UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-K




(Mark
One)
 [√]
                ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
      the fiscal year ended December 31,
2008
 
 or
 
 [
      ]
                  TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
      the transition period from __________________ to
      __________________________Commission
      file number: 0-27828
 
 DIGITAL
      LIFESTYLES GROUP INC.(Exact
      name of registrant as specified in its
charter)
 
 Delaware
                        13-3779546(State
      or other jurisdiction of incorporation or organization)
                        (I.R.S.
      Employer Identification
No.)
 
 649
      Sparta Highway, Suite 102, Crossville, TN
                        38555(Address
      of principal executive offices)
                        (Zip
      Code)
 
 Registrant's
      telephone number, including area code:
                    (931)
      707-9601
 
 Securities
registered under Section 12(b) of the Act:
 
 Title
      of each class
                      Name
      of each exchange on which registeredNone
                      Not
      applicable
 
 Securities
registered under Section 12(g) of the Act:
 
 Common
      Stock, par value $0.03 per share(Title
      of class)


Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.   [   ] Yes [√]
No





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. [ 
 ] Yes [√] No





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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 [   ] No [√]





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ 
 ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company:





Large
      accelerated filer
                  [
      ]
                  Accelerated
      filer
                  [  ]Non-accelerated
      filer
                    (Do
      not check if smaller reporting company)
                  [
      ]
                  Smaller
      reporting company
                  [√]





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





State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked prices of such common equity, as of the last
business day of the registrant's most recently completed second fiscal
quarter.  Approximately $839,112 on June 30, 2008.





Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.   32,223,975 shares of
common stock are issued and outstanding as of August 20, 2009.







DOCUMENTS
INCORPORATED BY REFERENCE
 
 List
hereunder the following documents if incorporated by reference and the Part of
the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933.  The listed documents should be
clearly described for identification purposes (e.g., annual report to security
holders for fiscal year ended December 24, 1980).  None.


DIGITAL
LIFESTYLES GROUP INC.


FORM
10-K


TABLE
OF CONTENTS





Page
      No.Part
      IItem
      1.
                                  Business.
                                  4Item
      1A.
                                  Risk
      Factors.
                                  7Item
      1B.
                                  Unresolved
      Staff Comments.
                                  9Item
      2.
                                  Properties.
                                  9Item
      3.
                                  Legal
      Proceedings.
                                  9Item
      4.
                                  Submission
      of Matters to a Vote of Security Holders.
                                  9Part
      IIItem
      5.
                                  Market
      for Registrant's Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities.
                                  9Item
      6.
                                  Selected
      Financial Data.
                                  10Item
      7.
                                  Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                                  10Item
      7A.
                                  Quantitative
      and Qualitative Disclosures About Market Risk.
                                  15Item
      8.
                                  Financial
      Statements and Supplementary Data.
                                  15Item
      9.
                                  Changes
      In and Disagreements With Accountants on Accounting and Financial
      Disclosure.
                                  15Item
      9A.(T)
                                  Controls
      and Procedures.
                                  16Item
      9B.
                                  Other
      Information.
                                  17Part
      IIIItem
      10.
                                  Directors,
      Executive Officers and Corporate Governance.
                                  17Item
      11.
                                  Executive
      Compensation.
                                  18Item
      12.
                                  Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.
                                  19Item
      13.
                                  Certain
      Relationships and Related Transactions, and Director
      Independence.
                                  20Item
      14.
                                  Principal
      Accounting Fees and Services.
                                  20Part
      IVItem
      15.
                                  Exhibits,
      Financial Statement Schedules.
                                  21







2
 
 CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING INFORMATION
 
 This report contains forward-looking
statements. These forward-looking statements are subject to known and unknown
risks, uncertainties and other factors which may cause actual results,
performance or achievements to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements.  These forward-looking statements were based on various
factors and were derived utilizing numerous assumptions and other factors that
could cause our actual results to differ materially from those in the
forward-looking statements.  These factors include, but are not
limited to, our ability to bring our filing requirements with the Securities and
Exchange Commission current, our ability to satisfy our obligations, our ability
to consummate the acquisition of an operating entity and/or assets, our ability
to generate revenues and pay our operating expenses, our ability to raise
capital as necessary, economic, political and market conditions and
fluctuations, government and industry regulation, interest rate risk, U.S. and
global competition, and other factors.  Most of these factors are
difficult to predict accurately and are generally beyond our
control.  You should consider the areas of risk described in
connection with any forward-looking statements that may be made
herein.  Readers are cautioned not to place undue reliance on these
forward-looking statements and readers should carefully review this report in
its entirety, including the risks described in "Item 1A. - Risk
Factors".  Except for our ongoing obligations to disclose material
information under the Federal securities laws, we undertake no obligation to
release publicly any revisions to any forward-looking statements, to report
events or to report the occurrence of unanticipated events.  These
forward-looking statements speak only as of the date of this report, and you
should not rely on these statements without also considering the risks and
uncertainties associated with these statements and our
business.




