UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





ýQUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
quarterly period endedOctober
3, 2009





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





For the
transition period from _____________ to _____________





Commission
File Number 000-33389





nFinanSe
Inc.





(Exact
name of registrant as specified in its charter)





Nevada
            65-1071956(State
      or other jurisdiction of
            (IRS
      Employer Identification No.)incorporation
      or organization)3923
      Coconut Palm Drive, Suite 107Tampa,
      Florida
            33619(Address
      of principal executive offices)
            (Zip
      Code)Issuer’s
      telephone number, including area code:
            (813)
      367-4400





Indicate
by check mark whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.





Yes
            X
            
            No





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).





Yes
            X
            
            No





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer   £
            Accelerated
      filer   £Non-accelerated
      filer (Do not check if a smaller reporting company)   £
            Smaller
      reporting company   T





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 stock, as
of the latest practicable date:
9,934,452shares of
common stock, $0.001 par value, outstanding as of November 6,
2009





DBI/63907448.2





nFinanSe
      Inc.A
      Development Stage EnterpriseTable
      of ContentsPage
      No.NOTE
      REGARDING FORWARD LOOKING STATEMENTS
            1PART
      I - FINANCIAL INFORMATIONItem
      1.     Financial Statements:Consolidated
      Balance Sheets as of October 3, 2009 (unaudited) and January 3, 2009
      (audited)
            2Consolidated
      Statements of Operations (unaudited) for the thirteen and thirty-nine
      weeks ended October 3, 2009 and September 27, 2008, and for the period
      July 10, 2000 (inception) to October 3, 2009
            3Consolidated
      Statements of Cash Flows (unaudited) for the thirty-nine weeks ended
      October 3, 2009 and September 27, 2008, and for the period July 10, 2000
      (inception) to October 3, 2009
            4Notes
      to Consolidated Financial Statements (unaudited)
            6Item
      2.     Management’s Discussion and Analysis of
      Financial Condition and Results of Operations.
            22Item
      3.     Quantitative and Qualitative Disclosures
      About Market Risk.
            29Item
      4T.     Controls and Procedures.
            29PART
      II - OTHER INFORMATIONItem
      1.     Legal Proceedings.
            30Item
      2.     Unregistered Sales of Equity Securities
      and Use of Proceeds.
            30Item
      3.     Defaults Upon Senior
      Securities.
            31Item
      4.     Submission of Matters to a Vote of
      Security Holders.
            31Item
      5.     Other Information.
            31Item
      6.     Exhibits.
            33SIGNATURES










DBI/63907448.2


FORWARD-LOOKING
STATEMENTS





In this
quarterly report, we make a number of statements, referred to as “forward-looking statements,”
which are intended to convey our expectations or predictions regarding the
occurrence of possible future events or the existence of trends and factors that
may impact our future plans and operating results. These forward-looking
statements are derived, in part, from various assumptions and analyses we have
made in the context of our current business plan and information currently
available to us and in light of our experience and perceptions of historical
trends, current conditions and expected future developments and other factors we
believe to be appropriate in the circumstances. You can generally identify
forward-looking statements through words and phrases such as “seek,” “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “budget,” “project,” “may be,” “may continue,” “may likely result,”and other similar
expressions and include statements regarding:





·
            the
      extent to which we continue to experience losses;·
            our
      real property leases and expenses related thereto;·
            our
      ability to fund our future cash needs through public or private equity
      offerings and debt financings;·
            whether
      our business strategy, expansion plans and hiring needs will significantly
      escalate our cash needs;·
            our
      need to raise additional capital and, if so, whether our success will
      depend on raising such capital;·
            our
      expectation of continued and increasing governmental regulation of the
      stored value card industry;·
            our
      anticipation of future earnings volatility;·
            our
      entrance into additional financings, which can result in a recognition of
      derivative instrument liabilities; and·
            the
      hiring of a substantial number of additional employees in sales,
      operations and customer service.





When
reading any forward-looking statement you should remain mindful that all such
statements are inherently uncertain as they are based on current expectations
and assumptions concerning future events or future performance of the Company,
and that actual results or developments may vary substantially from those
expected as expressed in or implied by that statement for a number of reasons or
factors, including those relating to:





·
            our
      ability to design and market our products;·
            the
      estimated timing of our product roll-outs;·
            our
      ability to protect our intellectual property rights and operate our
      business without infringing upon the intellectual property rights of
      others;·
            the
      changing regulatory environment related to our
products;·
            whether
      or not markets for our products develop and, if they do develop, the pace
      at which they develop;·
            our
      ability to attract the qualified personnel to implement our growth
      strategies,·
            our
      ability to develop sales and distribution capabilities;·
            our
      ability to work with our distribution partners;·
            the
      accuracy of our estimates and projections;·
            our
      ability to fund our short-term and long-term financing
    needs;·
            changes
      in our business plan and corporate strategies; and·
            other
      risks and uncertainties discussed in greater detail in this quarterly
      report, including those risks discussed under the heading “Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.”





Each
forward-looking statement should be read in context with, and with an
understanding of, the various other disclosures concerning the Company, as well
as other public reports filed with the United States Securities and Exchange
Commission. You should not place undue reliance on any forward-looking statement
as a prediction of actual results or developments. We are not obligated to
update or revise any forward-looking statement contained in this quarterly
report to reflect new events or circumstances unless and to the extent required
by applicable law.





As used
in this quarterly report, the terms “we,” “us,” “our,” “nFinanSe,” and “the Company” mean nFinanSe
Inc. and subsidiaries unless otherwise indicated. All dollar amounts in this
quarterly report are in U.S. dollars unless otherwise stated.





-1-





PART
I - FINANCIAL INFORMATION





Item
1. Financial Statements.


nFinanSe
Inc.


(A Development Stage
Enterprise)


CONSOLIDATED
BALANCE SHEETS





October
      3,
            
            
            January
      3,2009
            
            
            2009ASSETS
            
            (unaudited)
            
            
            (audited)CURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            5,407,887
            
            
            $
            475,608Restricted
      cash
            
            
            478,318
            
            
            
            472,500Receivables:Accounts
      (net of allowance for doubtful accounts of $0 and $0,
      respectively)
            
            
            47,398
            
            
            
            52,078Other
            
            
            25,478
            
            
            
            25,776Prepaid
      expenses and other current assets, including prepaid marketing costs of
      approximately $55,800 and $224,600, respectively
            
            
            297,313
            
            
            
            402,505Current
      portion of deferred financing costs (net of accumulated amortization of
      $383,305 and $38,301, respectively)
            
            
            76,601
            
            
            
            421,306Inventories
            
            
            2,638,591
            
            
            
            2,885,779Total
      current assets
            
            
            8,971,586
            
            
            
            4,735,552PROPERTY
      AND EQUIPMENT  (net of accumulated depreciation of $888,970 and
      $703,785, respectively)
            
            
            442,354
            
            
            
            625,746OTHER
      ASSETSDeferred
      financing costs (net of accumulated amortization of $1,279,603 and
      $127,532, respectively)
            
            
            259,349
            
            
            
            1,402,849Deferred
      cost of marketing incentive agreement warrants
              (net
      of accumulated amortization and impairment expenses of $532,926 and
      $151,676, respectively)
            
            
            -
            
            
            
            381,250Other
      assets
            
            
            107,331
            
            
            
            272,404TOTAL
      ASSETS
            
            $
            9,780,620
            
            
            $
            7,417,801LIABILITIES AND STOCKHOLDERS’
      EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            $
            454,675
            
            
            $
            343,020Accrued
      personnel costs
            
            
            178,314
            
            
            
            105,772Accrued
      inventory liability
            
            
            -
            
            
            
            210,159Accrued
      lease and contractual obligations
            
            
            246,624
            
            
            
            150,241Credit
      facility and term loans outstanding
            
            
            500,000
            
            
            
            1,200,000Deferred
      revenues
            
            
            6,667
            
            
            
            31,250Other
      accrued liabilities
            
            
            25,247
            
            
            
            522,113Total
      current liabilities
            
            
            1,411,527
            
            
            
            2,562,555COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS’
      EQUITY:Preferred
      stock - $0.001 par value:  25,000,000 shares authorized;
      16,758,487 and 12,537,984  shares issued and outstanding on
      October 3, 2009 and January 3, 2009, respectively, as
    follows:Series
      A Convertible Preferred Stock – 9,330,514 shares authorized; 7,500,484 and
      7,500,484 shares  issued and outstanding with a liquidation
      value of $7,611,594 and $7,692,620 (including undeclared accumulated
      dividends in arrears of $94,356 and $192,136) at October 3, 2009 and
      January 3, 2009, respectively
            
            
            7,
      500
            
            
            
            7,500Series
      B Convertible Preferred Stock – 1,000,010 shares authorized; 1,000,000
      shares issued and outstanding with a liquidation value of $3,000,000 at
      October 3, 2009 and January 3, 2009,respectively
            
            
            1,000
            
            
            
            1,000Series
      C Convertible Preferred Stock – 4,100,000 shares authorized; 4,037,500
      shares issued and outstanding with a liquidation value of $8,075,000 at
      October 3, 2009 and January 3, 2009, respectively
            
            
            4,038
            
            
            
            4,038Series
      D Convertible Preferred Stock – 4,666,666 shares
      authorized;  4,220,503 shares issued and outstanding with a
      liquidation value of $12,661,509 at October 3, 2009 and none at January 3,
      2009, respectively
            
            
            4,221
            
            
            
            -Common
      stock - $0.001 par value: 200,000,000 shares authorized; 9,934,452
      and  9,344,108 shares issued and outstanding as of October 3,
      2009 and January 3, 2009, respectively
            
            
            9,934
            
            
            
            9,344Additional
      paid-in capital
            
            
            71,142,913
            
            
            
            56,770,705Deficit
      accumulated during the development stage
            
            
            (62,800,513
            )
            
            
            (51,937,341
            )Total
      stockholders’ equity
            
            
            8,369,093
            
            
            
            4,855,246TOTAL LIABILITIES AND STOCKHOLDERS’
      EQUITY
            
            $
            9,780,620
            
            
            $
            7,417,801





See notes
to consolidated financial statements.


-2-


nFinanSe
Inc.


(A Development Stage
Enterprise)





CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)


For
      the
              thirteen
              weeksended
              October
      3, 2009
            
            
            For
      the
              thirteen
              weeksended
              September
      27, 2008
            
            
            For
      the
              thirty-nine
              weeks
      ended
              October
      3, 2009
            
            
            For
      the
              thirty-nine
              weeks
      ended
              September
      27, 2008
            
            
            For
      the
              period
              July
      10, 2000
              (inception)to
              October
      3, 2009REVENUES
            
            $
            6,706
            
            
            $
            13,202
            
            
            $
            2,826
            
            
            $
            29,194
            
            
            $
            1,242,403OPERATING
      EXPENSESTransaction
      and operating expenses
            
            
            461,902
            
            
            
            657,182
            
            
            
            1,833,974
            
            
            
            1,594,626
            
            
            
            6,600,165Selling
      and marketing expenses
            
            
            470,881
            
            
            
            939,470
            
            
            
            1,401,548
            
            
            
            3,016,436
            
            
            
            9,441,525General
      and administrative expenses
            
            
            1,411,571
            
            
            
            2,066,567
            
            
            
            4,357,302
            
            
            
            6,265,037
            
            
            
            34,860,898Total
      operating expenses
            
            
            2,344,354
            
            
            
            3,663,219
            
            
            
            7,592,824
            
            
            
            10,876,099
            
            
            
            50,902,588Loss
      before other income (expense)
            
            
            (2,337,648
            )
            
            
            (3,650,017
            )
            
            
            (7,589,998
            )
            
            
            (10,846,905
            )
            
            
            (49,660,185
            )Other
      income (expense):Interest
      expense
            
            
            (624,083
            )
            
            
            (38,712
            )
            
            
            (2,903,500
            )
            
            
            (94,178
            )
            
            
            (4,900,261
            )Interest
      income
            
            
            19
            
            
            
            13,645
            
            
            
            113
            
            
            
            20,487
            
            
            
            1,164,538Gain
      (loss) on derivative instruments
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (396,032
            )
            
            
            1,449,230Loss
      from litigation
            
            
            -
            
            
            
            (55,000
            )
            
            
            -
            
            
            
            (55,000
            )
            
            
            (105,500
            )Loss
      on debt extinguishment
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,685,518
            )Registration
      rights penalties
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (98,649
            )Other
      income (expense)
            
            
            800
            
            
            
            -
            
            
            
            (962
            )
            
            
            (758
            )
            
            
            (95,576
            )Total
      other income (expense)
            
            
            (623,264
            )
            
            
            (80,067
            )
            
            
            (2,904,349
            )
            
            
            (525,481
            )
            
            
            (7,271,736
            )Loss
      from continuing operations
            
            
            (2,960,912
            )
            
            
            (3,730,084
            )
            
            
            (10,494,347
            )
            
            
            (11,372,386
            )
            
            
            (56,931,921
            )Loss
      from discontinued operations
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (3,861,579
            )Net
      loss
            
            
            (2,960,912
            )
            
            
            (3,730,084
            )
            
            
            (10,494,347
            )
            
            
            (11,372,386
            )
            
            
            (60,793,500
            )Dividends
      paid on Series A Convertible
      Preferred    Stock
            
            
            -
            
            
            
            (189,519
            )
            
            
            (368,825
            )
            
            
            (585,837
            )
            
            
            (2,007,015
            )Undeclared
      and unpaid dividends on Series A Convertible Preferred
    Stock
            
            
            (111,110
            )
            
            
            (91,444
            )
            
            
            (111,110
            )
            
            
            (91,444
            )
            
            
            (111,110
            )Net
      loss attributable to common stockholders
            
            $
            (3,072,022
            )
            
            $
            (4,011,047
            )
            
            $
            (10,974,282
            )
            
            $
            (12,049,667
            )
            
            $
            (62,911,625
            )Net
      loss per share - basic and diluted:
            
            $
            (0.32
            )
            
            $
            (0.44
            )
            
            $
            (1.14
            )
            
            $
            (1.42
            )Weighted
      average number of shares outstanding
            
            
            9,533,436
            
            
            
            9,155,743
            
            
            
            9,605,996
            
            
            
            8,504,943





See notes
to consolidated financial statements.


-3-


nFinanSe
Inc.


