
$0 in the three months ended September 30, 2006 and 2005, respectively. Interest
income represents the interest earned on cash balances.

During  the three  months  ended  September  30,  2006,  the  Company  presented
accumulated  dividends  on its Series A Preferred  of $122,184 as an increase in
the net loss available to common stockholders.

For the three months ended  September 30, 2006, the net loss available to common
stockholders was $1,279,061 or $(0.12) per share on 10,490,543  weighted average
common  shares   outstanding   compared  to  a  net  loss  available  to  common
stockholders of $12,677,722 or $(6.18) per share on 2,049,970  weighted  average
common shares outstanding for the three months ended September 30, 2005.

NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2005.

For the nine months ended September 30, 2006, our consolidated revenues amounted
to $857,570  compared to $184,300 for the nine months ended  September 30, 2005.
The increase is  principally  the result of growth of our business,  principally
with the FormStream  product,  since the combinations were consummated with CSSI
in February 2005 and Entelagent in March 2005.

Cost of Sales for the nine months ended  September 30, 2006 amounted to $139,560
compared to $282,858 for the nine months ended September 30, 2005. Cost of sales
during the nine months ended  September 30, 2006 and September 30, 2005 includes
$99,980  and  $280,855,  respectively,   associated  with  the  amortization  of
developed technology that we acquired from CSSI and Entelagent.

Operating  expenses  amounted to $3,465,493 for the nine months ended  September
30, 2006 as compared to $6,345,170 for the nine months ended September 30, 2005,
a reduction of  $2,879,677.  The  reduction in  operating  expenses  includes an
increase of approximately $1,086,000 for salaries associated with an increase in
the number of employees  from  acquired  businesses,  approximately  $308,000 of
employee stock option compensation expense, approximately $173,000 for increased
legal and professional fees that we incurred  principally in connection with the
year-end  financial  audit,  the  negotiation  and  settlement  of various legal
matters under the creditor and claimant  liabilities  restructuring  program and
the   implementation  of  the  Series  A  Preferred  Stock  private   placement,
approximately   $23,000  for   amortization  of  acquired   intangible   assets,
approximately  $300,000 associated with the reduction in value of a put right in
2005 and  approximately  $8,000  associated  with a stock-based  penalty under a
collateralized  financing arrangement.  These increases were partially offset by
an approximately $1,239,000 reduction in non-employee stock-based compensation ,
approximately  $2,452,909 in gain  associated with the settlement of outstanding
litigation,  liabilities and claims under the creditor and claimant  liabilities
restructuring,   a   reduction   of   approximately   $240,000  in  general  and
administrative  expense, an expense reduction of $366,000 associated with a 2005
loss  on a  collateralized  financing  arrangement  and  approximately  $824,000
reduction in expense  associated  with a penalty  provision of an  Accommodation
Agreement.

Our  consolidated  loss from  operations for the nine months ended September 30,
2006 amounted to $2,747,483 compared to a loss of $6,443,728 for the same period
in 2005.  Our loss  was  reduced  as a result  of the  reductions  in  operating
expenses and the increase in revenues discussed above.

Interest  expense  during the nine months ended  September  30, 2006 amounted to
$1,125,449 as compared to  $12,355,249  for the nine months ended  September 30,
2005.  The reduction is due to the accretion of debt discounts and the intrinsic
value of the  conversion  option for bridge  note  holders  being lower in total
during the nine months


                                       41
<PAGE>


ended  September  30, 2006 as compared to the nine months  ended  September  30,
2005.  Offsetting this reduction was the increase in interest expense due to the
increased  level of total debt financing  during the nine months ended September
30, 2006 than during the same period in 2005.  Non-cash interest relating to the
amortization  of deferred  financing  costs and the accretion of debt  discounts
during the nine  months  ended  September  30, 2006  amounted  to  approximately
$303,038  compared to $3,678,606 in same period in 2005. The intrinsic  value of
the  conversion  option for bridge note  holders,  which has been  classified as
interest  expense  amounted to $192,000 for the nine months ended  September 30,
2006 compared to $8,000,000 in the same period in 2005. Amortization of deferred
finance charges which have been classified as interest expense was approximately
$282,129 in the nine months ended  September  30, 2006 compared to $1,751,232 in
the same  period in 2005.  Accretion  of debt  discounts  during the nine months
ended September 30, 2006 were  approximately  $20,909  compared to $1,927,374 in
the same  period in 2005.  Interest  income,  was $2,770 and $19,250 in the nine
months  ended  September  30,  2006  and  2005,  respectively.  Interest  income
represents  the interest  earned from loans that we made to Entelagent  prior to
our acquisition of that business on March 30, 2005 and interest on cash balances
in the nine months ended September 30, 2006.

During  the  nine  months  ended  September  30,  2006,  the  Company  presented
accumulated  dividends  on its Series A Preferred  of $246,968 as an increase in
the net loss available to common stockholders.

For the nine months ended  September 30, 2006,  the net loss available to common
stockholders  was $4,298,137 or $(0.87) per share on 4,945,846  weighted average
common  shares   outstanding   compared  to  a  net  loss  available  to  common
stockholders of $19,910,022 or $(10.43) per share on 1,909,483  weighted average
common shares outstanding for the nine months ended September 30, 2005.