OTHER
PERTINENT INFORMATION





Unless
specifically set forth to the contrary, when used in this prospectus the terms
“Digital Lifestyles", "we"", "our", the "Company" and similar terms refer to
Digital Lifestyles Group Inc., a Delaware corporation, and our
subsidiaries.  In addition, when used herein and unless specifically
set forth to the contrary, “2008” refers to the year ended December 31, 2008 and
“2007” refers to the year ended December 31, 2007.




3




PART I





ITEM
1.                                DESCRIPTION
OF BUSINESS.





We do not have any business or
operations and are considered a "shell" company under Federal securities
laws.  We are actively seeking to acquire assets or shares of an
entity actively engaged in business which generates revenues, in exchange for
our securities.  Our purpose is to seek, investigate and, if such
investigation warrants, acquire an interest in business opportunities presented
to us by persons or firms who or which desire to seek the perceived advantages
our company may offer.  We will not restrict our search to any
specific business, industry, or geographical location and we may participate in
a business venture of virtually any kind or nature.  This discussion
of the proposed business is purposefully general and is not meant to be
restrictive of our virtually unlimited discretion to search for and enter into
potential business opportunities. Management anticipates that it may be able to
participate in only one potential business venture because we have nominal
assets and limited financial resources. This lack of diversification should be
considered a substantial risk to our stockholders because it will not permit us
to offset potential losses from one venture against gains from
another.





We may seek a business opportunity with
entities which have recently commenced operations, or which wish to utilize the
public marketplace in order to raise additional capital in order to expand into
new products or markets, to develop a new product or service, or for other
corporate purposes.  We may acquire assets and establish wholly-owned
subsidiaries in various businesses or acquire existing businesses as
subsidiaries.  We anticipate that the selection of a business
opportunity in which to participate will be complex and extremely
risky.  Due to general economic conditions, rapid technological
advances being made in some industries and shortages of available capital,
management believes that there are numerous firms seeking the perceived benefits
of a publicly registered corporation.  These perceived benefits may
include facilitating or improving the terms on which additional equity financing
may be sought, providing liquidity for incentive stock options or similar
benefits to key employees, providing liquidity (subject to restrictions of
applicable statutes), for all stockholders and other
factors.  Potentially, available business opportunities may occur in
many different industries and at various stages of development, all of which
will make the task of comparative investigation and analysis of such business
opportunities extremely difficult and complex.





The analysis of new business
opportunities will be undertaken by, or under the supervision of, Mr. Ken Page,
our Chief Executive Officer, who may not be considered a professional business
analyst.  Mr. Page will be the key person in the search, review and
negotiation with potential acquisition or merger candidates.  We
intend to concentrate on identifying preliminary prospective business
opportunities which may be brought to our attention through present associations
of Mr. Page and legal counsel or by our stockholders.  In analyzing
prospective business opportunities, we will consider such matters
as:




•
              the
      available technical, financial and managerial resources;•
              working
      capital and other financial requirements;•
              history
      of operations, if any;•
              prospects
      for the future;•
              nature
      of present and expected competition;•
              the
      quality and experience of management services which may be available and
      the depth of that management;


•
            the
      potential for further research, development, or
    exploration;


•
            specific
      risk factors not now foreseeable but which then may be anticipated to
      impact our proposed activities;


•
            the
      potential for growth or expansion;


•
            the
      potential for profit;


•
              the
      perceived public recognition of acceptance of products, services, or
      trades; name identification; and•
              other
      relevant factors.





We will
not acquire or merge with any company for which audited financial statements
cannot be obtained within the time period prescribed by applicable rules of the
United States Securities and Exchange Commission which is presently four
business days from the closing date of the transaction.  This
requirement for readily available audited financial statement may require us to
preclude a transaction with a potential candidate which might otherwise be
beneficial to our stockholders.