(A Development Stage
Enterprise)





CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)





For
      the
              thirty-nine
              weeks
      ended
              October
      3, 2009
            
            
            For
      the
              thirty-nine
              weeks
      ended
              September
      27, 2008
            
            
            For
      the
              period
              July
      10, 2000
              (inception)
      to
              October
      3,
              2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (10,494,347
            )
            
            $
            (11,372,386
            )
            
            $
            (60,793,500
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            185,978
            
            
            
            224,817
            
            
            
            1,436,781Provision
      for inventory obsolescence
            
            
            223,186
            
            
            
            98,825
            
            
            
            888,994Provision
      for bad debts
            
            
            -
            
            
            
            57
            
            
            
            461,972Amortization
      of intangible assets
            
            
            -
            
            
            
            -
            
            
            
            15,485Stock-based
      compensation and consulting
            
            
            347,300
            
            
            
            1,529,389
            
            
            
            8,442,102Purchased
      in process research and development
            
            
            -
            
            
            
            -
            
            
            
            153,190Loss
      (gain) on derivative instruments
            
            
            -
            
            
            
            396,032
            
            
            
            (1,449,230
            )Loss
      on debt extinguishments
            
            
            -
            
            
            
            -
            
            
            
            4,685,518Loss
      on disposal of assets
            
            
            809
            
            
            
            394
            
            
            
            29,572Loss
      from impairment of assets
            
            
            594,563
            
            
            
            224,437
            
            
            
            2,064,646Debt
      forgiveness as a result of litigation settlement
            
            
            -
            
            
            
            -
            
            
            
            (50,000
            )Non-cash
      interest expense
            
            
            2,459,327
            
            
            
            42,374
            
            
            
            3,362,575Other
      non-cash expense
            
            
            6,038
            
            
            
            2,269
            
            
            
            15,947Changes in assets and
      liabilities, net:Restricted
      cash
            
            
            (5,818
            )
            
            
            -
            
            
            
            (478,318
            )Receivables
            
            
            4,977
            
            
            
            9,027
            
            
            
            (372,585
            )Prepaid
      expenses and other current assets
            
            
            449,897
            
            
            
            (124,737
            )
            
            
            (135,602
            )Inventories
            
            
            (195,349
            )
            
            
            (1,191,742
            )
            
            
            (3,616,721
            )Other
      assets
            
            
            165,073
            
            
            
            (237,319
            )
            
            
            (56,519
            )Assets
      of discontinued operations
            
            
            -
            
            
            
            -
            
            
            
            (229,060
            )Accounts
      payable and accrued  liabilities
            
            
            (394,228
            )
            
            
            182,990
            
            
            
            1,118,887Accrued
      registration rights penalties
            
            
            -
            
            
            
            -
            
            
            
            98,649Deferred
      revenues
            
            
            (24,583
            )
            
            
            (56,250
            )
            
            
            6,667NET
      CASH USED IN OPERATING ACTIVITIES
            
            
            (6,677,177
            )
            
            
            (10,271,823
            )
            
            
            (44,400,550
            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
            
            
            (4,195
            )
            
            
            (148,141
            )
            
            
            (2,114,900
            )Early
      redemption of short-term investment
            
            
            -
            
            
            
            725,496
            
            
            
            (2,504
            )Investment
      in Product Benefits Systems Corporation
            
            
            -
            
            
            
            -
            
            
            
            (15,737
            )Cash
      advanced under note receivable
            
            
            -
            
            
            
            -
            
            
            
            (202,000
            )Other
            
            
            -
            
            
            
            -
            
            
            
            (15,000
            )NET CASH PROVIDED BY (USED
      IN)   INVESTING ACTIVITIES
            
            
            (4,195
            )
            
            
            577,355
            
            
            
            (2,350,141
            )





(Continued)


-4-


nFinanSe
Inc.


(A Development Stage
Enterprise)





CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)





For
      the
              thirty-nine
              weeks
      ended
              October
      3,
              2009
            
            
            For
      the
              thirty-nine
              weeks
      ended
              September
      27,
              2008
            
            
            For
      the
              period
              July
      10, 2000
              (inception)
      to
              October
      3,
              2009CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuance of Series A Convertible Preferred Stock
            
            
            -
            
            
            
            -
            
            
            
            4,000,000Proceeds
      from issuance of Series B Convertible Preferred Stock
            
            
            -
            
            
            
            -
            
            
            
            3,000,000Proceeds
      from issuance of Series C Convertible Preferred Stock
            
            
            -
            
            
            
            8,075,000
            
            
            
            8,075,000Proceeds
      from issuance of Series D Convertible Preferred Stock
            
            
            6,936,199
            
            
            
            -
            
            
            
            6,936,199Proceeds
      from borrowings
            
            
            4,700,000
            
            
            
            -
            
            
            
            11,265,162Repayments
      of notes payable
            
            
            -
            
            
            
            -
            
            
            
            (147,912
            )Collections
      on note receivable from stockholder
            
            
            
            
            
            
            -
            
            
            
            3,000,000Payment
      for deferred financing costs
            
            
            -
            
            
            
            (432,660
            )
            
            
            (459,606
            )Payments
      for stock issuance costs
            
            
            (22,548
            )
            
            
            (683,580
            )
            
            
            (1,519,289
            )Proceeds
      from the exercise of vested stock options
            
            
            -
            
            
            
            -
            
            
            
            8,249Proceeds
      from the issuance of Common Stock
            
            
            -
            
            
            
            2,840,000
            
            
            
            18,000,775NET
      CASH PROVIDED BY FINANCING ACTIVITIES
            
            
            11,613,651
            
            
            
            9,798,760
            
            
            
            52,158,578





NET
      CHANGE IN CASH AND CASH EQUIVALENTS
            
            
            4,932,279
            
            
            
            104,292
            
            
            
            5,407,887CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            475,608
            
            
            
            2,497,365
            
            
            
            -CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            5,407,887
            
            
            $
            2,601,657
            
            
            $
            5,407,887SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid
            
            $
            446,330
            
            
            $
            31,859
            
            
            $
            1,001,894Income
      taxes paid
            
            $
            -
            
            
            $
            -
            
            
            $
            -SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Acquisition
      of assets by issuance of Common Stock
            
            $
            -
            
            
            $
            -
            
            
            $
            818,200Reclassification
      of proceeds from sales of Common Stock to derivative financial instrument
      liabilities
            
            $
            -
            
            
            $
            -
            
            
            $
            4,007,443Issuance
      of Common Stock for net assets of Pan American Energy Corporation in a
      recapitalization  - see Note A
            
            $
            -
            
            
            $
            -
            
            
            $
            2,969,000Issuance
      of Common Stock in lieu of cash payment of registration
      penalties
            
            $
            -
            
            
            $
            -
            
            
            $
            652,625Reclassification
      of long-lived assets to assets of discontinued telecom
      operations
            
            $
            -
            
            
            $
            -
            
            
            $
            100,000Warrants
      issued to DFS Services, LLC
            
            $
            -
            
            
            $
            (2,269
            )
            
            $
            535,302Warrants
      issued to Lenders
            
            $
            1,353,877
            
            
            $
            1,454,958
            
            
            $
            2,884,258Conversion
      of Series A Convertible Preferred Stock to Common Stock
            
            $
            -
            
            
            $
            320,000
            
            
            $
            1,828,000Dividends
      on Series A Convertible Preferred Stock
            
            $
            179,772
            
            
            $
            585,837
            
            
            $
            2,007,015Conversion
      of Senior Secured Convertible Promissory Notes and accrued interest to
      Series A Convertible Preferred Stock
            
            $
            -
            
            
            $
            -
            
            
            $
            5,327,934Exchange
      of Accommodation and Term Loans and accrued interest to Series D
      Convertible Preferred Stock
            
            $
            5,693,898
            
            
            $
            -
            
            
            $
            5,693,898





See notes
to consolidated financial statements.


-5-





nFinanSe
Inc.


(A Development Stage
Enterprise)





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





NOTE A -FORMATION, BACKGROUND AND OPERATIONS
OF THE COMPANY





Background





The
accompanying consolidated financial statements include the accounts of nFinanSe
Inc. (formerly Morgan Beaumont, Inc.) and those of its wholly owned
subsidiaries, nFinanSe Payments Inc. and MBI Services Group, LLC (currently
dormant) (collectively, the “Company,” “we, ” “us, ” or “our”).  All
significant inter-company balances and transactions have been
eliminated.  We made the decision to abandon MBI Services Group, LLC’s
prepaid telephone card business in the fourth quarter of fiscal
2006.  We accounted for this discontinued operation using the
component-business approach in accordance with a certain accounting standard as
defined in the Accounting Standards Codification (“ASC”). As such, the
results of MBI Services Group, LLC have been eliminated from ongoing operations
for all periods presented and shown as a single line item on the statements of
operations entitled “Loss from discontinued operations” for each period
presented.  Because we are continuing to raise funds, and because our
revenues have been minimal, we are considered to be a development stage
enterprise as defined in an ASC.





nFinanSe
Inc. is a provider of stored value cards (“SVCs”), for a wide
variety of markets, including grocery stores, convenience stores, general
merchandise stores and direct to customer through on-line or direct marketing
activities. Our products and services are aimed at capitalizing on the growing
demand for stored value and reloadable ATM/prepaid card financial products. We
believe SVCs are a fast-growing product segment in the financial services
industry.





Basis of
Presentation





The
consolidated financial statements contained herein have been prepared in
accordance with generally accepted accounting principles for interim financial
statements, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, these financial statements do not include all the information and
footnotes required by generally accepted accounting principles for annual
financial statements. In addition, certain comparative figures for the prior
year and inception to date period may have been reclassified to conform with the
current year’s presentation. In the opinion of management, the accompanying
consolidated financial statements contain all the adjustments necessary
(consisting only of normal recurring accruals and adjustments) to fairly present
the financial position of the Company at October 3, 2009 and January 3, 2009,
its results of operations for the thirteen weeks and the thirty-nine weeks ended
October 3, 2009 (“3Q2009” and “39 Wks 2009”,
respectively) and for the thirteen weeks and the thirty-nine weeks ended
September 27, 2008 (“3Q2008” and “39 Wks 2008”,
respectively) and its cash flows for the 39 Wks 2009 and 39 Wks 2008. Operating
results for 3Q2009 and 39 Wks 2009 are not necessarily indicative of the results
that may be expected for the fiscal year ending January 2, 2010. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company’s Annual Report on Form 10-K for the fiscal year ended January 3,
2009.




Revenue
Recognition





We
generate the following types of revenues:






•
       Wholesale fees, charged to our prepaid card distributors when our
      SVCs are reloaded.•
       Transaction fees, paid by the applicable networks and passed through
      by our card issuing banks when our SVCs are used in a purchase or ATM
      transaction.•
       Maintenance fees, charged to an SVC with a cash balance for initial
      activation and monthly maintenance.•
       Interest revenue, on overnight investing of SVC balances by our card
      issuing bank.




-6-





In July
2009, we made the decision to follow common industry practice in connection with
the initial sale of a reloadable SVC. As such, we lowered the retail price of
our reloadable general spend card from $5.95 collected at the point of sale to
$3.00 and we charge a $2.95 maintenance/activation fee to the card balance upon
activation by the card holder.  As a result, in accordance with our
existing distribution contracts, the fees previously retained by the
retailer/distributor at the point of sale now exceed the amount that is
collected at point of sale. As such, we now pay to the distributor a “Retailer
Fee” when our SVCs are sold as opposed to collecting a wholesale fee. The
difference is recouped when we charge the initial $2.95 maintenance fee. The net
result is essentially the same, but the manner in which it is collected now
follows common industry practice. We still charge a wholesale fee for reload
transactions.





Our
revenue recognition policy is consistent with the criteria set forth in SEC
guidance for determining when revenue is realized or realizable and earned. In
accordance with the requirements of this guidance, we recognize revenue when (1)
persuasive evidence of an arrangement exists (2) delivery has occurred (3) our
price to the buyer is fixed or determinable and (4) collectibility of the
receivables is reasonably assured. We recognize the costs of these revenues,
including the cost of printing the cards, packaging and collateral material, at
the time revenue is recognized.  Certain periodic card costs are
recognized as incurred.





Accounts Receivable and
Allowance for Doubtful Accounts





Our
credit terms to our prepaid card distributors for our wholesale fees and the
load value of gift cards and of the reloadable general spend cards vary by
customer but are less than two weeks. Payroll card loads are remitted by the
sponsor company directly to the issuing bank, in advance. Transaction fees and
interest income are paid monthly in arrears by the card-issuing bank
approximately two weeks into the month following the recognition of such fees or
interest income.  Maintenance fees are charged to active cards with
balances upon activation and then on the same day of each month in
arrears.





Accounts
receivable are determined to be past due if payment is not made in accordance
with the terms of our contracts. Receivables are written off when they are
determined to be uncollectible.  Our customers are typically prepaid
card distributors and large multi-unit retailers. We perform ongoing credit
evaluations of our customers and, with the exception of some minimum cash
balances, we generally do not require collateral.





We
evaluate the allowance for doubtful accounts based upon our review of the
collectability of our receivables in light of historical experience, adverse
situations that may affect our customers’ ability to repay, estimated value of
any underlying collateral and prevailing economic conditions. This evaluation is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available.





Use of
Estimates





The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements. The reported amounts of
revenues and expenses during the reporting period may be affected by the
estimates and assumptions we are required to make. Estimates that are critical
to the accompanying consolidated financial statements arise from our belief that
(1) we will be able to raise and generate sufficient cash to continue as a going
concern (2) all long-lived assets are recoverable, and (3) our inventory is
properly valued and deemed recoverable.  In addition, stock-based
compensation expense represents a significant estimate.  The markets
for our products are characterized by intense competition, rapid technological
development, evolving standards and regulations and short product life cycles,
all of which could impact the future realization of our assets. Estimates and
assumptions are reviewed periodically and the effects of revisions are reflected
in the period that they are determined to be necessary. It is at least
reasonably possible that our estimates could change in the near term with
respect to these matters.


-7-


Cash and Cash
Equivalents





For
purposes of the statement of cash flows, we consider all highly liquid
investments with an original maturity of thirteen weeks or less to be cash
equivalents.





Restricted
Cash





Funds
classified as restricted cash as at October 3, 2009 relate to loan advances on
our credit facility, as described in Note C – Credit Facility and Term
Notes.