LIQUIDITY AND CAPITAL RESOURCES

We incurred a net loss of  $4,051,169  for the nine months ended  September  30,
2006, which includes  $1,172,518 of non-cash charges including  non-cash charges
associated  with the fair  value of common  stock we issued as  penalties  under
certain  registration  rights  agreements  ($8,560),  fair value of a conversion
option in connection with bridge note holders  ($192,000),  accretion related to
warrants  issued in conjunction  with notes payable  ($20,909),  amortization of
deferred financing costs ($282,129),  loss on disposal of discontinued operation
($75,920),  non-cash  increase  in  interest  payable  to a  former  stockholder
($48,400),  depreciation  and  amortization  ($236,845),  and a charge for stock
option based  compensation  ($307,629).  We also used $511,691 of our restricted
cash escrowed to settle liabilities  assumed.  Offsetting these non-cash charges
was the non-cash  gain on  settlement  of  outstanding  liabilities,  claims and
litigation of $2,452,909. Including the amounts above, we used net cash flows in
our operating  activities of $4,732,156  during the nine months ended  September
30,  2006.  Our working  capital  deficiency  at  September  30, 2006 amounts to
$4,968,639 and we are continuing to experience  shortages in working capital. We
are involved in litigation  and are being  investigated  by the  Securities  and
Exchange Commission with respect to certain of our press releases and our use of
form  S-8 to  register  shares  of  common  stock  that  we  issued  to  certain
consultants in prior periods.  Our legal counsel representing us in such matters
has  indicated  that  while the SEC  Investigation  is  ongoing  and we have not
received  correspondence  from the SEC indicating  that the matter is officially
closed,  the Staff has indicated  that it does not intend to request  additional
information from us and that, at this time, it does not intend to recommend that
the SEC bring an enforcement  action  against us, our officers or directors.  We
cannot  provide any assurance  that the outcome of these matters will not have a
material  adverse  affect on our ability to sustain the business.  These matters
raise substantial doubt about our ability to continue as a going concern.

We expect to continue  incurring  losses for the  foreseeable  future due to the
inherent uncertainty that is related to establishing the commercial  feasibility
of technological  products and developing a presence in new markets. Our ability
to  successfully  integrate  the  acquired  businesses  described  in  Note 6 is
critical to the realization of its business plan. We raised  $5,460,501 of gross
proceeds  ($5,301,450  net  proceeds  after the  payment of certain  transaction
expenses) in financing  transactions  during the nine months ended September 30,
2006. We used  $4,732,156 of these  proceeds to fund its operations and a net of
$607,152 in investing  activities,  principally for the purchase and development
of  software  technology.  Additionally,  we made  $125,000  in  legal  payments
associated with the settlement of accommodation  agreements and incurred $54,000
in  deferred   financing  costs.  We  received  $50,000  in  proceeds  from  the
disposition  of  discontinued  operations  and received  $180,000 in proceeds in
connection with a financing settlement.


                                       42
<PAGE>


We are currently in the process of attempting  to raise  additional  capital and
have  taken  certain  steps to  conserve  our  liquidity  while we  continue  to
integrate  the acquired  businesses.  Although we believe that we have access to
capital resources,  we have not secured any commitments for additional financing
at this time nor can we provide any assurance  that we will be successful in our
efforts to raise  additional  capital and/or  successfully  execute our business
plan.  In an effort to  secure  additional  financing,  we  completed  a program
pursuant to which we offered our creditors and claimants an agreement to receive
shares of our capital stock for amounts owed to the holders of our  indebtedness
(including  lenders,  past-due trade  accounts,  and employees,  consultants and
other service providers with claims for fees, wages or expenses).

OFF-BALANCE SHEET ARRANGEMENTS

At September 30, 2006,  we did not have any  relationships  with  unconsolidated
entities  or  financial  partnerships,  such as  entities  often  referred to as
structured finance,  variable interest or special purpose entities,  which would
have  been  established  for  the  purpose  of  facilitating  off-balance  sheet
arrangements or other contractually narrow or limited purposes.  As such, we are
not exposed to any financing,  liquidity, market or credit risk that could arise
if we had engaged in such relationships.

CAUTIONARY STATEMENTS AND RISK FACTORS

The risks noted below and  elsewhere  in this report and in other  documents  we
file  with the SEC are risks  and  uncertainties  that  could  cause our  actual
results   to  differ   materially   from  the   results   contemplated   by  the
forward-looking  statements contained in this report and other public statements
we make.

RISKS RELATED TO OUR COMMON STOCK

THERE IS SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.

We  currently  have a number of  obligations  that we are unable to meet without
generating  additional  revenues  or  raising  additional  capital.  We are also
subject to  substantial  litigation  and an  investigation  by the SEC described
elsewhere herein. If we cannot generate  additional revenues or raise additional
capital in the near future, we may become  insolvent.  As of September 30, 2006,
our cash balance was $60,156 and we had a working capital deficit of $4,968,639.
This raises  substantial doubt about our ability to continue as a going concern.
Historically,  we have  funded  our  capital  requirements  with debt and equity
financing.  Our ability to obtain additional equity or debt financing depends on
a  number  of  factors  including  our  financial  performance  and the  overall
conditions in our industry.  If we are not able to raise additional financing or
if such financing is not available on acceptable terms, we may liquidate assets,
seek or be  forced  into  bankruptcy,  and/or  continue  operations  but  suffer
material harm to our  operations and financial  condition.  These measures could
have a material adverse affect on our ability to continue as a going concern.