We will not restrict our search for any
specific kind of company, but may acquire a venture which is in its preliminary
or development stage, which is already in operation, or in essentially any stage
of its corporate life. It is impossible to predict at this time the status of
any business in which we may become engaged, in that such business may need to
seek additional capital, may desire to have its shares publicly traded, or may
seek other perceived advantages which we may offer.  However, we do
not intend to obtain funds in one or more private placements to finance the
operation of any acquired business opportunity until such time as we have
successfully consummated such a merger or acquisition.





In implementing a structure for a
particular business acquisition, we may become a party to a merger,
consolidation, reorganization, joint venture, or licensing agreement with
another corporation or entity.  We may also acquire stock or assets of
an existing business.  On the consummation of a transaction, it is
probable that our present management and stockholders will no longer be in
control of our company.  In addition, our existing directors may, as
part of the terms of the acquisition transaction, resign and be replaced by new
directors without a vote of our stockholders.





4


We anticipate that any securities
issued in any such reorganization would be issued in reliance upon exemption
from registration under applicable federal and state securities laws. In some
circumstances, however, as a negotiated element of a transaction, we may agree
to register all or a part of such securities immediately after the transaction
is consummated or at specified times thereafter.  If such registration
occurs, of which there can be no assurance, it will be undertaken by the
surviving entity after we have successfully consummated a merger or acquisition
and we are no longer considered a "shell" company.  Until such time as
this occurs, we will not attempt to register any additional
securities.  The issuance of substantial additional securities and
their potential sale into any trading market which may develop in our securities
may have a depressive effect on the value of our securities in the future, if
such a market develops, of which there is no assurance.





Employees





As of August 20, 2009, we had one
employee, Mr. Page, our Chief Executive Officer.  Mr. Page is involved
in other part-time business activities and devotes approximately 90% of his time
and attention to our business.





Transaction
with Laurus Master Fund, Ltd.





On November 30, 2004, we closed a
financing transaction with Laurus Master Fund, Ltd. to obtain a $7.5 million
credit facility. The financing was completed pursuant to a security agreement
with Laurus, pursuant to which we issued to Laurus a $2,750,000 secured
convertible minimum borrowing note, a $4,750,000 secured convertible revolving
note and a common stock purchase warrant to purchase 3,846,154 shares of our
common stock (70% of which are vested as of December 31, 2005). Laurus was
permitted to convert all or a portion of the outstanding principal amount of the
notes and accrued interest thereon into shares of our common stock at a
conversion price of $0.39 per share, subject to certain anti-dilution
adjustments. The warrant issued to Laurus is dated November 29, 2004, has an
exercise price of $0.44 per share, and expires on November 29, 2009. We agreed
to file a registration statement covering the shares issued upon the conversion
of the note or the exercise of the warrant.  We have not filed this
registration statement and, accordingly, at December 31, 2008 our balance sheet
includes registration rights penalties of approximately $2,165,625.





As of December 31, 2004, we had
borrowed approximately $3.3 million under this facility, net of issuing costs. A
portion of these funds were used to repay our existing short-term financing. Our
obligations to Laurus under the credit facility were secured by substantially
all of our assets (other than intellectual property), including our ownership
interests in our operating subsidiaries. In May 2005, following the occurrence
of a number of events of default under the credit facility, Laurus accelerated
our payment obligations and ultimately commenced foreclosure proceedings against
all of our assets for failure to make payment. Following the liquidation of all
of our accounts receivable, inventories and equipment we presently owed Laurus
approximately $2.1 million under this credit facility. On December 8, 2005, we
entered into a letter agreement with Laurus whereby we agreed to a payment plan
for the outstanding secured debt we owed to Laurus. Under our agreement with
Laurus we agreed to make interest only payments to them beginning retroactively
on December 1, 2005, until the earlier of the consummation of a merger with
Protron Digital Corporation which is described later in this section under “Our
History” or February 20, 2006.  On February 15, 2006, Laurus agreed to
extend the date that interest only payments would be made until March 1, 2006.
Our agreement with Laurus provided that on the date we consummated the merger
with Protron, in full satisfaction of our debt to Laurus, we would pay Laurus
$950,000 in cash and issue to them that number of shares of our common stock
that is equal to $950,000, based upon a conversion price of the 30 day average
volume weighted average price calculated as of the date prior to the merger. On
March 1, 2006, Laurus agreed to indefinitely extend our right to make interest
only payments to them, subject to our assurances that we will use our best
efforts to consummate a merger with Protron as soon as is
practicable.