Inventories





Inventories
are charged to operations using the first in, first out method. Our inventory
costs generally arise from costs incurred to produce SVCs, including costs for
plastic and packaging, embossing fees, printing fees and
shipping.  During the 39 Wks 2009, we recognized impairment charges of
$219,351 on certain inventory items due to obsolescence.  These
impairment charges are included in transaction and operating
expenses.  Inventories consist of the following:


October
      3, 2009
            
            
            January
      3, 2009Finished
      cards
            
            $
            3,148,705
            
            
            $
            2,582,661Inventory
      in process
            
            
            165,285
            
            
            
            474,5333,313,990
            
            
            
            3,057,194Less
      reserve for damaged and obsolete inventory at distributors
            
            
            675,400
            
            
            
            171,415Total
      Inventories
            
            $
            2,638,590
            
            
            $
            2,885,779





Property and
Equipment





Property
and equipment are stated at cost. Major additions are capitalized, but minor
additions which do not extend the useful life of an asset, and maintenance and
repairs are expensed as incurred. Depreciation and amortization are provided
using the straight-line method over the shorter of the lease term, if any, or
the assets' estimated useful lives, which range from three to ten
years.





Long-Lived
Assets





In
accordance with ASC we evaluate the recoverability of long-lived assets and the
related estimated remaining lives when events or circumstances lead us to
believe that the carrying value of an asset may not be recoverable. During the
39 Wks 2009, we recognized impairment charges of $375,212 on an intangible asset
related to a marketing incentive agreement.  These impairment charges
are included in general and administrative expenses in the accompanying
statements of operations





As of
October 3, 2009, our estimates indicate that the remaining long-lived assets are
recoverable.





Advertising
Costs





Advertising
expenses, which were approximately $300,900 and $1,084,300 during the 39 Wks
2009 and the 39 Wks 2008, respectively, are expensed as incurred. The majority
of advertising for the 39 Wks 2009 was related to attending trade shows and
employing media consultants, while the majority of advertising for the 39 Wks
2008 was related to national trade print advertising.  At October 3,
2009, we had approximately $56,000 in prepaid marketing of which the majority is
related to product placement payments and advertising promotional payments made
to a nation-wide retailer. The product placement payments are being amortized as
a reduction of revenue over the contract period and the promotional payments are
expensed when the advertising event occurs.


-8-


Research and
Development





Research
and development costs, which approximated $806,200 and $907,200 during the 39
Wks 2009 and the 39 Wks 2008, respectively, are expensed as
incurred.  These costs are primarily related to network software
development, security compliance and systems maintenance.





Net Loss Per
Share





We
compute net loss per share in accordance with ASC and SEC
guidance.  Basic net loss per share is computed by dividing the net
loss attributable to common stockholders for the period after deducting
dividends on our Series A Convertible Preferred Stock (“Series A Preferred
Stock”) by the weighted average number of common shares outstanding
during the period. Diluted net loss per share is computed by dividing the net
loss for the period by the number of common and common equivalent shares
outstanding during the period (common stock equivalents arise from options,
warrants and convertible preferred stock). Because of our net losses, none of
these common stock equivalents have been dilutive at any time since our
inception; accordingly basic and diluted net loss per share are identical for
each of the periods in the accompanying consolidated statements of
operations.





The
following table lists the total of the Company’s common stock, par value $0.001
per share (the “Common
Stock”) and our common stock equivalents outstanding at October 3,
2009:





Description
            
            Shares
      of Common Stock and Common Stock Equivalents OutstandingCommon
      Stock
            
            
            9,934,452Series
      A Convertible Preferred Stock *
            
            
            7,500,484Series
      B Convertible Preferred Stock *
            
            
            1,000,000Series
      C Convertible Preferred Stock *
            
            
            4,037,500Series
      D Convertible Preferred Stock *
            
            
            42,205,030Stock
      Options
            
            
            2,921,638Warrants
            
            
            56,646,045Total
            
            
            124,245,149*  as-converted.





Income
Taxes





We
compute income taxes in accordance with relevant accounting
standards.  Under these ACS’s, deferred taxes are recognized for the
tax consequences of temporary differences by applying enacted statutory rates
applicable to future years to differences between the financial statement
carrying amounts and the tax basis of existing assets and liabilities. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. Significant temporary differences arise
primarily from reserves for inventory obsolescence, impairment charges and
accounts payable and accrued liabilities that are not deductible for tax
reporting until they are realized and/or paid.





Financial Instruments and
Concentrations





Financial
instruments, as defined in a certain accounting standard, consist of cash,
evidence of ownership in an entity and contracts that both (1) impose on one
entity a contractual obligation to deliver cash or another financial instrument
to a second entity, or to exchange other financial instruments on potentially
unfavorable terms with the second entity, and (2) conveys to that second entity
a contractual right (a) to receive cash or another financial instrument from the
first entity or (b) to exchange other financial instruments on potentially
favorable terms with the first entity. Our financial instruments consist
primarily of cash and cash equivalents, restricted cash, short-term
investment(s), accounts receivable, accounts payable, accrued liabilities and
credit facilities.  The carrying values of these financial instruments
approximate their respective fair values due to their short-term
nature.





-9-


Financial
instruments that potentially subject us to significant concentrations of credit
risk consist primarily of cash and cash equivalents, restricted cash and
accounts receivable. We frequently maintain cash balances in excess of federally
insured limits. However, we believe that cash balances held in non interest
bearing accounts are fully insured at this time. As such, with interest rates at
historical lows, we have made the decision to maintain cash balances at more
than one bank to diversify our exposure and to use our non-interest-earning
balances to lower any banking fees. Our revenues and accounts receivable balance
is and is expected to be primarily composed of amounts generated from our
largest distributor, Interactive Communications (“InComm”).  We
have not experienced any losses from receivables due from InComm.





Stock-Based
Compensation





We apply
relevant accounting standards to account for our stock-based compensation
arrangements. This statement requires us to recognize compensation expense in an
amount equal to the grant-date fair value of shared-based payments such as stock
options granted to employees.  These options generally vest over a
period of time and the related compensation cost is recognized over that vesting
period.





The
following table summarizes our stock-based compensation expense:





Stock-based
      compensation charged to:
            
            
            3Q2009
            
            
            
            3Q2008
            
            
            39
      Wks 2009
            
            
            39
      Wks 2008Transaction
      and operating expenses
            
            $
            753
            
            
            $
            -
            
            
            $
            2,346
            
            
            $
            243Selling
      and marketing expenses
            
            
            28,893
            
            
            
            46,296
            
            
            
            87,335
            
            
            
            175,819General
      and administrative expenses
            
            
            89,048
            
            
            
            384,852
            
            
            
            257,619
            
            
            
            1,353,327Interest
      expense
            
            
            -
            
            
            
            17,370
            
            
            
            9,925
            
            
            
            42,374Total
      stock-based compensation
            
            $
            118,694
            
            
            $
            448,518
            
            
            $
            357,225
            
            
            $
            1,571,763





Amounts
charged to interest expense represent the costs of warrants issued as
compensation to Mr. Bruce E. Terker, one of the Company’s directors, for
supplying the required collateral for bonds issued to support our state money
transmitter licenses.





Dividends on Preferred
Stock





Our
Series A Preferred Stock accrues dividends of 5% per annum are paid semiannually
and can be satisfied in cash or through the issuance of Common
Stock.  Unless and until these dividends are declared and paid in
full, the Company is prohibited from declaring any dividends on its Common
Stock.  Pursuant to the Company’s Amended and Restated Loan and
Security Agreement, dated November 26, 2008 (see Note C – Credit Facility and
Term Notes), the Company is limited to paying $500,000 in any fiscal year for
cash dividends or other cash distributions to the holders of shares of Series A
Preferred Stock.  There are no dividend requirements on our Series B
Convertible Preferred Stock, on our Series C Convertible Preferred Stock or on
our Series D Convertible Preferred Stock.






-10-





Dividends
owed but not declared on our Series A Preferred Stock were $192,136 as of
January 3, 2009 which were subsequently satisfied through the issuance of Common
Stock.  On August 11, 2009, the Company’s Board of Directors declared
$179,772 in dividends due through June 30, 2009 to be paid through the issuance
of 391,565 shares of our Common Stock. Dividends owed but not declared on our
Series A Preferred Stock were $111,110 as of October 3, 2009.





Fair
Value Measurements





An accounting standard defines fair value, establishes a
methodology for measuring fair value, and expands the required disclosure for
fair value measurements.  In February 2007 the standard was
amended. We
adopted the amended standard on December 30, 2007, the first day of our 2008
fiscal year. This standard permits entities to choose to measure many financial
instruments and certain other items at fair value.





In
October 2008, a clarification to the standard was issued.  It
clarifies the application of fair value in inactive markets and allows for the
use of management's internal assumptions about future cash flows with
appropriately risk-adjusted discount rates when relevant observable market data
does not exist. The objective of the accounting standard has not changed and
continues to be the determination of the price that would be received in an
orderly transaction that is not a forced liquidation or distressed sale at the
measurement date.





At
October 3, 2009, the Company did not have any items to be measured at fair
value.





Recently Issued Accounting
Pronouncements





In April
2009, an ASC regarding accounting for assets acquired and liabilities assumed in
a business combination that arise from contingencies was released.  It
addresses the initial recognition, measurement and subsequent accounting for
assets and liabilities arising from contingencies in a business combination, and
requires that such assets acquired or liabilities assumed be initially
recognized at fair value at the acquisition date if fair value can be determined
during the measurement period. If the acquisition-date fair value cannot be
determined, the asset acquired or liability assumed arising from a contingency
is recognized only if certain criteria are met.  The standard also
requires that a systematic and rational basis for subsequently measuring and
accounting for the assets or liabilities be developed depending on their
nature.  The standard is effective for assets or liabilities arising
from contingencies in business combinations for which the acquisition date is
during or after 2010. The Company does not anticipate that the adoption of this
statement will have a material impact on its consolidated financial statements,
absent any material business combinations.





In April
2009, the Financial Accounting Standards Board (the “FASB”) issued the
following three standards intended to provide additional application guidance
and enhance disclosures regarding fair value measurements and impairments of
securities:





One such
standard provides additional guidance for estimating fair value when the volume
and level of activity for the asset or liability have decreased
significantly.  The standard also provides guidance on identifying
circumstances that indicate a transaction is not orderly.  Its
adoption did not affect the Company’s consolidated financial
statements.





The
second standard requires disclosures about fair value of financial instruments
in interim reporting periods of publicly traded companies that were previously
only required to be disclosed in annual financial statements.  As this
standard amends only the disclosure requirements about fair value of financial
instruments in interim periods, its adoption did not affect the Company’s
consolidated financial statements.





-11-





The third
standard amends current other-than-temporary impairment guidance in GAAP for
debt securities to make the guidance more operational and to improve the
presentation and disclosure of other-than-temporary impairments on debt and
equity securities in the financial statements.  This standard does not
amend existing recognition and measurement guidance related to
other-than-temporary impairments of equity securities.  The adoption of
this standard did not affect the Company’s consolidated financial
statements.





In May
2009, the FASB issued a standard regarding subsequent events.  This
new pronouncement establishes principles and standards related to the accounting
for and disclosure of events that occur after the balance sheet date but before
the financial statements are issued.  This standard requires an entity
to recognize, in the financial statements, subsequent events that provide
additional information regarding conditions that existed at the balance sheet
date.  Subsequent events that provide information about
conditions that did not exist at the balance sheet date shall not be recognized
in the financial statements under this standard.  This standard was
adopted during this interim period and did not affect the Company’s consolidated
financial statements.





In
June 2009, the FASB issued a standard regarding accounting for transfers of
financial assets.  The provisions of this standard amend previous
guidance by removing the concept of a qualifying special-purpose entity and
removing and exception regarding variable interest entities that were previously
considered qualifying special-purpose entities. The provisions of the standard
will become effective for us on January 3, 2010. The adoption of this
standard is not expected to affect the Company’s consolidated financial
statements.





In
June 2009, the FASB issued a standard which establishes the FASB Accounting
Standards Codification as the source of accounting principles and the framework
for selecting the principles to be used in the preparation of financial
statements. The provisions of this standard will be applied prospectively
beginning in the third quarter of 2009 and will have no impact on the Company’s
consolidated financial statements.





NOTE
B - GOING CONCERN





Our
consolidated financial statements are prepared using accounting principles
generally accepted in the United States of America applicable to a going
concern, which contemplate the realization of assets and liquidation of
liabilities in the normal course of business.  Our operations have
historically been funded primarily through equity capital.  At October
3, 2009, we had a cash balance of approximately
$5,886,000.    During the fourth quarter of 2008 and the 39
Wks 2009, in order to fund our operations, we received short term financing from
several of our major stakeholders, two of which are affiliated with Mr. Terker,
one of our directors.  In August and September 2009, we issued
4,220,503 shares of its Series D Convertible Preferred Stock and warrants to
purchase 42,205,040 shares of the Company’s common stock at an exercise price of
$0.01 per share, for an aggregate purchase price of $12,661,509.  Of
the aggregate purchase price, $6,967,611 was paid by the investors in cash and
$5,693,898 was paid through the exchanges of a like amount of the short term
loans referred to here and described in Note C. We completed additional sales of
our Series D Preferred during the month of October 2009. We believe this equity
financing should be adequate to fund our fiscal year 2009 operations and cash
commitments; however, we have incurred significant losses and negative cash
flows from operations since our inception, and as a result no assurance can be
given that we will be successful in attaining profitable operations, especially
when one considers the problems, expenses and complications frequently
encountered in connection with entrance into established markets and the
competitive environment in which we operate.





These
factors, among others, indicate that we may be unable to continue as a going
concern for a reasonable period of time. Our consolidated financial statements
do not include any adjustments relating to the recoverability and classification
of recorded asset amounts or the amounts and classification of liabilities that
might be necessary should we be unable to continue as a going
concern.


-12-





NOTE
C – CREDIT FACILITY and TERM NOTES





Credit
Facility


On June
10, 2008, the Company and its wholly owned subsidiary, nFinanSe Payments Inc.
(collectively, the “Borrowers”), entered
into a Loan and Security Agreement (the “Original Loan
Agreement”) and, on November 26, 2008, entered into an Amended and
Restated Loan and Security Agreement (the “Amended and Restated Loan
Agreement”) with Ballyshannon Partners, L.P., Ballyshannon Family
Partnership, L.P., Midsummer  Investment, Ltd., Porter Partners, L.P.
and Trellus Partners, L.P. (collectively, the “Lenders”).  The
Original Loan Agreement established a revolving credit facility in the maximum
aggregate principal amount of $15,500,000 (the “Credit Facility”),
with the Borrowers’ obligations secured by a lien on substantially all of the
Company’s assets.  Loans under the Original Loan Agreement (each, a
“Loan”) may be
used solely to make payments to card issuing banks for credit to
SVCs.  The Amended and Restated Loan Agreement modified the Original
Loan Agreement by establishing a sub-commitment of $3,400,000, pursuant to which
each Lender, excluding Midsummer which did not participate in the
sub-commitment, in its sole discretion, may advance funds (each, an “Accommodation Loan”)
that may be used by the Company for working capital expenditures, working
capital needs and other general corporate purposes.  Loans and
Accommodation Loans will be funded by the Lenders into separately controlled
accounts subject to the Lenders’ lien.  Loan amounts deposited into a
lender-controlled loan account are reflected as Restricted Cash on our balance
sheet and bear interest at 6% per annum until withdrawn (for the sole purpose of
funding SVCs) from that deposit account, at which time they bear interest at 16%
per annum.  Accommodation Loans are funded into a company-controlled
operating account and bear interest at 16% per annum.  Loans may be
repaid and re-borrowed in accordance with the provisions of the Original Loan
Agreement.  Accommodation Loans may be repaid and re-borrowed in
accordance with the provisions of the Amended and Restated Loan Agreement,
including the requirement that upon the occurrence and during an event of
default, Accommodation Loans will be repaid after the repayment in full of all
other loans under the Credit Facility.