We have restructured  approximately $24.5 million of our previously  outstanding
claims,  liabilities,  demands,  causes of action, costs,  expenses,  attorneys'
fees,  damages,  indemnities,  and  obligations  of every kind and  nature  that
certain  creditors  and  claimants  had with us  pursuant  to our  creditor  and
claimant liabilities restructuring described in Note 17. We are currently unable
to provide  assurance that the acceptance of the claims settlement will actually
improve our  ability to fund the further  development  of our  business  plan or
improve  our  operations.  Our failure to fund the  further  development  of our
business plan and operations  would  materially  adversely affect our ability to
continue as a going concern.

INVESTORS MAY NOT BE ABLE TO ADEQUATELY  EVALUATE OUR BUSINESS AND PROSPECTS DUE
TO OUR  LIMITED  OPERATING  HISTORY,  LACK  OF  REVENUES  AND  LACK  OF  PRODUCT
OFFERINGS.

We are at an early stage of executing  our business  plan and have no history of
offering information security capabilities.  We were incorporated in Delaware in
2002. Significant business operations only began with the acquisitions completed
in  February  and March  2005.  As a result of our  limited  history,  it may be
difficult to plan operating  expenses or forecast our revenues  accurately.  Our
assumptions about customer or network requirements


                                       43
<PAGE>


may be wrong.  The revenue and income  potential of these  products is unproven,
and the markets  addressed by these products are volatile.  If such products are
not successful, our actual operating results could be below our expectations and
the expectations of investors and market analysts,  which would likely cause the
price of our common stock to decline.

We  generated  no revenue  from  operations  before  December  31, 2004 and only
limited  revenues  in the year  ended  December  31,  2005.  We have  relied  on
financing   generated   from  our  capital   raising   activities  to  fund  the
implementation  of our business plan. We have incurred  operating and net losses
and negative cash flows from operations since our inception. As of September 30,
2006, we had an  accumulated  deficit of  approximately  $88.7  million.  We may
continue to incur  operating  and net losses,  due in part to  implementing  our
acquisitions  strategy,  engaging in financing  activities  and expansion of our
personnel and our business  development  capabilities.  We will continue to seek
financing for the acquisition of other acquisition  targets that we may identify
in the future.  We continue to believe that we will secure financing in the near
future, but there can be no assurance of our success. If we are unable to obtain
the  necessary  funding,  it will  materially  adversely  affect our  ability to
execute our business plan and to continue our operations.

In addition, we may not be able to achieve or maintain profitability,  and, even
if we do  achieve  profitability,  the  level  of any  profitability  cannot  be
predicted and may vary significantly from quarter to quarter.

THE  AUTOMATIC  CONVERSION  OF OUR SERIES A-1  PREFERRED  STOCK HAS  RESULTED IN
SIGNIFICANT DILUTION TO OUR EXISTING STOCKHOLDERS AND A CHANGE IN CONTROL OF OUR
COMPANY,  AND COULD ALSO  RESULT IN  ADDITIONAL  VOLATILITY  IN THE PRICE OF OUR
COMMON STOCK.

The  automatic  conversion  of our Series A-1  Preferred  Stock on July 31, 2006
resulted in significant  dilution to our existing  stockholders  and resulted in
our former creditors and claimants owning approximately 85.3% of our outstanding
shares of common stock. These creditors and claimants, to the extent they act in
concert, would be able to determine all actions brought before our stockholders.

Upon the  registration  of the shares of common stock issued upon the conversion
of our Series A-1 Preferred Stock,  there will be a substantial amount of shares
eligible  for sale in the  public  market.  If former  holders of our Series A-1
Preferred  Stock decide to sell their  shares of  registered  stock,  such sales
could result in  significant  volatility in the market price of our common stock
and would likely cause the market price of our common stock to decline.

THERE CAN BE NO GUARANTY  THAT A MARKET WILL  DEVELOP FOR THE PRODUCTS WE INTEND
TO OFFER.

We currently have a limited offering of products.  We intend to acquire products
through the acquisition of existing businesses. There is no guarantee,  however,
that a market will develop for Internet security solutions of the type we intend
to  offer.  We cannot  predict  the size of the  market  for  Internet  security
solutions,  the rate at which the  market  will  grow,  or  whether  our  target
customers will accept our acquired products.

OUR  OPERATING  RESULTS  MAY  FLUCTUATE  SIGNIFICANTLY,   WHICH  MAY  RESULT  IN
VOLATILITY OR HAVE AN ADVERSE EFFECT ON THE MARKET PRICE OF OUR COMMON STOCK.