On April 23, 2007, we entered into a
letter agreement with Laurus whereby we agreed to make payment of $200,000 in
cash and issue a warrant to purchase 1, 000,000 shares of our common stock at
$0.40 in consideration for the extinguishment of the balance of the $2.1 million
in outstanding debt.  We agreed to pay $50,000 in cash immediately,
and had until August 1, 2007 to pay the remaining $150,000 cash
obligation.  We also agreed to amend the exercise price of a
previously issued warrant to Laurus from $0.44 to $0.40.





On June 26, 2007, Laurus agreed to
further amend the payment terms of the April 2007 agreement by allowing us to
pay immediately $50,000 of the remaining balance and extending the time due for
the remaining $100,000 owed until September 14, 2007. On June 27, 2007, we made
the $50,000 payment to Laurus.  On July 31, 2007, Laurus agreed to amend
the payment terms of the April 2007 agreement to allow us to make a payment of
$25,000 of the remaining $100,000 owed to Laurus on August 1, 2007, and agreeing
to a payment schedule that allowed us to pay another $25,000 on or by September
1, 2007, another $25,000 on or by October 1, 2007 and the final $25,000 on or by
November 1, 2007. As of December 31, 2007, we owed $35,000.  By April
2008 we made the final payments to Laurus in full satisfaction of the original
agreement.





5


Sale
of Convertible Promissory Notes to Mr. L.E. Smith





On September 29, 2005, we executed an
agreement with Mr. L.E. Smith whereby we received an initial amount of $250,000
from Mr. Smith in immediately available funds through the issuance of a
promissory note convertible into common stock at a conversion price of
$0.25.  Mr. Smith also committed an additional $250,000 in funds upon
achievement of certain milestones by us. The convertible promissory note issued
to Mr. Smith bears interest at a rate of 7% per annum and had an initial
maturity date on September 29, 2005. Presently, we are in default under our
obligations to make interest payments to Mr. Smith. The convertible note is
convertible at any time from the date of issuance into shares of our common
stock at a price per share equal to $0.25. Mr. Smith was also issued
corresponding warrants to purchase shares of common stock. The number of shares
that the purchaser is eligible to purchase is equal to 20% of the aggregate
amount of shares issued upon conversion of each convertible promissory note and
the with an exercise price of $0.25 per share. The warrants, which total 200,000
shares of our common stock, expire five years from the date of issuance and are
exercisable immediately. In connection with both the convertible note and the
warrants, we entered into a registration rights agreement with the purchaser
whereby we agreed to register for resale the shares underlying the convertible
note and warrants.  The note remains outstanding and at December 31,
2008 we owed Mr. Smith $500,000 principal and $109,000 accrued but unpaid
interest on this note.  We have not filed the required registration
statement.  Mr. Smith served as our Chief Executive Officer, Chairman
and member of our Board of Directors from April 2007 until September
2007.





Sale
of $250,000 principal amount 7.5% Convertible Promissory Note to Mr. Dan
Page





In April 2007 we executed an agreement
with Mr. Dan Page whereby we received $250,000 in funds to be advanced through
the issuance of a promissory line of credit note.  The convertible
promissory note issued bears interest at a rate of 7.5% per annum and had a
maturity date of April 23, 2008. The convertible note is convertible at any time
from the date of issuance into shares of our common stock at a price per share
equal to $0.35.  We pay interest only payments until the maturity date
of the convertible note, unless it is converted or prepaid.  We also
agreed to issue to the purchaser a four year warrant to purchase shares of
common stock. The number of shares that the purchaser will be eligible to
purchase pursuant to the warrant will be equal to 20% of the total share amount
issued upon conversion of the note, with an exercise price of $0.35 per
share.  In connection with both the convertible note and the warrant,
we entered into a registration rights agreement with the purchaser whereby we
agreed to register for resale the shares underlying the convertible note and
warrants.  We have not filed the required registration
statement.





On September 27, 2007, Mr. Page agreed
to amend the note and provide an additional $100,000 of working capital to us.
Under the terms of the amendment, the additional $100,000 is convertible into
shares of our common stock at a price per share equal to $0.18. As consideration
for this extension, we agreed to issue to the purchaser a warrant to purchase
shares of common stock. The number of shares that the purchaser will be eligible
to purchase pursuant to the warrant will be equal to 20% of the total share
amount issued upon conversion of the note, with an exercise price of $0.18 per
share, solely as it relates to this additional $100,000. The warrant will expire
four years from the date of issuance, which shall be deemed to be on the earlier
of (i) the maturity date of the Note; (ii) the date on which the funds are
advanced in full and owing by us; or (iii) the date on which we elect to pay off
the note in full during the term. In connection with both the convertible note
and the warrant, we agreed to register for resale the shares underlying the
convertible note and warrants.