Prior to
their conversion as discussed below, the maturity date of the Credit Facility
was November 25, 2009, one year after the initial borrowing.  On
October 29, 2009 the Lenders approved the extension of maturity for an
additional six months upon the satisfaction of certain conditions set forth in
the Amended and Restated Loan Agreement.  The Credit Facility provides
for usual and customary events of default, including but not limited to (i) the
occurrence of a Material Adverse Change and (ii) the occurrence of a Change of
Control (as such terms are defined in the Amended and Restated Loan
Agreement).  The Credit Facility contemplates that, with the Lenders’
consent, the maximum commitment may be increased to up to $20,000,000, and
additional lenders may be added.  As of July 4, 2009 the Borrowers had
drawn $3,900,000 under the Amended and Restated Loan Agreement, of
which $3,400,000 consisted of Accommodation Loans.





The
Lenders received warrants dated July 21, 2008 (the “Original Warrants”)
entitling the Lenders to purchase up to an aggregate of 1,007,500 shares of
Common Stock at an exercise price of $2.30 per share, which exercise price is
subject to customary adjustments for Common Stock splits and reverse stock
splits.  The warrants expire after five years and may be exercised by
means of a “cashless exercise.”   The Original Warrants were valued
using the Black-Scholes option pricing model at an aggregate fair value of
approximately $1.4 million, which amount was recorded as deferred financing
costs and is being amortized over the twelve-month period to the initial
maturity of the Original Loan Agreement on November 25, 2009.





As
consideration for providing the Accommodation Loans, the Company agreed to issue
new warrants (the “Accommodation Loan
Warrants”) to the Accommodation Lenders (as such term is defined in the
Amended and Restated Loan Agreement) entitling them to purchase up to an
aggregate of 1,700,000 shares of Common Stock at a per share price of $2.00,
which exercise price is subject to customary adjustments for Common Stock splits
and reverse stock splits. The Accommodation Loan Warrants expire on November 26,
2009; however, in the event the Company and the Accommodation Lenders extend the
maturity of the Credit Facility from one year to 18 months, the exercise period
of the Accommodation Loan Warrants will automatically extend to the 18 month
anniversary of the date of the Accommodation Loan Warrants.





The fair
value of these warrants of $314,940, determined using the Black-Scholes option
pricing model, was recorded as an increase to deferred financing costs and is
being amortized over the period to the maturity of the Credit Facility on
November 25, 2009.  On February 3, 2009, as further consideration for
the commitment by the Accommodation Loan Lenders to fund up to $3.4 million in
Accommodation Loans, the Company also agreed to amend all warrants held by the
participating Accommodation Loan Lenders and any further Accommodation Loan
Warrants to be issued such that the exercise price was reduced to $1.00 per
share.  This amendment to the existing warrants held by the
participating Accommodation Loan Lenders was valued using the Black-Scholes
option pricing model and the resulting aggregate fair value of $620,517 was
recorded as an increase to deferred financing costs.





-13-


Collins
Stewart LLC and Emerging Growth Equities, Ltd. (“EGE”) acted as
placement agents for Original Loan Agreement and shared equally a $310,000
fee.  The placement agent fees are reflected in deferred financing
costs.





Mr.
Terker, a current member of the Board of Directors of the Company, has sole
voting and dispositive power over the securities held by Ballyshannon Partners,
L.P. and its affiliates, two of which are Accommodation Loan
Lenders.  Mr. Terker has a financial interest in such entities, and,
as such, has a financial interest in the Amended and Restated Loan Agreement,
the Warrant Amendments and the Accommodation Loan Warrants.





Term
Loan Notes


Commencing
on May 7, 2009, the Company sold term loan notes (the “June Term Loan
Notes”) with a principal amount of $1,000,000.  The June Term
Loan Notes accrue interest at 10% annually and were amended to mature on August
31, 2009.  The Company’s obligations under the Term Loan Notes are
secured by a lien on substantially all of its assets. The Term Loan Notes
were purchased by each of Ballyshannon Partners, L.P., Odyssey Capital Group,
L.P., Lancaster Investment Partners, L.P., 5 Star Partnership, L.P., EDJ Limited
and Trellus Partners, L.P.





The June
Term Loan Notes provide for usual and customary events of default, including but
not limited to (i) failure to pay interest or any fees within three business
days of the date when due, and (ii) the occurrence of any event of default under
the Amended and Restated Loan Agreement.





Mr.
Terker, a current member of the Board of Directors, has sole voting and
dispositive power over the securities held by Ballyshannon Partners, L.P. and
its affiliates, two of which are purchasers of the Term Loan
Notes.  Mr. Terker has a financial interest in such entities, and, as
such, has a financial interest in the Note Offering and the Term Loan
Notes.





In
connection with the June Term Loan Notes, the purchasers of the June Term Loan
Notes entered into an Intercreditor Agreement with the Company and the
Accommodation Lenders.  Upon the occurrence and during an event of
default under the June Term Loan Notes, the June Term Loan Notes shall be repaid
after the repayment in full of the Accounts Receivable Loans (as defined in the
Amended and Restated Loan Agreement) and prior to any repayment of the
Accommodation Loans.





Pursuant
to the terms and conditions of the June Term Loan Notes, the Company issued
warrants (the “June
Term Note Warrants”) to the purchasers of June Term Loan Notes, which, in
the aggregate, entitled such June Term Loan Note holders to purchase an
aggregate of 2,000,000 shares of Common Stock at a per share price of $0.50,
which exercise price is subject to customary adjustments for Common Stock splits
and reverse stock splits.





In June
2009, the Company received permission from the Required Lenders of the Amended
and Restated Credit Agreement as well as the Requisite Holders of its Series A
Preferred Stock to issue up to an additional $1 million of Term Loans (the
“July Term
Loans”), Commencing on July 3, 2009, the Company sold additional term
loan notes (the “July
Term Loans”) with a principal amount of $1,000,000.  The July
Term Loans accrue interest at 10% annually and mature on August 31,
2009.   The July Term Loans were purchased by each of
Ballyshannon Partners, L.P., Odyssey Capital Group, L.P. and Lancaster
Investment Partners.





Pursuant
to the terms and conditions of the July Term Loans, the Company agreed to issue
warrants (the “July
Term Loan Warrants”) to the purchasers of the July Term Loans, which, in
the aggregate, entitled such holders to purchase a like amount of Common Stock
at a per share price equal to the conversion price of Series D Preferred stock
sold for cash, or 3,333,333 shares at $0.30 per share, which exercise price is
subject to customary adjustments for Common Stock splits and reverse stock
splits.  Additionally, the Company agreed to modify the number and
exercise price of the June Term Note Warrants to a like amount.  The
June Term Note Warrants were subsequently amended such that the total was
increased from 2,000,000 to 3,333,332 and the exercise price was reduced from
$0.50 to $0.30 in connection with the sale of the July Term Loans.





The June
Term Note Warrants and the July Term Loan Warrants (“Term Note Warrants”)
expire after a five-year term.  The Term Note Warrants may not be
exercised by means of a “cashless exercise.”  In the event that the
Company shall consolidate with or merge with or into another person or entity,
or the Company shall sell, transfer or lease all or substantially all of its
assets, or the Company shall change its Common Stock into property or other
securities (each, a “Triggering
Transaction”), the Term Note Warrants shall terminate and shall
thereafter represent only the right to receive the cash, evidences of
indebtedness or other property as the holders of the Notes would have received
had they been the record owner, at the time of completion of a Triggering
Transaction, of that number of shares of Common Stock receivable upon exercise
of the Term Note Warrants in full, less the aggregate exercise price payable in
connection with the full exercise of the Term Note Warrants.  The Term
Note Warrants are not exercisable by the holders of the Term Loan Notes to the
extent that, if exercised, they or any of their affiliates would beneficially
own in excess of 9.99% of the then issued and outstanding shares of Common
Stock.  The Term Note Warrants were valued using the Black-Scholes
option pricing model and the resulting aggregate fair value of $755,768 was
recorded as an increase to deferred financing costs.





-14-


As
written above, Mr. Terker, a current member of the Board, has sole voting and
dispositive power over the securities held by Ballyshannon Partners, L.P. and
its affiliates, two of which are recipients of Term Note
Warrants.  Mr. Terker has a financial interest in such entities, and,
as such, has a financial interest in the June Term


Loan
Notes, the July Term Loans and the Term Note Warrants.





The
Accommodation Loans, June Term Loan Notes, the July Term Loans and accrued
interest thereon were exchanged for Series D Preferred Stock on August 21, 2009
as described in Note D.  As of the exchange date, all unamortized
deferred financing costs were recorded to additional
paid-in-capital.  All Term Note Warrants were amended in connection
with the purchase of the Series D Preferred Stock that reduced the exercise
price to $0.01 per share.





NOTE
D – SERIES D PREFERRED STOCK OFFERING





During
August and September, the Company entered into Securities Purchase Agreements
(the “Purchase
Agreements”), with several institutional and accredited investors,
including Ballyshannon Partners, LP, Mr. Robert Berlacher, Porter Partners, LP,
Midsummer Investment, Ltd. and Trellus Offshore Fund Ltd., all of which
beneficially own five percent or more of the Common Stock (collectively, the
“Investors”),
pursuant to which the Company issued 4,220,503 shares of its Series D
Convertible Preferred Stock, $0.001 par value per share (“Series D Preferred
Stock”), and warrants (the “Warrants”) to
purchase 42,205,040 shares of Common Stock, at an exercise price of $0.01 per
share, for the aggregate purchase price
of  $12,661,509,  $6,967,611 of which was paid by Investors
in cash and $5,693,898 was paid by Investors through the exchanges of a like
amount of certain outstanding accommodation loans, term loans and accrued
interest payable thereon.





Pursuant
to the terms of the Purchase Agreements, each Investor who invested an amount
equal to or greater than 25% of the amounts invested in prior transactions
involving stock or certain accommodation loans and term loans had the exercise
price of any Company warrants held by such Investor reduced to (i) $0.30 per
share of Common Stock, if they invested $100,000 or more, of which 206,250 were
re-priced as such, or (ii) $0.01 per share of Common Stock, if they invested
$250,000 or more of which 12,899,207 were re-priced as such.





The
Warrants entitle the Investors to purchase shares of Common Stock at an exercise
price of $0.01 per share, which exercise price is subject to customary
adjustments for Common Stock splits and reverse stock splits.  The
Warrants are exercisable during the period commencing on the first anniversary
of the date of the Warrant and expiring four (4) years thereafter, and may be
exercised by means of a “cashless exercise.”  In the event that the
Company shall consolidate with or merge with or into another person or entity,
or the Company shall sell, transfer or lease all or substantially all of its
assets, or the Company shall change its Common Stock into property or other
securities (each, a “Triggering
Transaction”), the Warrants shall terminate and shall thereafter
represent only the right to receive the cash, evidences of indebtedness or other
property as the Investors would have received had they been the record owner, at
the time of completion of a Triggering Transaction, of that number of shares of
Common Stock receivable upon exercise of the Warrants in full, less the
aggregate exercise price payable in connection with the full exercise of the
Warrants.  The Warrants are not exercisable by the Investors to the
extent that, if exercised, they or any of their affiliates would beneficially
own in excess of 9.99% of the then issued and outstanding shares of Common
Stock.  With respect to the securities purchased by Midsummer
Investment, Ltd. (“Midsummer”), the
Company has agreed that the Series D Preferred Stock and Warrants held by
Midsummer shall not be converted or exercised (as the case may be) such that
Midsummer or any of its affiliates would own in excess of 4.9% of the then
issued and outstanding shares of Common Stock.





Emerging
Growth Equities, Ltd. (“EGE”) received fees
of $34,400 in connection with the introduction of certain new investors for the
above-described transactions.  Robert A. Berlacher, a current
stockholder of the Company, is a co-founder and director of EGE Holdings, Ltd.
(“EGE
Holdings”), a holding company with a 100% ownership interest in
EGE.  Mr. Berlacher received no compensation from EGE Holdings or EGE
related to the Company’s sale of Series D Preferred Stock and the
Warrants.  Bruce E. Terker, a member of our Board, controls two
entities that are investors in EGE Holdings.





NOTE
E - STOCK OPTIONS AND WARRANTS





On March
1, 2007, our stockholders approved the 2007 Omnibus Equity Compensation Plan
(the “2007
Plan”) which combined the 709,850 shares that were issued and outstanding
under the Company’s 2004 Stock Option Plan with the 2,300,000 shares available
for issuance under the 2007 Plan.  On May 8, 2008 at the Company’s
Annual Stockholders’ Meeting, the Company’s stockholders voted to amend the 2007
Plan by increasing the number of authorized shares available for issuance by
1,000,000 shares, thus providing a total of 4,009,850 shares for issuance under
the combined plans.  As of October 3, 2009, we had 1,084,462 shares
available under the combined plans for future option grants and 2,925,388 total
options outstanding, consisting of 2,897,916 options issued to employees and
non-employee directors and 25,250 options issued to consultants. Such options
vest over various periods up to three years and expire on various dates through
2019.





-15-


The fair
value of each option grant is estimated at the date of grant using the
Black-Scholes option valuation model with the following weighted average
assumptions for the periods ended October 3, 2009 and September 27,
2008:




39
      Wks
                2009
              
              
              39
      Wks
                2008Expected
      term in years
              
              
              5
              
              
              
              5Expected
      stock price volatility
              
              
              165%
      - 191
              %
              
              
              73.1%
      - 75.1
              %Risk
      free interest rate
              
              
              1.50%
      - 2.31
              %
              
              
              2.7%
      - 3.1
              %Dividend
      yield
              
              
              0
              %
              
              
              0
              %


Expected
stock price volatility is determined using historical volatility of the
Company's stock.  The average expected life was estimated based on
historical employee exercise behavior.