The  market  prices  of the  securities  of  technology-related  companies  have
historically  been  volatile and may continue to be volatile.  Thus,  the market
price of our common stock is likely to be subject to wide  fluctuations.  If our
revenues do not grow or grow more slowly than we  anticipate,  if  operating  or
capital   expenditures   exceed   our   expectations   and   cannot  be  reduced
appropriately,  or if some other event adversely affects us, the market price of
our common stock could decline.  Only a small public market currently exists for
our common stock and the number of shares eligible for sale in the public market
is currently  very limited,  but is expected to increase.  Sales of  substantial
shares in the future would depress the price of our common  stock.  In addition,
we currently do not receive any stock market research coverage by any recognized
stock  market  research  or  trading  firm and our  shares are not traded on any
national  securities  exchange.  A larger and more active  market for our common
stock may not develop.


                                       44
<PAGE>


Because of our limited  operations  history  and lack of assets and  revenues to
date, our common stock is believed to be currently  trading on speculation  that
we will be successful in implementing  our  acquisition  and growth  strategies.
There can be no assurance  that such  success  will be achieved.  The failure to
implement our acquisitions  and growth  strategies would likely adversely affect
the  market  price  of  our  common  stock.  In  addition,  if  the  market  for
technology-related stocks or the stock market in general experiences a continued
or greater loss in investor  confidence or otherwise  fails, the market price of
our common stock could decline for reasons unrelated to our business, results of
operations  and financial  condition.  The market price of our common stock also
might decline in reaction to events that affect other  companies in our industry
even if these events do not directly  affect us.  General  political or economic
conditions, such as an outbreak of war, a recession or interest rate or currency
rate  fluctuations,  could also cause the  market  price of our common  stock to
decline.  Our  common  stock  has  experienced,  and is likely  to  continue  to
experience, these fluctuations in price, regardless of our performance.

WE ARE  CURRENTLY  SUBJECT TO AN SEC  INVESTIGATION  WHICH COULD HAVE AN ADVERSE
AFFECT ON OUR BUSINESS AND RESULTS OF OPERATIONS.

Pursuant  to  Section  20(a)  of the  Securities  Act and  Section  21(a) of the
Securities  Exchange Act of 1934, as amended (the "Exchange  Act"), the staff of
the SEC (the "Staff"),  issued an order (In the Matter of Patron Systems, Inc. -
Order  Directing  a  Private  Investigation  and  Designating  Officers  to Take
Testimony  (C-03739-A,   February  12,  2004))  (the  "Order")  that  a  private
investigation (the "SEC  Investigation") be made to determine whether certain of
our actions and certain of the actions of our former  officers and directors and
others (as described below) violated Section 5(a) and 5(c) of the Securities Act
and/or Section 10 and Rule 10b-5 promulgated under the Exchange Act.  Generally,
the Order provides,  among other things, that the Staff is investigating (i) the
legality of two (2) separate  Registration  Statements  filed by us on Form S-8,
filed on  December  20,  2002 and on April 2, 2003,  as amended on April 9, 2003
(collectively,  the "Registration  Statements"),  covering the resale of, in the
aggregate,   4,375,000   shares  of  common  stock  issued  to  various  of  our
consultants,  and (ii) whether in connection with the purchase or sale of shares
of common stock,  certain of our officers,  directors and others (a) sold common
stock  in  violation  of  Section  5 of the  Securities  Act  and/or,  (b)  made
misrepresentations and/or omissions of material facts and/or employed fraudulent
devices in connection  with such  purchases  and/or sales relating to certain of
our  press  releases  regarding,   among  other  items,   proposed  mergers  and
acquisitions  that were never  consummated.  If the SEC brings an action against
us, it could  result in,  among  other  items,  a civil  injunctive  order or an
administrative  cease-and-desist  order being entered against us, in addition to
the imposition of a significant civil penalty.  Moreover,  the SEC Investigation
and/or a subsequent  SEC action could affect  adversely  our ability to have our
common stock listed on a stock exchange  and/or quoted on the OTC Bulletin Board
or  NASDAQ,  our  ability  to sell our  securities  and/or  have our  securities
registered with the SEC and/or in various states and/or our ability to implement
our  business  plan.  Our legal  counsel  representing  us in such  matters  has
indicated that while the SEC  Investigation  is ongoing and we have not received
correspondence from the SEC indicating that the matter is officially closed, the
Staff has indicated  that it does not intend to request  additional  information
from us and that,  at this time,  it does not intend to  recommend  that the SEC
bring an  enforcement  action  against us or our former  officers and directors.
There can be no  assurance  that the SEC will accept the Staff's  recommendation
not to bring an  enforcement  action against us or that the Staff will not elect
at some future time to seek additional information from us with respect to these
matters.

FUTURE SALES OF SHARES BY EXISTING  STOCKHOLDERS  COULD CAUSE OUR STOCK PRICE TO
DECLINE.

If our  existing  or  future  stockholders  sell,  or  are  perceived  to  sell,
substantial  amounts of our common stock in the public market,  the market price
of our common stock could decline. As of October 13, 2006, there were 14,462,260
shares of common  stock  outstanding,  of which  5,527,432  shares  were held by
directors,  executive  officers  and  other  affiliates,  the sale of which  are
subject to volume limitations under Rule 144, various vesting agreements and our
quarterly  and  other  "blackout"  periods.   Furthermore,   shares  subject  to
outstanding  options and warrants and shares  reserved for future issuance under
our stock option plan will become  eligible for sale in the public market to the
extent  permitted by the provisions of various vesting  agreements,  the lock-up
agreements and Rule 144 under the Securities Act.