At December 31, 2008 we owed Mr. Page
$339,850 of principal and approximately $34,000 of accrued but unpaid interest
under these notes.  Mr. Dan Page, a principal shareholder of our
company, is the father of Mr. Ken Page, currently our sole officer and a member
of our Board of Directors.





Our
History





We were incorporated in Delaware on May
17, 1994 as CD Kidz Inc.  On March 20, 1995, our name was changed to
Wanderlust Interactive, Inc.  In March 1996, we completed an initial
public offering of our securities and the net proceeds were used principally to
establish our New York headquarters and to produce two CD-ROM games based upon
the Pink Panther character, which games were completed in September 1996 and
September 1997, respectively.  We initially marketed such games
through distributors in the United States and licensed such games for
distribution by others both in the United States and in over fifteen foreign
countries.





In February 1997, we acquired all of
the outstanding stock of Western Technologies, Inc. as well as certain assets
and liabilities of Smith Engineering, a sole proprietorship, from Jay Smith III,
our then President, Chief Executive Officer and Treasurer.  Western
Technologies designed and developed video and computer games and electronic toys
and electronic consumer products, mostly pursuant to funded contracts with other
name brand manufacturers.  The agreement provided for the sale of 100%
of the outstanding shares of stock of Western Technologies and certain assets
and certain liabilities of Smith Engineering in exchange for 266,667 shares of
our common stock. The cost of the acquired enterprise was
$5,082,000.  We assigned value of $15 per share to the shares issued
and assumed liabilities in excess of assets which amounted to
$1,082,000.  As part of the acquisition, a license agreement was
entered into between Western Technologies and Mr. Smith in which Mr. Smith
granted to Western Technologies the exclusive right to use and market patents
and license agreements owned by Mr. Smith.





After expending most of the funds
raised in our initial public offering to produce the two Pink Panther CD-ROM
games during 1996 and 1997, we realized that the development costs of such
CD-ROM games greatly exceeded both the short-term and long-term anticipated
revenue streams from such products and shifted our focus to pre-funded or
contract design and development work, such as that historically conducted by
Western Technologies. In September 1997, we substantially downsized our New York
office and shifted our headquarters to Western Technologies’ offices located in
Los Angeles. In April 1998, we closed our New York office permanently and
consolidated our entire staff in our remaining Los Angeles office and production
space.





6


On May 14, 1998, the Company’s name was
further changed to Adrenalin Interactive, Inc. In December 1999, we completed a
reverse merger with McGlen Micro, Inc., in which the stockholders of McGlen
Micro, Inc. acquired control of us. As a result of the acquisition, each share
of McGlen Micro, Inc. was converted into 0.0988961 shares of our common stock,
with 2,548,553 shares being issued. On December 17, 1999, we changed our name to
McGlen Internet Group, Inc. and on March 15, 2002, we changed our name to
Northgate Innovations, Inc.





On March 20, 2002, we completed a
reverse acquisition with Lan Plus Corporation in which the stockholders of Lan
Plus acquired control of our company. As a result of the acquisition, each share
of Lan Plus was converted into approximately 3.128 shares of our common stock,
with approximately 14,113,000 shares being issued.  In addition,
immediately prior to the close of the merger, we instituted a 10:1 reverse stock
split and the our accounts payable to, and advances from Lan Plus, in the amount
of approximately $2.3 million were converted to common stock eliminating the
debt; the stock was then retired to treasury and cancelled. Lan Plus was a
manufacturer of branded turnkey computer products and services. Under our
Northgate(R) brand name we developed, manufactured, marketed, and sold a wide
range of desktop systems, notebook computers, workstations and network servers,
as well as offering a variety of hardware components and peripherals to
complement our desktop systems, notebook computers, and network
servers.





In December 2003, an investor group
acquired a majority of our outstanding common stock and in early 2004 this
investor group brought in a new management team and implemented a new business
strategy. As part of this new business strategy, in June 2004, we changed our
name from Northgate Innovations, Inc. to Digital Lifestyles Group, Inc.
Beginning in late 2004, we deemphasized the sale of our Northgate(R) brand
products to focus our resources solely on the development, marketing and sale of
a new product line, branded hip-e, which featured desktop computers, notebook
computers and peripherals and was designed and targeted to the teen
market.