The
following table describes our stock option activity for the thirty-nine weeks
ended October 3, 2009:




Number
      of
                Options
              
              
              Weighted
      average
                exercise
                price
      per share
                (price
      at
                date
      of grant)Outstanding
      at January 3, 2009
              
              
              2,641,779
              
              
              $
              3.57Granted
              
              
              563,500
              
              
              $
              0.83Cancelled
              
              
              (283,641
              )
              
              $
              2.08Outstanding
      at October 3, 2009
              
              
              2,921,638
              
              
              $
              3.19Options
      granted at or above market value during the period ended October 3,
      2009
              
              
              563,500


The
following table summarizes information regarding options that are outstanding at
October 3, 2009:





Options
      outstanding
            
            
            Options
      exercisableRange
      of
              exercise
      prices
            
            
            Number
              outstanding
            
            
            Weighted
              average
              remaining
              contractual
              life
      in years
            
            
            Weighted
              average
              exercise
              price
            
            
            Number
              Exercisable
            
            
            Weighted
              average
              exercise
              price
      per
              share$
            0.50
      -$1.50
            
            
            
            1,491,
      901
            
            
            
            8.0
            
            
            $
            1.30
            
            
            
            1,029,346
            
            
            $
            1.50$
            2.20-$3.75
            
            
            
            567,963
            
            
            
            6.5
            
            
            $
            3.29
            
            
            
            502,019
            
            
            $
            3.29$
            4.00-$7.00
            
            
            
            637,417
            
            
            
            6.5
            
            
            $
            4.20
            
            
            
            599,028
            
            
            $
            4.21$
            8.00-$32.00
            
            
            
            224,357
            
            
            
            5.4
            
            
            $
            12.63
            
            
            
            224,357
            
            
            $
            12.632,921,638
            
            
            
            7.2
            
            
            $
            3.19
            
            
            
            2,354,750
            
            
            $
            3.63








The
grant-date fair value of options granted during 39 Wks 2009 and the 39 Wks 2008
was approximately $309,700 and $1,024,900, respectively.  The total
fair value of shares vested during the thirty-nine week period ended October 3,
2009 was approximately $341,300.  At October 3, 2009, we estimate the
aggregate stock-based compensation attributable to unvested options was
approximately $458,500, which amount is expected to be recognized over a period
of approximately three years.





-16-


Officer Stock
Options





On
February 23, 2009, the Compensation Committee recommended to the Board and the
Board granted to our Chief Executive Officer, Jerry R. Welch, 250,000 stock
options at an exercise price of $1.00 per share, which, using the Black-Scholes
option pricing model, were valued at an aggregate of
$143,840.  Options to purchase 50,000 shares will become fully vested
on the anniversary date of the grant and 50,000 options will vest ratably over
the 12 months beginning March 31, 2010. Of the final 150,000 options, 75,000
will vest on the first anniversary date of the grant and 75,000 will vest
ratably over the 12 months beginning March, 2010, provided the Company has
positive EBITDA in any month prior to September 30, 2009. The Company failed to
achieve positive EBITDA and the 150,000 stock options were subsequently
forfeited by Mr. Welch.





On
February 23, 2009, the Compensation Committee recommended to the Board and the
Board granted to our Chief Financial Officer, Raymond P. Springer, 50,000 stock
options at an exercise price of $1.00 per share, which, using the Black-Scholes
option pricing model, were valued at an aggregate of $28,768.  The
options will become fully vested in two years, with one half vesting on the
anniversary date of the grant and 1/12 of the remaining grant vesting monthly
thereafter.





On
January 29, 2009 , the Compensation Committee recommended to the Board and the
Board granted to six officers of the Company an aggregate of 116,000 stock
options at an exercise price of $1.02 per share, which, using the Black-Scholes
option pricing model, were valued at an aggregate of $113,555. The options
become fully vested in two years, one half vests on the anniversary date of the
grant and 1/12 of the remaining grant vests monthly thereafter.





On
January 24, 2008, Messrs. Welch and Springer were awarded 95,000 and 45,000
stock options, respectively, at an exercise price of $4.00 per share, which were
valued using the Black-Scholes option pricing model at aggregate fair values of
approximately $234,000 and $111,000, respectively.  These amounts were
recognized as stock-based compensation expense as the options
vested.   The options were divided into 28 equal installments,
with the first seventeen installments vesting on January 28, 2008 and additional
installments vesting on the final day of each month through December 31,
2008.  At January 3, 2009, all options have vested and all
compensation expense related to these options has been recognized.





On
January 24, 2008, the Board also awarded a total of 155,000 stock options to
eight other officers at an exercise price of $4.00 per share, which were valued
using the Black-Scholes option pricing model at an aggregate fair value of
approximately $381,300.  The options vest one-third at the one-year
anniversary of the grants and then ratably for the following 24 months. The fair
value of these options is being recognized as stock-based compensation expense
over the vesting period of the options.











-17-


Outstanding
Warrants





The
following table summarizes information on warrants issued and outstanding at
October 3, 2009 that allow the holder to purchase a like amount of Common
Stock.





Warrants
      issued in connection with/as:
            
            Number
      outstanding
            
            Exercise
      price per share
            
            Expiration
      datePartial
      compensation for our placement agent in connection with the sale of our
      Series A Convertible Preferred Stock on December 28, 20061
            
            320,000
            
            $0.01
            
            December
      28, 2011Partial
      compensation for our placement agent in connection with the sale of our
      Series B Convertible Preferred Stock and Common Stock on June 29,
      20071
            
            120,928
            
            $0.01
            
            June
      29, 2012Partial
      compensation for our placement agents in connection with the sale of our
      Series C Convertible Preferred Stock and Common Stock on June 12, 2008 as
      amended for participation in the August 2009 Securities Purchase
      Agreements 1,2
            
            54,575
            
            $0.01
            
            June
      12, 2013Partial
      compensation for our placement agents in connection with the sale of our
      Series C Convertible Preferred Stock and Common Stock on June 12, 2008
      2
            
            54,575
            
            $2.53
            
            June
      12, 2013Compensation
      for Mr. Bruce E. Terker in connection with the Guarantee and
      Indemnification Agreements for bond collateral required for our state
      licensing initiative1,3
            
            33,912
            
            $0.01
            
            3,716
      on April 1, 2013, 8,455 on June 30, 2013, 8,455 on September 30, 2013
      and
              8,455
      on December 31, 2013 and 4,831 on February 15, 2013Pursuant
      to Securities Purchase Agreements dated June 29, 2007, as amended for
      participation in the August 2009 Securities Purchase Agreements1
            
            1,175,000
            
            $0.01
            
            June
      29, 2012Pursuant
      to Securities Purchase Agreements dated June 29, 2007, as amended for
      participation in the August 2009 Securities Purchase Agreements1
            
            100,000
            
            $0.30
            
            June
      29, 2012Pursuant
      to Securities Purchase Agreements dated June 29, 2007, as amended for
      participation in the June 12, 2008 Securities Purchase Agreements4
            
            131,600
            
            $2.30
            
            June
      29, 2012Pursuant
      to Securities Purchase Agreements dated June 29, 2007
            
            105,000
            
            $5.00
            
            June
      29, 2012Pursuant
      to Securities Purchase Agreements dated June 12, 2008, as amended for
      participation in the August 2009 Securities Purchase Agreements 1
            
            1,820,625
            
            $0.01
            
            June
      12, 2013Pursuant
      to Securities Purchase Agreements dated June 12, 2008, as amended for
      participation in the August 2009 Securities Purchase Agreements 1
            
            156,250
            
            $0.30
            
            June
      12, 2013Pursuant
      to Securities Purchase Agreements dated June 12, 2008
            
            751,875
            
            $2.30
            
            June
      12, 2013Pursuant
      to Securities Purchase Agreements dated August through September
      2009
            
            42,205,040
            
            $0.01
            
            Various
      dates from August 2014 through September 2014Pursuant
      to Loan and Security Warrant Agreements dated July 21, 2008 as amended for
      participation in August 2009 Securities Purchase Agreements 1,5
            
            1,007,500
            
            $0.01
            
            July
      21, 2013Accommodation
      Loan Warrant Agreements as amended for participation in August 2009
      Securities Purchase Agreements 1,6
            
            1,700,000
            
            $0.01
            
            Various
      dates from November 2009 through March 2010Term
      Note Warrant Agreements 1,7,8
            
            6,666,665
            
            $0.01
            
            Various
      dates from May  2010 through July 2010Warrants
      held by DFS Services LLC dated November 12, 2007
            
            200,000
            
            $3.00
            
            November
      12, 2010Consulting
      services agreement dated April 1, 2006
            
            37,500
            
            $5.00
            
            Various
      dates through 2011Cooperation
      Agreement dated November 22, 2006
            
            5,000
            
            $1.20
            
            November
      22, 2011Total
      warrants and weighted average exercise price per share outstanding at
      October 3, 2009
            
            56,646,045
            
            $0.07




-18-


1.           Pursuant
to the terms of the Stock Purchase Agreements dated August through September
2009, each Investor who invested an amount equal to or greater than 25% of the
amounts invested in prior transactions involving stock or certain accommodation
loans and term loans had the exercise price of any Company warrants held by such
Investor reduced to (i) $0.30 per share of Common Stock, if they invested
$100,000 or more, of which 206,250 were re-priced as such, or (ii) $0.01 per
share of Common Stock, if they invested $250,000 or more of which 12,899,207
were re-priced as such.  Except for such re-pricing, the warrants
remained unchanged and in full force and effect.





2.           Collins
Stewart LLC and Emerging Growth Equities, Ltd. acted as placement agents for the
June 12, 2008 Securities Purchase and Exchange Agreements transactions and
received, as partial compensation, warrants to purchase 109,150 shares of Common
Stock, exercisable at $2.53 per share and expiring on June 12, 2013, which were
valued using the Black-Scholes option pricing model at an aggregate fair value
of approximately $184,300.





3.           On
February 19, 2008, we completed the funding of collateral required for bonds
issued in connection with our state licensing efforts amounting to approximately
$1.8 million.  Approximately $0.8 million of the collateral for the
letter of credit was provided by Mr. Terker, one of the Company’s directors. In
connection with this accommodation, the Company and Mr. Terker entered into a
Guaranty and Indemnification Agreement.  Mr. Terker agreed to be
compensated in the form of warrants to purchase 33,912 shares of the Common
Stock at a purchase price of $3.35 per share, which would be earned ratably over
the course of the year and expensed to interest expense as the warrants were
earned.  As of April 3, 2009, all of these warrants had been earned.
The aggregate fair value of these warrants, which was estimated using the
Black-Scholes option pricing model at $59,745, was recognized as non-cash
interest expense as the warrants were earned. These were subsequently re-priced
as a result of the August Stock Purchase Agreements, as listed above in note
1.





4.           As
part of the terms of the June 12, 2008 Securities Purchase Agreements, for each
investor who invested an amount equal to at least 50% of such investor’s
investment in the Company’s June 29, 2007 offer and sale of Common Stock, Series
B Convertible Preferred Stock and Warrants, such investor’s existing June 2007
Warrants were amended such that the exercise price per share of such investor’s
June 2007 Warrants was reduced from $5.00 per share to $2.30 per
share.  Except for the above-referenced amendment, the June 2007
Warrants remained unchanged and in full force and effect.





5.           As
part of the Original Loan Agreement, the Lenders received warrants dated July
21, 2008, entitling the Lenders to purchase up to an aggregate of 1,007,500
shares of Common Stock at an exercise price of $2.30 per share, which exercise
price is subject to customary adjustments for Common Stock splits and reverse
stock splits.  Pursuant to an amendment, the warrant shares were
re-priced (see 1 above) to an exercise price of $0.01 per share. The warrants
were valued using the Black-Scholes option pricing model at an aggregate fair
value of $1,538,953, which amount was recorded as deferred financing costs and
is being amortized, beginning in fiscal December 2008, over the twelve month
period to the maturity of the Amended and Restated Loan Agreement on November
25, 2009.





6.           On
November 26, 2008, the Company amended the Original Loan Agreement and
subsequently issued to the Accommodation Lenders (as such term is defined in the
Original Loan Agreement) warrants entitling them to purchase an aggregate of
1,700,000 shares of Common Stock at an exercise price of $2.00 per share with an
expiration date one year from issuance.   The warrants were
valued using the Black-Scholes option pricing model at an aggregate fair value
of $40,775.  In addition, the warrants issued to the Accommodation
Lenders under the Original Loan Agreement were re-priced from $2.30 to
$1.00.  The cost of re-pricing these warrants, using the Black-Scholes
option pricing model, was estimated at $314,940.  The amounts were
recorded as deferred financing costs and were amortized to non-cash interest
expense, beginning in December 2008 over the twelve month period to the maturity
of the Amended and Restated Loan Agreement on November 25, 2009, up to the
exchange for Series D Preferred Stock.  The balance of deferred
financing costs as of the exchange date was recorded to additional
paid-in-capital.  These warrants were subsequently re-priced to $0.01
as part of the August 2009 Stock Purchase Agreements (see 1 above).





7.           On
May 7, 2009, the Company commenced the sale of June Term Loan Notes in an amount
not to exceed $1,000,000.  In connection with the sale, the Company
issued June Term Note Warrants to the purchasers of June Term Loan Notes, which,
in the aggregate, entitled such holders to purchase an aggregate of 2,000,000
shares of the Company’s common stock, $0.001 par value per share, at a per share
price of $0.50, which exercise price is subject to customary adjustments for
common stock splits and reverse stock splits.  The Term Note Warrants
were valued using the Black-Scholes option pricing model and the resulting
aggregate fair value of $755,768 was recorded as an increase to deferred
financing costs.  The June Term Note Warrants were subsequently
amended such that the total was increased from 2,000,000 to 3,333,332 and the
exercise price was reduced from $0.50 to $0.30 in connection with the sale of
the July Term Loans. The amounts were recorded as deferred financing costs and
were amortized, in June to non-cash interest expense.  The balance in
deferred financing costs as of the exchange date relating to the June Term Notes
was recorded to additional paid-in-capital  These warrants were
subsequently re-priced to $0.01 as part of the August 2009 Stock Purchase
Agreements (see 1 above).