                                       45
<PAGE>


THE  UNPREDICTABILITY  OF AN ACQUIRED COMPANY'S  QUARTERLY RESULTS MAY CAUSE THE
TRADING PRICE OF OUR COMMON STOCK TO DECLINE.

The quarterly  revenues and  operating  results of companies we may acquire will
likely continue to vary in the future due to a number of factors,  many of which
are outside of our control.  Any of these  factors  could cause the price of our
common stock to decline. The primary factors that may affect future revenues and
future operating results include the following:

         o        the demand for our subsidiaries' current product offerings and
                  our future products;

         o        the length of sales cycles;

         o        the timing of recognizing revenues;

         o        new product introductions by us or our competitors;

         o        changes in our pricing policies or the pricing policies of our
                  competitors;

         o        variations in sales channels, product costs or mix of products
                  sold;

         o        our ability to develop,  introduce and ship in a timely manner
                  new  products  and  product  enhancements  that meet  customer
                  requirements;

         o        our ability to obtain  sufficient  supplies of sole or limited
                  source components for our products;

         o        variations in the prices of the components we purchase;

         o        our  ability to attain and  maintain  production  volumes  and
                  quality  levels for our products at  reasonable  prices at our
                  third-party manufacturers;

         o        our ability to manage our customer base and credit risk and to
                  collect our accounts receivable; and

         o        the  financial  strength  of  our  value-added  resellers  and
                  distributors.

Our  operating  expenses are largely  based on  anticipated  revenues and a high
percentage  of our  expenses  are,  and will  continue to be, fixed in the short
term. As a result,  lower than  anticipated  revenues for any reason could cause
significant  variations  in our  operating  results from quarter to quarter and,
because of our rapidly growing operating  expenses,  could result in substantial
operating losses.

OUR  COMMON  STOCK  IS  SUBJECT  TO THE  SEC'S  PENNY  STOCK  RULES.  THEREFORE,
BROKER-DEALERS MAY EXPERIENCE DIFFICULTY IN COMPLETING CUSTOMER TRANSACTIONS AND
TRADING ACTIVITY IN OUR SECURITIES MAY BE ADVERSELY AFFECTED.

If at any time a company has net tangible  assets of  $5,000,000 or less and the
common  stock has a market price per share of less than $5.00,  transactions  in
the common stock may be subject to the "penny stock" rules promulgated under the
Exchange Act. Under these rules, broker-dealers who recommend such securities to
persons other than institutional accredited investors must:

         o        make a  special  written  suitability  determination  for  the
                  purchaser;

         o        receive the  purchaser's  written  agreement to a  transaction
                  prior to sale;

         o        provide the purchaser  with risk  disclosure  documents  which
                  identify  certain risks  associated  with  investing in "penny
                  stocks" and which describe the market for these "penny stocks"
                  as well as a purchaser's legal remedies; and

         o        obtain a signed and dated  acknowledgment  from the  purchaser
                  demonstrating  that the  purchaser  has actually  received the
                  required risk  disclosure  document  before a transaction in a
                  "penny stock" can be completed.

If our common stock becomes subject to these rules,  broker-dealers  may find it
difficult  to  effectuate  customer  transactions  and  trading  activity in our
securities  may be  adversely  affected.  As a result,  the market  price of our
securities may be depressed, and stockholders may find it more difficult to sell
their shares of our common stock.


                                       46
<PAGE>


RISKS RELATED TO OUR BUSINESS

WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE ACQUIRED BUSINESSES.

Our business plan is dependent upon the acquisition and integration of companies
that have previously operated independently.  To date we have experienced delays
in  implementing  our business  plan as a result of limited  capital  resources,
which have had a material adverse effect on our business.  Further delays in the
process of integrating  could cause an interruption  of, or loss of momentum in,
the activities of our business and the loss of key  personnel.  The diversion of
management's attention and any delays or difficulties  encountered in connection
with our integration of acquired  operations could have an adverse effect on our
business, results of operations, financial condition or prospects.

WE CURRENTLY DO NOT HAVE SUFFICIENT  REVENUES TO SUPPORT OUR BUSINESS ACTIVITIES
AND IF OPERATING LOSSES CONTINUE,  WILL BE REQUIRED TO OBTAIN ADDITIONAL CAPITAL
THROUGH FINANCINGS WHICH WE MAY NOT BE ABLE TO SECURE.

To achieve our intended growth, we will require substantial  additional capital.
We have  encountered  difficulty  and delays in raising  capital to date and the
market   environment  for  development  stage  companies,   like  ours,  remains
particularly challenging. There can be no assurance that funds will be available
when  needed or on  acceptable  terms.  Technology  companies  in  general  have
experienced  difficulty in recent years in accessing  capital.  Our inability to
obtain  additional  financing  may require us to delay,  scale back or eliminate
certain of our growth  plans which could have a material  and adverse  effect on
our business,  financial condition or results of operations or could cause us to
cease  operations.  Even if we are able to  obtain  additional  financing,  such
financing  could be  structured  as  equity  financing  that  would  dilute  the
ownership percentage of any investor in our securities.