In April 2005, we received notice from
Microsoft Corporation that it had terminated our license to use its proprietary
Windows(R) operating system due to our failure to make required royalty
payments. Due to the loss of the license, we were unable to ship our products,
the majority of which use Microsoft’s proprietary Windows(R) operating system
and as a result we were unable to fulfill any orders for our hip-e brand desktop
computers.  As we lacked sufficient funds required to renew our
license with Microsoft and were unable to distribute or sell our products, our
management team decided to cease all operations other than to liquidate our
assets for the benefit of Laurus.




On
March 8, 2006, we entered into a definitive merger agreement with Protron
Digital Corporation, a consumer electronics company focused on the manufacture
and sale of home entertainment systems. Under the terms of the merger agreement,
Protron would continue as the surviving entity as a wholly-owned subsidiary of
our company.  Protron was a privately held company, of which one of
its principal owners was Leo Chen, then a member of our board of
directors.  At the effective time of the merger, we were to issue
74,353,942 shares of our common stock to the stockholders of Protron,
representing 70% of our issued and outstanding shares.  The
consummation of the merger was subject to customary closing conditions,
including, among others (i) the approval of the merger agreement and the merger
by our stockholders; (ii) our company having filed all reports required to be
filed pursuant to the Securities Exchange Act of 1934, as amended; (iii) receipt
of all applicable regulatory approvals; (iv) the absence of any government
action prohibiting consummation of the merger; and (v) neither our company nor
Protron having suffered any material adverse effect.  The terms of the
merger agreement required that all conditions to closing be satisfied and the
merger completed by December 31, 2006.  On September 6, 2006, we
delivered a notice of termination of the merger agreement to Protron due to our
determination that Protron had breached certain covenants of the merger
agreement, including the failure to timely deliver audited financial statements.
Pursuant to the terms of the merger agreement, the termination of the agreement
was effective on September 11, 2006 and we did not incur any material penalties
in connection with the termination of the merger agreement. On September 7,
2006, we received correspondence from Protron disputing our contention that
Protron breached the merger agreement and notifying us Protron was also seeking
to terminate the merger agreement.  We have not been contacted further
on this matter.





ITEM
1.A                      RISK
FACTORS.





Before
you invest in our securities, you should be aware that there are various risks.
You should consider carefully these risk factors, together with all of the other
information included in this annual report before you decide to purchase our
securities. If any of the following risks and uncertainties develop into actual
events, our business, financial condition or results of operations could be
materially adversely affected.





Our auditors have raised substantial
doubts as to our ability to continue as a going concern.





Our
consolidated financial statements have been prepared assuming we will continue
as a going concern. Since inception we have experienced recurring losses from
operations, which losses have caused an accumulated deficit of approximately $
22.5 million as of December 31, 2008. These factors, among others, raise
substantial doubt about our ability to continue as a going concern. Our
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.  We anticipate that we will continue to
incur losses in future periods until we are successful in completing a business
combination with an operating entity.  There are no assurances that we
will be able to consummate a transaction with an operating company or continue
as a going concern, in which event investors would lose their entire investment
in our company.





7


We
are not current in our reporting obligations with the SEC and our status as a
public company could be revoked at any time.





We are
not current in our filing obligations with the SEC and in March 2009 we were
notified by the SEC that it appeared we were delinquent in our reporting
obligations pursuant to Section 13(a) of the Securities Exchange Act of 1934 and
could be subject, without further notice, to an administrative hearing to revoke
the registration of our securities under Section 12(g) of the Securities
Exchange Act of 1934.  On August 13, 2009 we filed our Annual Report
on Form 10-K for the year ended December 31, 2006 and on August 19, 2009 we
filed our Annual Report on Form 10-K for the year ended December 31, 2007, we
still need to file our quarterly reports for the 2009 interim periods to become
current in our reporting obligations.  While we are using our best
efforts to file all delinquent reports with the SEC, if we are unable to
complete those filings before the SEC seeks to bring an administrative action
against us it is likely that we would cease being a public
company.  In that event the attractiveness of our vehicle to an
operating company would be severely diminished and our ability to consummate a
business combination would be in jeopardy.





We
have a significant amount of past due debt and no cash or assets.





At December 31, 2008 our balance sheet
includes approximately $11.4 million of debt, including past due unsecured
convertible notes, accounts payable, liquidated damages, accrued expenses,
including approximately $70,500 of unpaid wages, and derivative and warrant
liabilities.  We do not have the funds necessary to satisfy these
obligations and it is not likely that we will be able to raise capital until we
complete a business combination. The existence of these obligations may make our
company less attractive to a company interested in a possible business
combination.