-19-


8.           On
July 3, 2009 the Company commenced the sale of July Term Loans in an amount not
to exceed $1,000,000. In connection with the sale, the Company issued July Term
Loan Warrants to the purchasers of June Term Loan Notes, which, in the
aggregate, entitled such holders to purchase an aggregate of 3,333,333 shares of
the Company’s common stock, $0.001 par value per share, at a per share price of
$0.30, which exercise price is subject to customary adjustments for common stock
splits and reverse stock splits.  The value of the July Term Notes was
recorded to additional paid-in-capital as they were exchanged for Series D
Preferred Stock.  These warrants were subsequently re-priced to $0.01
as part of the August 2009 Stock Purchase Agreements (see 1 above).





Summary
of Warrants outstanding by Exercise Price:


ExercisePrice
              per
      Share
            
            
            Number
      of
              Warrants
      Outstanding$
            0.01
            
            
            
            55,104,245$
            0.30
            
            
            
            256,250$
            1.20
            
            
            
            5,000$
            2.30
            
            
            
            883,475$
            2.53
            
            
            
            54,575$
            3.00
            
            
            
            200,000$
            5.00
            
            
            
            142,500Total
      warrants  weighted average exercise price
            
            $
            0.07
            
            
            
            56,646,045





NOTE
F - COMMITMENTS AND CONTINGENCIES





Operating
Leases





We are
obligated under various operating lease agreements for our
facilities.  Future minimum lease payments and anticipated common area
maintenance charges under all of our operating leases are approximately as
follows at October 3, 2009:





Twelve
      months ending:
            
            AmountsSeptember
      2010
            
            $
            207,500September
      2011
            
            
            203,600September
      2012
            
            
            208,000September
      2013
            
            
            17,400September
      2014
            
            
            -Total
            
            $
            636,500





Rent
expense included in loss from continuing operations for 39 Wks 2009 and 39 Wks
2008, was approximately $194,100 and $289,200, respectively.


-20-




Employment
Agreements





We are
obligated under employment agreements with our Chief Executive Officer, Jerry R.
Welch, and our Chief Financial Officer, Raymond P. Springer.  The
employment agreements had an initial term from September 5, 2006 to December 31,
2008 and were automatically renewed for two years with a new expiration date of
December 31, 2010.  The employment agreements provide to Messrs. Welch
and Springer a current annual salary of $275,000 and $200,000, respectively.
Each agreement is to be automatically renewed indefinitely for succeeding terms
of two years unless otherwise terminated in accordance with the
agreement.  Both Mr. Welch and Mr. Springer also receive
performance-based bonuses and certain medical and other benefits.  If
we terminate Mr. Welch or Mr. Springer without cause, we will be required to pay
severance to them in the amount of compensation and benefits they would have
otherwise earned in the remaining term of their employment agreements or twelve
months, whichever period is shorter.





Service and Purchase
Agreements





We have
entered into renewable contracts with DFS Services LLC, our card network, Palm
Desert National Bank (“PDNB”), and First
National Bank & Trust of Pipestone, Minnesota (“FNB&T”), our
card-issuing banks, and Metavante Corporation (“Metavante”), our
processor, that have initial expiration dates from June 30, 2010 through October
2011.    Because the majority of the fees to be paid are
contingent primarily on card volume, it is not possible to calculate the amount
of the future commitment on these contracts. The Metavante and FNB&T
agreements also require a minimum payment of $5,000 and $7,500 per month,
respectively.  During the 39 Wks 2009 and 39 Wks 2008, we made
aggregate payments of approximately $737,677 and $429,700, respectively to
Metavante, $4,733 and $2,100, respectively to PDNB and $113,715 and $78,600,
respectively, to FNB&T under these agreements.





Our
agreements with PDNB and FNB&T require us to maintain certain reserve
balances for our card programs.  As of October 3, 2009, the reserve
balance held at PDNB was $10,000 and two reserve balances held at FNB&T
totaled $75,000.  These amounts are included in “Other assets” on the
Company’s balance sheet as of October 3, 2009.





Pending or Threatened
Litigation





We may
become involved in certain litigation from time to time in the ordinary course
of business. However at October 3, 2009, to the best of our knowledge, no such
litigation exists or is threatened.





Bond
Collateral





On
February 1, 2009, the Company completed a partial funding of collateral
amounting to approximately $500,000 for performance bonds issued in connection
with our state licensing efforts.  The collateral, in the form of a
letter of credit arranged by Mr. Jeffrey Porter, was issued by a bank and was
placed with the insurance company that issued the various bonds aggregating to a
face amount of approximately $8,300,000.  Mr. Porter entered into a
Guarantee and Indemnification Agreement with the Company dated February 1, 2009.
Accordingly, we are currently contingently liable for the face amount of the
letter of credit. Mr. Porter was to be compensated in cash at 2% of the average
outstanding amount of the letter of credit per quarter paid in arrears, however,
he chose to take the compensation in the form of Series D Preferred Stock during
the August equity raise. The Guarantee and Indemnification Agreement can be
cancelled by the Company upon receiving a more favorable arrangement from
another party. Upon demand, the Company will be required to increase the
collateral up to 10% of the face amount of bonds issued by the insurance
company.





NOTE
G – SUBSEQUENT EVENTS




The
Company has evaluated subsequent events through the time of filing these
financial statements with the SEC on Form 10-Q on November 13,
2009.





As
described in Note D above, during August and September 2009, the Company entered
into Securities Purchase Agreements.  During October 2009, the Company
has entered into additional Purchase Agreements pursuant to which the Company
issued an additional 104,667 shares of its Series D Preferred Stock and warrants
to purchase 1,046,670 shares of Common Stock for the aggregate cash purchase
price of $314,000.













End
of Financial Statements.


-21-





Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.




Overview.nFinanSe
Inc. is a provider of stored value cards (“SVCs”), for a wide
variety of markets, including grocery stores, convenience stores and general
merchandise stores. Our products and services are aimed at capitalizing on the
growing demand for stored value and reloadable ATM/prepaid card financial
products. We believe SVCs are a fast-growing product segment in the financial
services industry.








Discontinued Operations.In
September 2006, we discontinued the operations of our wholesale long distance
and prepaid phone card business.  All financial information pertaining
to this discontinued business has been eliminated from ongoing operations for
all periods presented in our financial statements included in this report and is
shown as a single line item entitled “Discontinued Operations.”





Results of Operations. Our
principal operations commenced in 2001.  However, to date, we have had
limited revenues.  Accounting guidelines set forth guidelines for
identifying an enterprise in the development stage and the standards of
financial accounting and reporting applicable to such an enterprise. In the
opinion of management, our activities from our inception through October 3, 2009
fall within the referenced guidelines. Accordingly, we report our activities in
this report in accordance with this guidelines.





Lack of Profitability of Business
Operations since 2001.During the years leading up to fiscal 2006, we
were primarily focused on selling Visa® and MasterCard® SVCs and experienced
significant difficulties and interruptions with our third-party card issuers due
to administrative errors, defective cards and poor service. Additionally, it
became apparent to management that there was a flaw in focusing solely on the
sale of SVC products that did not include a convenient load solution for
consumers. Consequently, management made the decision to expand our focus to
include the development of a process, which became known as the nFinanSe Network
TM, to
allow the consumer to perform value loads in a retail environment. To enhance
the load center footprint, in fiscal 2006, we entered into agreements with
MoneyGram® and Western Union® whereby our SVCs could be loaded at their
locations.





Further,
in 2006, and as amended in June 2007, we signed an agreement with DFS Services,
LLC that permits us to provide Discover® Network-branded SVCs directly or
through a card issuing bank. We believe the Discover® Network SVC products have
multiple competitive advantages over the SVCs we were previously selling.
Consequently, we focused on implementing the agreement with DFS Services, LLC in
lieu of pursuing SVC sales through our existing arrangements. Accordingly, our
sales efforts were interrupted while we developed our new Discover® Network SVC
programs and abandoned our then-existing SVC programs by disposing of the
associated SVC inventory. The time and money lost due to the difficulties and
interruptions we experienced hindered our progress and ability to make a
profit.





In late
2006, we developed a new go-to-market strategy centered on marketing bank-issued
Discover® Network-branded SVCs through well-established prepaid card
distributors combined with the load performing ability of the nFinanSe
NetworkTM.  In 2007, we secured agreements with several prepaid card
distributors including Interactive Communications (“InComm”), which
distributes prepaid card products to retailers with more than 100,000 locations
throughout the United States.  We had to source a new bank to issue
cards for InComm’s retailers and we began the task of integrating our network
with InComm’s.  Additionally, the issuing bank required that we
immediately begin making applications for licenses in those states claiming
jurisdiction over SVCs. The general spend card is a relatively new product for
most distributors and it has taken time to integrate with distributors and to
market to their retail partners. During the fourth quarter of 2008, several
large InComm retailers began marketing our cards.


-22-





At
October 3, 2009, there were over 80,000 locations where our SVCs could be loaded
(mostly Western Union® and Moneygram® locations) and approximately 10,000 retail
locations currently offering our SVCs for sale and for reload
services.





Revenues. We produce revenues
through four general types of transactions:




•
       Wholesale fees, charged to our prepaid card distributors when our
      SVCs are sold or reloaded.•
       Transaction fees, paid by the applicable networks and passed through
      by our card issuing banks when our SVCs are used in a purchase or ATM
      transaction.•
       Maintenance fees, charged to an SVC with a cash balance for initial
      activation and monthly maintenance.•
       Interest revenue, on overnight investing of SVC balances by our card
      issuing bank.


These
fees differ by card type, issuing bank and transaction
type.


In July
2009, we made the decision to follow common industry practice in connection with
the initial sale of a reloadable SVC. As such, we lowered the retail price of
our reloadable general spend card from $5.95 collected at the point of sale to
$3.00 and we charge a $2.95 maintenance/activation fee to the card balance upon
activation by the card holder.  As a result, in accordance with our
existing distribution contracts, the fees previously retained by the
retailer/distributor at the point of sale now exceed the amount that is
collected at point of sale. As such, we now pay to the distributor a “Retailer
Fee” when our SVCs are sold as opposed to collecting a wholesale fee. The
difference is recouped when we charge the initial $2.95 maintenance fee. The net
result is essentially the same, but the manner in which it is collected now
follows common industry practice. We still charge a wholesale fee for reload
transactions.





Revenues
for the thirteen weeks ended October 3, 2009 (“3Q2009”) and the
thirteen weeks ended September27, 2008 (“3Q2008”) were $6,706
and $13,202, respectively.  Revenues for the thirty-nine weeks ended
October 3, 2009 (“39
Wks 2009”) and the thirty-nine weeks ended September 27, 2008 (“39 Wks 2008”) were
$2,826 and $29,194, respectively. The negligible revenue for the 39 Wks 2009 is
attributable to the amortization of $90,000 of marketing funds paid to a
national retailer.  We are required under generally accepted
accounting principles to reflect this type of amortization expense as a
contra-revenue item in our financial statements. Gross revenues for 3Q2009 were
$36,706, compared with $13,202 for 3Q2008 and gross revenues for the 39 Wks 2009
were $92,826, compared with $29,194 for the 39 Wks
2008.   Revenues in both 2009 and 2008 were restricted due to
delays in getting cards for sale into retail locations.  These delays
stem from our distributors inability to (i) implement our distribution
agreements in a timely manner, (ii) provide a consistent platform for retailer
connections, (iii) timely test retailer connectivity and (iv) successfully
complete pilots.  During fiscal 2008, our retail focus was on
implementing our distribution agreement with InComm, getting licensed in over 40
states that require licenses and in which we intend to do business and executing
agency agreements with retailers to sell and load our SVCs. InComm provides
prepaid programs at more than 100,000 retail locations in the United States and
is expected to provide more than a sufficient base to meet our
needs.  Additionally, we expect that other prepaid card distributors
servicing retailers across the United States will add to our overall sales
capacity.





Operating Expenses.Operating expenses for 3Q2009 decreased $1,318,865 to $2,344,354 compared
with $3,663,219 for 3Q2008, a 36% decrease. Operating expenses for the 39 Wks
2009 decreased $3,283,274 to $7,592,824 compared with $10,876,098 for the 39 Wks
2008, a 30% decrease. These changes in our operating expenses are attributable
to the following:


-23-





Transaction and operating expenses.Transaction and operating expenses for 3Q2009 and 3Q2008 were $461,902
and $657,182, respectively, a 30% decrease, and for 39 Wks 2009 and 39 Wks 2008
transaction and operating expenses were $1,833,974 and $1,594,626, respectively,
a 15% increase.   The components of expense are:





Description
            
            
            3Q2009
            
            
            
            3Q2008
            
            
            39
      Wks 2009
            
            
            39
      Wks 2008SVC
      card cost, program and transaction expenses
            
            $
            251,003
            
            
            $
            366,735
            
            
            $
            852,307
            
            
            $
            832,357Inventory
      reserves
            
            
            51,825
            
            
            
            40,901
            
            
            
            223,186
            
            
            
            98,825Inventory
      impairment
            
            
            -
            
            
            
            -
            
            
            
            219,851
            
            
            
            -Stock-based
      compensation
            
            
            753
            
            
            
            -
            
            
            
            2,346
            
            
            
            243Customer
      service expenses
            
            
            158,321
            
            
            
            249,546
            
            
            
            536,284
            
            
            
            663,201Total
      Transaction and Operating Expenses
            
            $
            461,902
            
            
            $
            657,182
            
            
            $
            1,833,974
            
            
            $
            1,594,626





SVC card
cost, program and transaction expenses decreased 32% to $251,003 for 3Q2009 from
$366,735 for 3Q 2008.  For the 39 Wks 2009, the increase was $19,950,
or 2%, when compared with the 39 Wks 2008.  The decrease in the 3Q2009
was due to the elimination of the costs charged by our processor to maintain our
increased card inventory on their system.  The increase for the 39
week period is primarily a one time accrual to recognize a minimum contract fee
liability; slightly offset by, a decrease in the amortization of marketing
funds.  We implemented a process to reduce the costs charged by our
processor to maintain card inventory that was fully reflected in the 3Q2009
results and will be fully reflected in future periods.





Inventory
reserves increased $10,924 and $124,361 when comparing 3Q2009 with 3Q2008 and
the 39 Wks 2009 with the 39 Wks 2008, respectively, due primarily to the higher
inventory levels, which results in a higher potential for lost, damaged or
obsolete SVC packages.





We
recorded an inventory impairment charge of $219,851 for inventory that was
nearing its “valid thru” dates, due to the delays in implementation of our
program.





Customer
service expenses decreased by $91,225 and $126,917 to $158,321 and $536,284when
comparing 3Q2009 with 3Q2008 and the 39 Wks 2009 and 389 Wks 2008, respectively,
due to efficiencies in scheduling customer service representative
coverage.