DOWNTURNS IN THE INTERNET  INFRASTRUCTURE,  NETWORK SECURITY AND RELATED MARKETS
MAY DECREASE OUR REVENUES AND MARGINS.

The  market  for our  current  products  and other  products  we intend to offer
depends on economic  conditions  affecting the broader Internet  infrastructure,
network  security  and related  markets.  Downturns  in these  markets may cause
enterprises  and  carriers to delay or cancel  security  projects,  reduce their
overall or security-specific  information technology budgets or reduce or cancel
orders for our current  products and other products we intend to offer.  In this
environment, customers such as distributors,  value-added resellers and carriers
may  experience  financial  difficulty,  cease  operations and fail to budget or
reduce  budgets for the  purchase of our current  products or other  products we
intend to offer.  This,  in turn,  may lead to longer  sales  cycles,  delays in
purchase  decisions,  payment  and  collection,  and may  also  result  in price
pressures,  causing us to realize  lower  revenues,  gross margins and operating
margins.  In  addition,   general  economic   uncertainty  caused  by  potential
hostilities involving the United States,  terrorist  activities,  the decline in
specific markets such as the service  provider market in the United States,  and
the general  decline in capital  spending in the information  technology  sector
make it difficult to predict changes in the purchase and network requirements of
our potential  customers and the markets we intend to serve. We believe that, in
light of these events, some businesses may curtail or eliminate capital spending
on  information  technology.  A decline in capital  spending  in the  markets we
intend to serve may  adversely  affect our future  revenues,  gross  margins and
operating margins and make it necessary for us to gain significant  market share
from our future  competitors in order to achieve our financial goals and achieve
profitability.

COMPETITION MAY DECREASE OUR PROJECTED REVENUES, MARKET SHARE AND MARGINS.

The market for network security  products is highly  competitive,  and we expect
competition  to intensify in the future.  Competitors  may gain market share and
introduce new competitive  products for the same markets and customers we intend
to serve with our products.  These products may have better  performance,  lower
prices and broader  acceptance than the products we currently offer or intend to
offer.

Many of our potential competitors have longer operating histories,  greater name
recognition,   large  customer  bases  and  significantly   greater   financial,
technical,  sales, marketing and other resources than we have. In addition, some
of our  potential  competitors  currently  combine  their  products  with  other
companies'  networking and security products.


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<PAGE>


These  potential  competitors  also  often  combine  their  sales and  marketing
efforts. Such activities may result in reduced prices, lower gross and operating
margins and longer sales  cycles for the products we currently  offer and intend
to offer.  If any of our larger  potential  competitors  were to commit  greater
technical,  sales,  marketing  and other  resources  to the markets we intend to
serve, or reduce prices for their products over a sustained  period of time, our
ability to successfully  sell the products we intend to offer,  increase revenue
or meet our or market analysts expectations could be adversely affected.

FAILURE TO ADDRESS  EVOLVING  STANDARDS  IN THE NETWORK  SECURITY  INDUSTRY  AND
SUCCESSFULLY  DEVELOP AND INTRODUCE NEW PRODUCTS OR PRODUCT  ENHANCEMENTS  WOULD
CAUSE OUR REVENUES TO DECLINE.

The market for network security products is characterized by rapid technological
change, frequent new product introductions, changes in customer requirements and
evolving   industry   standards.   We  expect  to  introduce  our  products  and
enhancements  to existing  products to address  current  and  evolving  customer
requirements and broader networking trends and  vulnerabilities.  We also expect
to develop products with strategic partners and incorporate third-party advanced
security  capabilities  into  our  intended  product  offerings.  Some of  these
products and enhancements  may require us to develop new hardware  architectures
that involve complex and time consuming processes. In developing and introducing
our  intended  product  offerings,  we have  made,  and will  continue  to make,
assumptions with respect to which features,  security  standards and performance
criteria will be required by our potential customers.  If we implement features,
security  standards  and  performance  criteria  that are  different  from those
required by our potential  customers,  market acceptance of our intended product
offerings may be significantly reduced or delayed,  which would harm our ability
to penetrate existing or new markets.

Furthermore,  we may not be able to develop new products or product enhancements
in a timely  manner,  or at all. Any failure to develop or  introduce  these new
products and product  enhancements  might cause our existing products to be less
competitive, may adversely affect our ability to sell solutions to address large
customer  deployments  and, as a  consequence,  our  revenues  may be  adversely
affected.  In addition,  the introduction of products embodying new technologies
could render existing  products we intend to offer obsolete,  which would have a
direct,  adverse  effect on our market  share and  revenues.  Any failure of our
future products or product enhancements to achieve market acceptance could cause
our revenues to decline and our operating  results to be below our  expectations
and the expectations of investors and market analysts,  which would likely cause
the price of our common stock to decline.