We
currently do not have an operating business, but also do not intend to pursue a
course of complete liquidation and dissolution, and accordingly, the value of
your shares may decrease.





We
currently do not have any operating business.  We continue to incur
operating expenses while we consider alternative operating plans. These plans
may include business combinations with or investments in other operating
companies, or entering into a completely new line of business. We have not yet
identified any such opportunities, and thus, you will not be able to evaluate
the impact of such a business strategy on the value of your stock. In addition,
we cannot assure you that we will be able to identify any appropriate business
opportunities. Even if we are able to identify business opportunities that our
Board deems appropriate, we cannot assure you that such a strategy will provide
you with a positive return on your investment, and it may in fact result in a
substantial decrease in the value of your stock. These factors will
substantially increase the uncertainty, and thus the risk, of investing in our
shares.





Our
sole officer does not devote all of his time and attention to our
business.





Mr. Page, who serves as our sole
officer, devotes only approximately 90% of his time to the business and affairs
of our company.  Because Mr. Page is primarily responsible for the
identification and consummation of an acquisition of an operating company for
us, we are materially dependent upon his efforts on our part.  It is
possible that because he does not spend his all of his time and efforts on our
behalf that it may take longer to identify and close an acquisition of an
operating company than if he was employed by us on a full-time
basis.





We
may not be able to identify or fully capitalize on any appropriate business
opportunities.





We have
not yet identified any appropriate business opportunities, and, due to a variety
of factors outside of our control, we may not be able to identify or fully
capitalize on any such opportunities. These factors include:





•
            competition
      from other potential acquirers and partners of and investors in potential
      acquisitions, many of whom may have greater financial resources than we
      do;


•
            in
      specific cases, failure to agree on the terms of a potential acquisition,
      such as the amount or price of our acquired interest, or incompatibility
      between us and management of the company we wish to acquire;
      and


•
            the
      possibility that we may lack sufficient capital and/or expertise to
      develop promising opportunities.





Even if
we are able to identify business opportunities that our Board deems appropriate,
we cannot assure you that such a strategy will provide you with a positive
return on your investment, and may in fact result in a substantial decrease in
the value of your stock. In addition, if we enter into a combination with a
business that has operating income, we cannot assure you that we will be able to
utilize all or even a portion of our existing net operating loss carryover for
federal or state tax purposes following such a business combination. If we are
unable to make use of our existing net operating loss carryover, the tax
advantages of such a combination may be limited, which could negatively impact
the price of our stock and the value of your investment. These factors will
substantially increase the uncertainty, and thus the risk, of investing in our
shares.





8


Our
common stock is quoted in the over the counter market on the Pink
Sheets.





Our common stock is
quoted on the Pink Sheets.  Pink Sheets offers a quotation service to
companies that are unable to list their securities on an exchange or for
companies, such as ours, whose securities are not eligible for quotation on the
OTC Bulletin Board.  The requirements for quotation on the Pink Sheets
are considerably lower and less regulated than those of the OTC Bulletin Board
or an exchange.  Because our common stock is quoted on the Pink
Sheets, it is possible that even fewer brokers or dealers would be interested in
making a market in our common stock which further adversely impacts its
liquidity.





You
may find it extremely difficult or impossible to resell our shares. Even if an
active public market is established, we cannot guarantee you that there will
ever be any liquidity in our common stock.





While our common stock is quoted on the
Pink Sheets, there is not an active market for our common stock and there can be
no assurance that an active public market for our common stock will ever be
established.  Purchasers of our shares of common stock will face
significant obstacles if they wish to resell the shares. Absent an active public
market for our common stock, an investment in our shares should be considered
illiquid.  Even if an active public market is established, it is
unlikely a liquid market will develop. Because we are a shell company, the
investment community may show little or no interest in our securities and
investors may not be readily able to liquidate their investment, if at all.
Investors seeking liquidity in a security should not purchase our shares of
common stock.





The
tradability of our common stock is limited under the penny stock regulations
which may cause the holders of our common stock difficulty should they wish to
sell the shares.





Because the quoted price of our common
stock is less than $5.00 per share, our common stock is considered a “penny
stock,” and trading in our common stock is subject to the requirements of Rule
15g-9 under the Securities Exchange Act of 1934.  Under this rule,
broker/dealers who recommend low-priced securities to persons other than
established customers and accredited investors must satisfy special sales
practice requirements. The broker/dealer must make an individualized written
suitability determination for the purchaser and receive the purchaser’s written
consent prior to the transaction.