Selling and marketing
expenses. Selling and marketing expenses decreased $468,589 to $470,881
when comparing 3Q2009 with 3Q2008, a 50% decrease, and decreased $1,614,888 to
$1,401,548 when comparing the 39  Wks 2009 with the 39 Wks 2008, a 54%
decrease.  The components of expense are:





Description
            
            
            3Q2009
            
            
            
            3Q2008
            
            
            39
      Wks 2009
            
            
            39
      Wks 2008Advertising
      and marketing expenses
            
            $
            204,978
            
            
            $
            446,117
            
            
            $
            508,708
            
            
            $
            1,327,823Sales
      force expenses
            
            
            237,010
            
            
            
            447,057
            
            
            
            805,505
            
            
            
            1,512,794Stock-based
      compensation
            
            
            28,893
            
            
            
            46,296
            
            
            
            87,335
            
            
            
            175,819Total
      Selling and Marketing Expenses
            
            $
            470,881
            
            
            $
            939,470
            
            
            $
            1,401,548
            
            
            $
            3,016,436





Advertising
      and marketing expenses decreased 54%, or $241,139, to $204,978 when
      comparing 3Q2009 with 3Q2008.  For the 39 Wks 2009 compared to
      the 39 Wks 2008, advertising and marketing expenses decreased 62%, or
      $819,115 to $508,708.   These period to period changes were
      primarily attributable to the expenses of a national trade print
      advertising campaign in 3Q2008 and the 39 Wks 2008 as opposed to none in
      3Q2009 or the 39 Wks 2009.
              
              Sales
      force expenses decreased $210,047 to $237,010, a 47% decrease for 3Q2009
      when compared with 3Q2008.  For the 39 Wks 2009 compared to the
      39 Wks 2008, sales force expenses decreased 47%, or $707,289 to $805,505.
      The principal components of this decrease are employee compensation and
      benefits, expense travel and entertainment expense, and rent
      expense.  The decrease in sales force compensation and travel
      and entertainment expenses can be attributed to reductions in the sales
      force to seven employees at the end of the 3Q2009 from a total of 13
      employees at the end of the 3Q2008.  In addition, rent expense
      decreased due to the elimination in the third quarter of 2008 of a
      temporary warehouse space used to store point-of-purchase displays for our
      distributors.
              
              Stock-based
      compensation decreased in 3Q2009 and the 39 Wks 2009 due to forfeiture of
      options and the termination of stock based compensation expense associated
      with the reduction of sales force employees from the 39 Wks
      2008.




-24-


General and administrative expenses.General and administrative expenses decreased 32%, or $654,996, to
$1,411,571 during 3Q2009 when compared with 3Q2008.  For the 39 Wks
2009, general and administrative expenses decreased 30%, or $1,907,735, to
$4,357,302 when compared with the 39 Wks 2008.  The components of
expense are:





Description
            
            
            3Q2009
            
            
            
            3Q2008
            
            
            39
      Wks 2009
            
            
            39
      Wks 2008Payroll,
      benefits and taxes
            
            $
            670,049
            
            
            $
            748,498
            
            
            $
            2,116,801
            
            
            $
            2,324,492Stock-based
      compensation
            
            
            89,048
            
            
            
            384,852
            
            
            
            257,619
            
            
            
            1,353,327Professional,
      legal and licensing expense
            
            
            211,165
            
            
            
            325,756
            
            
            
            660,473
            
            
            
            1,239,983Office
      and occupancy expenses
            
            
            193,362
            
            
            
            256,459
            
            
            
            603,613
            
            
            
            718,529Impairment
      expense
            
            
            144,974
            
            
            
            224,437
            
            
            
            375,212
            
            
            
            224,437Other
      administrative expense
            
            
            102,973
            
            
            
            126,565
            
            
            
            343,584
            
            
            
            404,269Total
      General and Administrative Expenses
            
            $
            1,411,571
            
            
            $
            2,066,567
            
            
            $
            4,357,302
            
            
            $
            6,265,037




When
      comparing 3Q2009 with 3Q2008, changes in the expense categories are
      primarily attributable to:





▪
            decreased
      payroll, benefits and taxes expenses of $78,499, due primarily to lower
      general and administrative payroll in 3Q2009 than
  3Q2008;▪
            decreased
      stock-based compensation expense of $295,804, which is primarily
      attributable to our having fully expensed the stock option grants to Mr.
      Welch and Mr. Springer under their employment agreements as of the end of
      fiscal 2008;▪
            decreased
      professional, legal and licensing expense of $114,591 due primarily to
      reduced legal fees incurred in connection with the completion of our state
      licensing initiative and no litigation activity; and▪
            impairment
      of asset charge of $144,974 in 3Q 2009 to write-down the balance
      of  the expected value of a marketing incentive agreement
      compared with $224,437 in 3Q2008 for the costs of certain gift cards to be
      destroyed due to their impending
expiration.





When
      comparing the 39 Wks 2009 with the 39 Wks 2008, changes in the expense
      categories are primarily attributable
to:





▪
            decreased
      payroll, benefits and taxes expenses of $207,691, due primarily to
      $125,000 in higher bonuses paid in the 39 Wks 2008 than the 39 Wks 2009
      and annual compensation increases offset by lower general and
      administrative payroll in 3Q2009 than 3Q2008;▪
            decreased
      stock-based compensation expense of $1,095,708, which is primarily
      attributable to our having fully expensed the stock option grants to Mr.
      Welch and Mr. Springer under their employment agreements as of the end of
      fiscal 2008;▪
            decreased
      professional, legal and licensing expense of $579,510 due to $220,657 in
      lower recruiting fees incurred in the prior year to increase our sales
      force and $353,099 in lower legal fees incurred in connection with the
      completion of our state licensing initiative and reduced litigation
      activity; and▪
            impairment
      of asset charge of $375,212 in the 39 Wks 2009 to write-down the balance
      of the expected value of a marketing incentive agreement compared with
      $224,437 for the costs of certain gift cards to be destroyed due to their
      impending expiration in the 39 Wks
2008.





Loss Before Other Income
(Expense).  As a result of the above, loss before other income
(expense) for 3Q2009 and 3Q2008 was $2,337,648 and $3,650,017, respectively and
for the 39 Wks 2009 and the 39 Wks 2008 was $7,589,998 and $10,846,905,
respectively.





-25-


Other
Income (Expense):





Interest expense.Interest
expense was $624,083 for 3Q2009.  Non-cash interest expense for this
period was $501,263. Of this, $386,881 relates to the amortization of the cost
of the warrants issued under the Amended and Restated Loan Agreement and the
Term Loan Notes, and $114,382 is primarily represented by interest accrued for
funds advanced under the Amended and Restated Loan Agreement that was converted
into shares of our Series D Convertible Preferred Stock.  Cash
interest was $122,820.  Of this, $7,093 was paid or payable to the
lenders for funds advanced under the terms of the Amended and Restated Loan
Agreement and $114,902 represents the amortization of placement fees and legal
fees incurred in connection with the Amended and Restated
Agreement.   Interest expense incurred during 3Q2008 was $38,712,
composed primarily of $17,371 for the fair value of warrants earned during the
period under the Guaranty and Indemnification Agreement between the Company and
Mr. Terker and, $2,000 for payment to Mr. Jeffrey Porter under his agreement to
provide the required collateral for bonds issued to states in connection with
licensing.





Interest
expense was $2,903,500 for the 39 Wks 2009.  Non-cash interest expense
for this period was $2,459,327.  Of this, $9,925 relates to the fair
value of warrants earned during the period under the Guaranty and
Indemnification Agreement between the Company and Mr. Terker, $293,898 relates
primarily to interest accrued for funds advanced under the Amended and Restated
Loan Agreement that was converted into shares of our Series D Convertible
Preferred Stock, and the remaining $2,155,505 relates to the amortization of the
fair value of the warrants issued under the Amended and Restated Loan
Agreement.  Cash interest was $443,371.  Of this, $97,372
was paid or payable to the Lenders for funds advanced under the terms of the
Amended and Restated Loan Agreement, and $344,705 represents the amortization of
placement fees and legal fees incurred in connection with the Amended and
Restated Loan Agreement.   Interest expense incurred during the
39 Wks 2008 was $94,178, Non-cash interest expense for the 39 Wks 2008 was
$42,374 and relates to the fair value of warrants earned under the Guaranty and
Indemnification Agreement between the Company and Mr. Bruce E.
Terker.  Cash interest of approximately $50,000 for the 39 Wks 2008
relates to the Guaranty and Indemnification Agreement between the Company and
Mr. Jeffrey Porter.





Loss on derivative financial
instruments.Loss on derivative financial instruments was
$396,032 for the 39 Wks 2008.  No income or expense was incurred or
recognized for 3Q2008, 3Q2009 or the 39 Wks 2009.





Loss from
litigation.  In 3Q2008, we recorded a $55,000 expense incurred
as a result of the settlement of a breach of contract dispute under a services
agreement.  We had none in 3Q2009 and the 39 Wks 2009.





Other
income (expense).


For
3Q2009, we recorded other income of $800 and none in 2Q2008.  For the
39 Wks 2009 we recorded other expense of $961 and $758 in the 39 Wks
2008.





Loss from Continuing
Operations. Loss from continuing operations was $2,960,912 and
$10,494,347 for 3Q2009 and the 39 Wks 2009, respectively or $769,172 and
$878,039 lower than the loss from continuing operations of $3,730,084 and
$11,372,386 for 3Q2008 and the 39 Wks 2008, respectively.





Liquidity and Capital Resources.From inception to October 3, 2009, we have raised net proceeds of
approximately $52.2 million from financing activities. We used these proceeds to
fund operating and investing activities. We had a cash balance of approximately
$5,700,000 as of October 30, 2009.


-26-





Net cash
used in operating activities was approximately $6.7 million and $10.3 million
for the 39 Wks 2009 and the 39 Wks 2008, respectively.  The decrease
in cash used in operations was the result of increases in inventories for the
SVCs and prepayments for our national trade print advertising campaign that
occurred during the 39 Wks 2008.  These increases were not repeated
during the 39 Wks 2009.   In addition, we incurred lower
operating losses during the current thirty-nine weeks compared with the same
period of the prior year.  This was primarily due to lower selling and
marketing expenses and lower general and administrative expenses.





Net cash
provided by investment activities for the 39 Wks 2008 was approximately $577,400
consisting of the redemption of our short-term investment of $725,500 offset by
$148,100 for purchases of property and equipment, primarily for additional
computer hardware and software for new employees and the
nFinanSe NetworkTM.  We
recorded minimal investment activity for the 39 Wks 2009.





As
described in Note C to our consolidated financial statements, on June 10, 2008,
we entered into a revolving credit facility with various lenders in the
aggregate principal amount of $15,500,000 (the “Credit
Facility”).  Loans under the Credit Facility are to be used
solely to make payments to card issuing banks for credit to SVCs.  On
November 26, 2008, the Credit Facility was subsequently amended to establish a
sub-commitment of $3,400,000, pursuant to which each lender in its sole
discretion, may advance funds (each, an “Accommodation Loan”)
that may be used by the Company for working capital expenditures, working
capital needs and other general corporate purposes.  Loans and
Accommodation Loans may be repaid and re-borrowed.  The maturity date
of the Credit Facility was November 25, 2009, one year after the initial
borrowing and on October 29, 2009 the Lenders approved the extension of maturity
for an additional six months upon the satisfaction of certain conditions set
forth in the Amended and Restated Loan Agreement.  The Credit Facility
contemplates that, with the Lenders’ consent, the maximum commitment may be
increased to up to $20,000,000, and additional lenders may be
added.  In addition, commencing on May 7, 2009, the Company sold term
loan notes (the “June
Term Loan Notes”) with a principal amount of $1,000,000.  The
June Term Loan Notes accrue interest at 10% annually and were amended to mature
on August 31, 2009.  The Company’s obligations under the Term Loan
Notes are secured by a lien on substantially all of its assets. The Term
Loan Notes were purchased by each of Ballyshannon Partners, L.P., Odyssey
Capital Group, L.P., Lancaster Investment Partners, L.P., 5 Star Partnership,
L.P., EDJ Limited and Trellus Partners, L.P.  In June 2009, the
Company received permission from the Required Lenders of the Amended and
Restated Credit Agreement as well as the Requisite Holders of its Series A
Preferred Stock to issue up to an additional $1 million of Term Loans (the
“July Term
Loans”), Commencing on July 3, 2009, the Company sold additional term
loan notes (the “July
Term Loans”) with a principal amount of $1,000,000.  The July
Term Loans accrue interest at 10% annually and mature on August 31,
2009.   The July Term Loans were purchased by each of
Ballyshannon Partners, L.P., Odyssey Capital Group, L.P. and Lancaster
Investment Partners.  As of October 3, 2009, we had drawn $500,000
under the Amended and Restated Loan Agreement.  The amounts drawn
under the Term Loan Notes and Accommodation Loans and accrued interest thereon
were exchanged for Series D Preferred Stock on August 21, 2009 as described in
Note D.  Duringthe 39 Wks 2009, the
cash provided by financing activities of $11.6 million was the result of $2.7
million of Accommodation Loan borrowings, $2.0 million of Term Loan Note
borrowings and $6.9 million from the sale of Series D Preferred
Stock.





Mr.
Terker, a current member of the Board of Directors, has sole voting and
dispositive power over the securities held by Ballyshannon Partners, L.P. and
its affiliates, two of which are recipients of Note Offering
Warrants.  Mr. Terker has a financial interest in such entities, and,
as such, has a financial interest in the Note Offering, the Term Loan Notes and
the Note Offering Warrants.





During
the39 Wks. 2008,
we secured net cash provided by financing activities of approximately $9.8
million through sales of our equity instruments slightly offset by $432,700 of
deferred financing costs incurred in connection with our Amended and Restated
Loan Agreement and $683,600 in stock issuance costs for the sale of our equity
instruments.


-27-





Changes in Number of Employees and
Location.We anticipate that the development of our business will require
the hiring of a substantial number of additional employees in sales,
administration, operations and customer service.





Off-Balance
Sheet Arrangements:





Operating
Leases





We are
obligated under various operating lease agreements for our
facilities.  Future minimum lease payments and anticipated common area
maintenance charges under all of our operating leases are approximately as
follows at October 3, 2009:





Twelve
      months ending:
            
            AmountsSeptember
      2010
            
            $
            207,500September
      2011
            
            
            203,600September
      2012
            
            
            208,000September
      2013
            
            
            17,400September
      2014
            
            
            -Total
            
            $
            636,500





Rent
expense included in loss from continuing operations for 39 Wks 2009 and 39 Wks
2008, was approximately $194,100 and $289,200, respectively.