WE HAVE EXPERIENCED ISSUES WITH OUR FINANCIAL  SYSTEMS,  CONTROLS AND OPERATIONS
THAT COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Our ability to sell our intended  product  offerings  and implement our business
plan successfully in a volatile and growing market requires effective management
and financial systems and a system of financial processes and controls.  Through
the quarter  ended  December 31, 2005,  our Chief  Executive  Officer and Acting
Chief Financial Officer  evaluated the effectiveness of our disclosure  controls
and  procedures  in  accordance  with  Exchange  Act Rules  13a-15 or 15d-15 and
identified material weakness in our internal controls. These material weaknesses
affected  our ability to timely file our  reports  with the SEC and  communicate
critical  information to management that was needed to make business  decisions.
Although  we have taken steps to correct  these  previous  deficiencies  and are
currently in compliance with the SEC's reporting  requirements,  we have limited
capital  resources  and are still at risk for the loss of key  personnel  in our
finance department.  The loss of key personnel in our finance department, or any
other  conditions  that could disrupt our operations in this area,  could have a
material  adverse affect on our ability to communicate  critical  information to
management and our investors,  raise capital and/or maintain compliance with our
SEC reporting  obligations.  These  circumstances,  if they arise,  could have a
material adverse affect on our business.

We have  limited  management  resources to date and are still  establishing  our
management and financial systems.  Growth, to the extent it occurs, is likely to
place a considerable strain on our management resources,  systems, processes and
controls.  To address  these  issues,  we will need to  continue  to improve our
financial and managerial  controls,  reporting systems and procedures,  and will
need to continue to expand, train and manage our work force worldwide. If we are
unable to maintain an adequate level of financial processes and controls, we may
not be able to accurately report our financial performance on a timely basis and
our business and stock price would be harmed.


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<PAGE>


IF OUR FUTURE  PRODUCTS DO NOT  INTEROPERATE  WITH OUR END CUSTOMERS'  NETWORKS,
INSTALLATIONS WOULD BE DELAYED OR CANCELLED,  WHICH COULD  SIGNIFICANTLY  REDUCE
OUR ANTICIPATED REVENUES.

Future  products will be designed to interface with our end customers'  existing
networks,  each of which have  different  specifications  and  utilize  multiple
protocol standards. Many end customers' networks contain multiple generations of
products  that  have  been  added  over time as these  networks  have  grown and
evolved.  Our future products must  interoperate with all of the products within
these  networks  as well as with  future  products  that might be added to these
networks in order to meet end customers' requirements.  If we find errors in the
existing  software used in our end customers'  networks,  we may elect to modify
our  software  to fix or  overcome  these  errors  so  that  our  products  will
interoperate and scale with their existing software and hardware.  If our future
products do not  interoperate  with those  within our end  customers'  networks,
installations  could be delayed or orders for our products  could be  cancelled,
which could significantly reduce our anticipated revenues.

AS A PUBLIC  COMPANY,  WE MAY  INCUR  INCREASED  COSTS AS A RESULT  OF  RECENTLY
ENACTED AND  PROPOSED  CHANGES IN LAWS AND  REGULATIONS  RELATING  TO  CORPORATE
GOVERNANCE MATTERS AND PUBLIC DISCLOSURE.

Recently  enacted and  proposed  changes in the laws and  regulations  affecting
public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and
rules adopted or proposed by the SEC will result in increased costs for us as we
evaluate the  implications of these laws,  regulations and standards and respond
to their  requirements.  These laws and regulations could make it more difficult
or more costly for us to obtain certain types of insurance,  including  director
and officer liability  insurance,  and we may be forced to accept reduced policy
limits and  coverage or incur  substantially  higher costs to obtain the same or
similar  coverage.  The impact of these events could also make it more difficult
for us to  attract  and  retain  qualified  persons  to  serve  on our  board of
directors,  board  committees or as executive  officers.  We cannot estimate the
amount or timing of additional  costs we may incur as a result of these laws and
regulations.

WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS  EFFECTIVELY  IN A RAPIDLY
CHANGING  MARKET,  AND IF WE ARE UNABLE TO HIRE  ADDITIONAL  PERSONNEL OR RETAIN
EXISTING  PERSONNEL,  OUR  ABILITY TO EXECUTE  OUR  BUSINESS  STRATEGY  WOULD BE
IMPAIRED.

Our  future  success  depends  upon  the  continued  services  of our  executive
officers. The loss of the services of any of our key employees, the inability to
attract  or  retain  qualified  personnel  in the  future,  or  delays in hiring
required  personnel,  could  delay the  development  and  introduction  of,  and
negatively impact our ability to sell, our intended product offerings.

WE MIGHT HAVE TO DEFEND  LAWSUITS OR PAY DAMAGES IN CONNECTION  WITH ANY ALLEGED
OR ACTUAL FAILURE OF OUR PRODUCTS AND SERVICES.

Because our intended product  offerings and services provide and monitor network
security and may protect valuable information,  we could face claims for product
liability,  tort or breach of  warranty.  Anyone who  circumvents  our  security
measures could misappropriate the confidential  information or other property of
end  customers  using our  products,  or  interrupt  their  operations.  If that
happens,  affected  end  customers  or others may sue us.  Defending  a lawsuit,
regardless of its merit, could be costly and could divert management  attention.
Our business  liability  insurance coverage may be inadequate or future coverage
may be unavailable on acceptable terms or at all.

WE COULD BECOME SUBJECT TO LITIGATION  REGARDING  INTELLECTUAL  PROPERTY  RIGHTS
THAT COULD BE COSTLY AND RESULT IN THE LOSS OF SIGNIFICANT RIGHTS.