Employment
Agreements





We are
obligated under employment agreements with our Chief Executive Officer, Jerry R.
Welch, and our Chief Financial Officer, Raymond P. Springer.  The
employment agreements had an initial term from September 5, 2006 to December 31,
2008 and were automatically renewed for two years with a new expiration date of
December 31, 2010.  The employment agreements provide to Messrs. Welch
and Springer a current annual salary of $275,000 and $200,000, respectively.
Each agreement is to be automatically renewed indefinitely for succeeding terms
of two years unless otherwise terminated in accordance with the
agreement.  Both Mr. Welch and Mr. Springer also receive
performance-based bonuses and certain medical and other benefits.  If
we terminate Mr. Welch or Mr. Springer without cause, we will be required to pay
severance to them in the amount of compensation and benefits they would have
otherwise earned in the remaining term of their employment agreements or twelve
months, whichever period is shorter.





Service and Purchase
Agreements





We have
entered into renewable contracts with DFS Services LLC, our card network, Palm
Desert National Bank (“PDNB”), and First
National Bank & Trust of Pipestone, Minnesota (“FNB&T”), our
card-issuing banks, and Metavante Corporation (“Metavante”), our
processor, that have initial expiration dates from June 30, 2010 through October
2011.    Because the majority of the fees to be paid are
contingent primarily on card volume, it is not possible to calculate the amount
of the future commitment on these contracts. The Metavante and FNB&T
agreements also require a minimum payment of $5,000 and $7,500 per month,
respectively.  During the 39 Wks 2009 and 39 Wks 2008, we made
aggregate payments of approximately $737,677 and $429,700, respectively to
Metavante, $4,733 and $2,100, respectively to PDNB and $113,715 and $78,600,
respectively, to FNB&T under these agreements.




Our
agreements with PDNB and FNB&T require us to maintain certain reserve
balances for our card programs.  As of October 3, 2009, the reserve
balance held at PDNB was $10,000 and two reserve balances held at FNB&T
totaled $75,000.  These balances are included in Other
assets.





-28-


Pending or Threatened
Litigation





We may
become involved in certain litigation from time to time in the ordinary course
of business. However at October 3, 2009, to the best of our knowledge, no such
litigation exists or is threatened.





Bond
Collateral





On
February 1, 2009, the Company completed a partial funding of collateral
amounting to approximately $500,000 for performance bonds issued in connection
with our state licensing efforts.  The collateral, in the form of a
letter of credit arranged by Mr. Jeffrey Porter, was issued by a bank and was
placed with the insurance company that issued the various bonds aggregating to a
face amount of approximately $8,600,000.  Mr. Porter entered into a
Guarantee and Indemnification Agreement with the Company dated February 1, 2009.
Accordingly, we are currently contingently liable for the face amount of the
letter of credit. Mr. Porter was to be compensated in cash at 2% of the average
outstanding amount of the letter of credit per quarter paid in arrears, however,
he chose to take the compensation in the form of Series D Preferred Stock during
the August equity raise. The Guarantee and Indemnification Agreement can be
cancelled by the Company upon receiving a more favorable arrangement from
another party. Upon demand, the Company will be required to increase the
collateral up to 10% of the face amount of bonds issued by the insurance
company.





Critical
Accounting Estimates





The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements. The reported amounts of
revenues and expenses during the reporting period may be affected by the
estimates and assumptions we are required to make. Estimates that are critical
to the accompanying consolidated financial statements arise from our belief that
we will generate adequate cash to continue as a going concern and that all
long-lived assets are recoverable.  In addition, stock-based
compensation expense represents a significant estimate.  The markets
for our products are characterized by intense competition, rapid technological
development, evolving standards, short product life cycles and price
competition, all of which could impact the future realization of our assets.
Estimates and assumptions are reviewed periodically and the effects of revisions
are reflected in the period that they are determined to be necessary. It is at
least reasonably possible that our estimates could change in the near term with
respect to these matters.





See
Note A — “Formation, Background and Operations of the Company” to the
consolidated financial statements, regarding the effect of certain recent
accounting pronouncements on our consolidated financial
statements.





Item
3.  Quantitative and Qualitative Disclosures About Market
Risk.





Not
applicable.




Item
4T.  Controls and Procedures.





Evaluation
of Disclosure Controls and Procedures





An
evaluation of the effectiveness of our disclosure controls and procedures as
defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of
1934, as amended (the “Securities Exchange
Act”), as of October 3, 2009 was carried out by us under the supervision
and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures as of the end of the period covered by this report are
effective.





Disclosure
controls and procedures are designed to ensure that information required to be
disclosed in our reports filed or submitted under the Securities Exchange Act
are recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms.  Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in our reports filed or
submitted under the Securities Exchange Act is accumulated and communicated to
our management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding
disclosure.





Change
in Internal Control over Financial Reporting





There
were no changes in our internal control over financial reporting during our most
recent fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.





-29-





PART
II - OTHER INFORMATION





Item
1. Legal Proceedings.





We may
become involved in certain other litigation from time to time in the ordinary
course of business. However at October 3, 2009, to the best of our knowledge, no
such litigation exists or is threatened.





Item
2. Unregistered Sales of Equity Securities and Use of Proceeds.





Series
D Preferred Stock Offering





During
August and September, the Company entered into Securities Purchase Agreements
(the “Purchase
Agreements”), with several institutional and accredited investors,
including Ballyshannon Partners, LP, Mr. Robert Berlacher, Porter Partners, LP,
Midsummer Investment, Ltd. and Trellus Offshore Fund Ltd., all of which
beneficially own five percent or more of the Common Stock (collectively, the
“Investors”),
pursuant to which the Company issued  4,220,503 shares of its Series D
Convertible Preferred Stock, $0.001 par value per share (“Series D Preferred
Stock”), and warrants (the “Warrants”) to
purchase 42,205,040 shares of the Company’s common stock, $0.001 par value per
share (“Common
Stock”), at an exercise price of $0.01 per share, for the aggregate
purchase price of  $12,661,509,  $6,967,611 of which was
paid by Investors in cash and $5,693,898 was paid by Investors through the
exchanges of a like amount of certain outstanding accommodation loans, term
loans and accrued interest payable thereon.





Pursuant
to the terms of the Purchase Agreements, each Investor who invested an amount
equal to or greater than 25% of the amounts invested in prior transactions
involving stock or certain accommodation loans and term loans had the exercise
price of any Company warrants held by such Investor reduced to (i) $0.30 per
share of Common Stock, if they invested $100,000 or more, of which 206,250 were
re-priced as such, or (ii) $0.01 per share of Common Stock, if they invested
$250,000 or more of which 12,899,207 were re-priced as such.





The
Warrants entitle the Investors to purchase shares of Common Stock at an exercise
price of $0.01 per share, which exercise price is subject to customary
adjustments for Common Stock splits and reverse stock splits.  The
Warrants are exercisable during the period commencing on the first anniversary
of the date of the Warrant and expiring four (4) years thereafter, and may be
exercised by means of a “cashless exercise.”  In the event that the
Company shall consolidate with or merge with or into another person or entity,
or the Company shall sell, transfer or lease all or substantially all of its
assets, or the Company shall change its Common Stock into property or other
securities (each, a “Triggering
Transaction”), the Warrants shall terminate and shall thereafter
represent only the right to receive the cash, evidences of indebtedness or other
property as the Investors would have received had they been the record owner, at
the time of completion of a Triggering Transaction, of that number of shares of
Common Stock receivable upon exercise of the Warrants in full, less the
aggregate exercise price payable in connection with the full exercise of the
Warrants.  The Warrants are not exercisable by the Investors to the
extent that, if exercised, they or any of their affiliates would beneficially
own in excess of 9.99% of the then issued and outstanding shares of Common
Stock.  With respect to the securities purchased by Midsummer
Investment, Ltd. (“Midsummer”), the
Company has agreed that the Series D Preferred Stock and Warrants held by
Midsummer shall not be converted or exercised (as the case may be) such that
Midsummer or any of its affiliates would own in excess of 4.9% of the then
issued and outstanding shares of Common Stock.





Emerging
Growth Equities, Ltd. (“EGE”) received fees
of $34,400 in connection with the introduction of certain new investors for the
above-described transactions.  Robert A. Berlacher, a current
stockholder of the Company, is a co-founder and director of EGE Holdings, Ltd.
(“EGE
Holdings”), a holding company with a 100% ownership interest in
EGE.  Mr. Berlacher received no compensation from EGE Holdings or EGE
related to the Company’s sale of Series D Preferred Stock and the
Warrants.  Bruce E. Terker, a member of our Board of Directors,
controls two entities that are investors in EGE Holdings.


-30-





Item
3. Defaults Upon Senior Securities.





None.





Item 4. Submission of Matters to a
Vote of Security Holders.





Special Meeting of the
Holders of Series A Convertible Preferred Stock, Series B Convertible Preferred
Stock and Series C Convertible Preferred Stock





The
Special Meeting of the Holders of Series A, Series B and Series C Convertible
Preferred Stock of nFinanSe Inc. was held on August 11, 2009.  The
matters voted upon at the meeting and the votes cast with respect to such
matters are as follows:





Proposal
and Vote Tabulation




Votes
      CastFor
            
            
            AgainstManagement
      ProposalTo
      consider the creation of a new series of nFinanSe preferred stock
      designated as Series D Convertible Preferred Stock, par value
      $0.001.
            
            
            9,227,153
            
            
            
            -To
      consider an amendment (the “Series A Charter
      Amendment”) to the Certificate of Designations, Rights and
      Preferences of Series A Convertible Preferred Stock (the “Series A
      Charter”), such that the Series A Preferred’s “Liquidation
      Preference” (as such term is defined in the Series A Charter) will be paid
      on a subordinated basis to the payment of the respective liquidation
      preference payments applicable to the Series D Preferred.
            
            
            5,989,653
            
            
            
            -To
      consider an amendment (the “Series B Charter
      Amendment”) to the Certificate of Designations, Rights and
      Preferences of Series B Convertible Preferred Stock (the “Series B
      Charter”), such that the Series B Preferred’s “Liquidation
      Preference” (as such term is defined in the Series B Charter) will be paid
      on a subordinated basis to the payment of the respective liquidation
      preference payments applicable to the Series D Preferred.
            
            
            1,000,000
            
            
            
            -To
      consider an amendment (the “Series C Charter
      Amendment”) to the Certificate of Designations, Rights and
      Preferences of Series B Convertible Preferred Stock (the “Series C
      Charter”), such that the Series C Preferred’s “Liquidation
      Preference” (as such term is defined in the Series C Charter) will be paid
      on a subordinated basis to the payment of the respective liquidation
      preference payments applicable to the Series D Preferred.
            
            
            2,237,500
            
            
            
            -





Item
5. Other Information.





None.


-31-





Item
6. Exhibits.





Exhibit Number
            
            Description of Exhibit10.1
            
            Form
      of Securities Purchase Agreement, as executed by the Company and the
      Investors on August 21, 2009 (attached as Exhibit 99.1 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.2
            
            Form
      of Warrant, as issued by the Company to the Investors on August 21, 2009
      (attached as Exhibit 99.2
      to that certain Form 8-K, filed by the Company with the Securities and
      Exchange Commission on August 26, 2009).10.3
            
            Certificate
      of Amendment to Certificate of Designation For Nevada Profit Corporation
      for Series A Preferred Stock, as filed with the Secretary of State of the
      State of Nevada on August 25, 2009 (attached as Exhibit 99.3 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.4
            
            Certificate
      of Amendment to Certificate of Designation For Nevada Profit Corporation
      for Series B Preferred Stock, as filed with the Secretary of State of the
      State of Nevada on August 25, 2009 (attached as Exhibit 99.4 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.5
            
            Certificate
      of Amendment to Certificate of Designation For Nevada Profit Corporation
      for Series C Preferred Stock, as filed with the Secretary of State of the
      State of Nevada on August 25, 2009 (attached as Exhibit 99.5 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.6
            
            Certificate
      of Designations, Rights and Preferences of the Series D Convertible
      Preferred Stock, as filed with the Secretary of State of the State of
      Nevada on August 21, 2009 (attached as Exhibit 99.6 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).*31.1
            
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*31.2
            
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*32.1
            
            Certification
      of Chief 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002





* filed
herewith.


-32-





SIGNATURES





In
accordance with the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.





NFINANSE
      INC.Date: November
      13, 2009
            By:
            /s/ Jerry R. WelchJerry
      R. Welch, Chief Executive Officer and
              Chairman
      of the Board of Directors
              (Principal
      Executive Officer)





NFINANSE
      INC.Date:  November
      13, 2009
            By:
            /s/ Raymond P. SpringerRaymond
      P. Springer, Chief Financial Officer
              (Principal
      Financial Officer)





NFINANSE
      INC.Date:  November
      13, 2009
            By:
            /s/ Jerome A. KollarJerome
      A. Kollar, Vice President Finance and
              Controller
      (Principal Accounting Officer)





-33-





EXHIBITS
INDEX





Exhibit Number
            
            Description of Exhibit10.1
            
            Form
      of Securities Purchase Agreement, as executed by the Company and the
      Investors on August 21, 2009 (attached as Exhibit 99.1 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.2
            
            Form
      of Warrant, as issued by the Company to the Investors on August 21, 2009
      (attached as Exhibit 99.2
      to that certain Form 8-K, filed by the Company with the Securities and
      Exchange Commission on August 26, 2009).10.3
            
            Certificate
      of Amendment to Certificate of Designation For Nevada Profit Corporation
      for Series A Preferred Stock, as filed with the Secretary of State of the
      State of Nevada on August 25, 2009 (attached as Exhibit 99.3 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.4
            
            Certificate
      of Amendment to Certificate of Designation For Nevada Profit Corporation
      for Series B Preferred Stock, as filed with the Secretary of State of the
      State of Nevada on August 25, 2009 (attached as Exhibit 99.4 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.5
            
            Certificate
      of Amendment to Certificate of Designation For Nevada Profit Corporation
      for Series C Preferred Stock, as filed with the Secretary of State of the
      State of Nevada on August 25, 2009 (attached as Exhibit 99.5 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).10.6
            
            Certificate
      of Designations, Rights and Preferences of the Series D Convertible
      Preferred Stock, as filed with the Secretary of State of the State of
      Nevada on August 21, 2009 (attached as Exhibit 99.6 to that
      certain Form 8-K, filed by the Company with the Securities and Exchange
      Commission on August 26, 2009).*31.1
            
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*31.2
            
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*32.1
            
            Certification
      of Chief 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002





* filed
herewith.







-34-