In recent  years,  there has been  significant  litigation  in the United States
involving patents and other intellectual  property rights. We may become a party
to litigation in the future to protect our intellectual  property or as a result
of an alleged infringement of another party's intellectual property.  Claims for
alleged infringement and any resulting lawsuit, if successful,  could subject us
to significant liability for damages and invalidation of our proprietary rights.
These lawsuits,  regardless of their success, would likely be time-consuming and
expensive to resolve and would


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<PAGE>


divert  management  time and  attention.  Any  potential  intellectual  property
litigation could also force us to do one or more of the following:

         o        stop or delay  selling,  incorporating  or using products that
                  use the challenged intellectual property; and/or

         o        obtain from the owner of the infringed  intellectual  property
                  right a license to sell or use the relevant technology,  which
                  license might not be available on reasonable  terms or at all;
                  or redesign the products that use that technology.

If we are forced to take any of these  actions,  our business might be seriously
harmed.  Our insurance may not cover potential claims of this type or may not be
adequate to indemnify us for all liability that could be imposed.

OUR INABILITY TO OBTAIN ANY THIRD-PARTY LICENSE REQUIRED TO DEVELOP NEW PRODUCTS
AND PRODUCT  ENHANCEMENTS  COULD REQUIRE US TO OBTAIN  SUBSTITUTE  TECHNOLOGY OF
LOWER QUALITY OR PERFORMANCE STANDARDS OR AT GREATER COST, WHICH COULD SERIOUSLY
HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

From time to time, we may be required to license  technology  from third parties
to develop new products or product enhancements. Third-party licenses may not be
available to us on  commercially  reasonable  terms or at all. Our  inability to
obtain any  third-party  license  required  to develop  new  products or product
enhancements  could require us to obtain substitute  technology of lower quality
or  performance  standards or at greater cost,  which could  seriously  harm our
business, financial condition and results of operations.

GOVERNMENTAL  REGULATIONS  AFFECTING  THE  IMPORT OR EXPORT  OF  PRODUCTS  COULD
NEGATIVELY AFFECT OUR REVENUES.

Governmental  regulation  of imports  or  exports or failure to obtain  required
export approval of our encryption  technologies could harm our international and
domestic sales.  The United States and various foreign  governments have imposed
controls,  export license  requirements and restrictions on the import or export
of some technologies,  especially encryption technology.  In addition, from time
to time, governmental agencies have proposed additional regulation of encryption
technology,  such as requiring the escrow and  governmental  recovery of private
encryption keys.

In particular,  in light of recent terrorist  activity,  governments could enact
additional regulation or restrictions on the use, import or export of encryption
technology.  Additional  regulation  of  encryption  technology  could  delay or
prevent the  acceptance and use of encryption  products and public  networks for
secure  communications.  This might  decrease  demand for our  intended  product
offerings and services.  In addition,  some foreign  competitors  are subject to
less stringent controls on exporting their encryption technologies. As a result,
they may be able to compete  more  effectively  than we can in the  domestic and
international network security market.

MANAGEMENT COULD INVEST OR SPEND OUR CASH OR CASH EQUIVALENTS AND INVESTMENTS IN
WAYS THAT MIGHT NOT ENHANCE OUR RESULTS OF OPERATIONS OR MARKET SHARE.

We have  made no  specific  allocations  of our  cash  or cash  equivalents  and
investments.  Consequently,  management  will  retain a  significant  amount  of
discretion over the application of our cash or cash  equivalents and investments
and could spend the proceeds in ways that do not improve our  operating  results
or increase our market share. In addition, these proceeds may not be invested to
yield a favorable rate of return.


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<PAGE>


                          PART II - OTHER INFORMATION

ITEM 6. EXHIBITS

See attached Exhibit Index.



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<PAGE>


                                   SIGNATURES

In accordance with the  requirements of the Exchange Act, the registrant  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.


Date: May 21, 2007                   PATRON SYSTEMS, INC.
                                         (Registrant)


                                        /s/ Braden Waverley
                                     -------------------------------------------
                                     By:    Braden Waverley
                                     Its:   Chief Executive Officer


                                        /s/ Martin T. Johnson
                                     -------------------------------------------
                                     By:    Martin T. Johnson
                                     Its:   Chief Financial Officer


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<PAGE>


                                  EXHIBIT INDEX


EXHIBIT
NUMBER                              DESCRIPTION OF EXHIBIT
-------        -----------------------------------------------------------------

10.1           Stock  Purchase  Agreement  dated April 18, 2006  between  Patron
               Systems, Inc. and Walnut Valley, Inc.  Previously filed with  the
               Form 10-QSB.

31.1           Certification   of  Principal   Executive   Officer  pursuant  to
               Securities  Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted
               pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2           Certification   of  Principal   Financial   Officer  pursuant  to
               Securities  Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted
               pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1           Certification  of  Principal  Executive  Officer  pursuant  to 18
               U.S.C.  Section 1350,  as adopted  pursuant to Section 906 of the
               Sarbanes-Oxley Act of 2002.

32.2           Certification  of  Principal  Financial  Officer  pursuant  to 18
               U.S.C.  Section 1350,  as adopted  pursuant to Section 906 of the
               Sarbanes-Oxley Act of 2002.


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