SEC regulations also require additional
disclosure in connection with any trades involving a “penny stock,” including
the delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and its associated risks. These requirements
severely limit the liquidity of securities in the secondary market because few
broker or dealers are likely to undertake these compliance activities and this
limited liquidity will make it more difficult for an investor to sell his shares
of our common stock in the secondary market should the investor wish to
liquidate the investment.  In addition to the applicability of the
penny stock rules, other risks associated with trading in penny stocks could
also be price fluctuations and the lack of a liquid market.





ITEM
      1B.
            UNRESOLVED
      STAFF COMMENTS.





Not applicable to a smaller reporting
company.





ITEM
      2.
              DESCRIPTION
      OF PROPERTY.


We rent our principal executive offices
from an unrelated third party on a month to month basis for a monthly rental of
$350.00.




ITEM
      3.
              LEGAL
      PROCEEDINGS.


We are
not a party to any pending or threatened litigation.





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


None.





PART
II




ITEM
      5.
              MARKET
      FOR COMMON STOCK AND RELATED STOCKHOLDER
  MATTERS.




Market
Price of and Dividends on Common Equity and Related Stockholder
Matters





Since May 2005 our common stock has
been quoted in the over-the-counter market on the Pink Sheets under the symbol
DLGF.  Trading in our common stock is extremely
limited.  The reported high and low bid prices for the common stock as
reported on the OTC Bulletin Board and subsequently on the Pink Sheets are shown
below for the periods indicated. The quotations reflect inter-dealer prices,
without retail mark-up, markdown or commission, and may not represent actual
transactions.





9


High
                          
                          
                          Low2007First
      quarter ended March 31, 2007
                          
                          $
                          .23
                          
                          
                          $
                          .09Second
      quarter ended June 30, 2007
                          
                          $
                          .39
                          
                          
                          $
                          .11Third
      quarter ended September 30, 2007
                          
                          $
                          .20
                          
                          
                          $
                          .10Fourth
      quarter ended December 31, 2007
                          
                          $
                          .11
                          
                          
                          $
                          .032008First
      quarter ended March 31, 2008
                          
                          $
                          .05
                          
                          
                          $
                          .01Second
      quarter ended June 30, 2008
                          
                          $
                          .03
                          
                          
                          $
                          .02Third
      quarter ended September 30, 2008
                          
                          $
                          .03
                          
                          
                          $
                          .02Fourth
      quarter ended December 31, 2008
                          
                          $
                          .02
                          
                          
                          $
                          .012009First
      quarter ended March 31, 2009
                          
                          $
                          .02
                          
                          
                          $
                          .01Second
      quarter ended June 30, 2009
                          
                          $
                          .02
                          
                          
                          $
                          .01





The last
sale price of our common stock as reported on the Pink Sheets was $0.035 per
share on August 21, 2009.  As of August 17, 2009, there were
approximately 140 record owners of our common stock.





Dividend
Policy





We have never paid cash dividends on
our common stock.  Under Delaware law, we may declare and pay
dividends on our capital stock either out of our surplus, as defined in the
relevant Delaware statutes, or if there is no such surplus, out of our net
profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year.  If, however, the capital of our company,
computed in accordance with the relevant Delaware statutes, has been diminished
by depreciation in the value of our property, or by losses, or otherwise, to an
amount less than the aggregate amount of the capital represented by the issued
and outstanding stock of all classes having a preference upon the distribution
of assets, we are prohibited from declaring and paying out of such net profits
any dividends upon any shares of our capital stock until the deficiency in the
amount of capital represented by the issued and outstanding stock of all classes
having a preference upon the distribution of assets shall have been
repaired.





Recent
Sales of Unregistered Securities





None.





ITEM 6.
              SELECTED
      FINANCIAL DATA.


Not applicable to a smaller reporting
company.




ITEM
      7.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.




The following discussion of our
financial condition and results of operationfor 2008 and 2007
should be read in conjunction with the financial statements and the notes to
those statements that are included elsewhere in this report. Our discussion
includes forward-looking statements based upon current expectations that involve
risks and uncertainties, such as our plans, objectives, expectations and
intentions. Actual results and the timing of events could differ materially from
those anticipated in these forward-looking statements as a result of a number of
factors, including those set forth under the Item 1A. Risk Factors, Cautionary
Notice Regarding Forward-Looking Statements and Business sections in this Form
10-K.  We use words such as “anticipate,” “estimate,” “plan,”
“project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,”
“will,” “should,” “could,” and similar expressions to identify forward-looking
statements.





Plan
of Operations





Our
current business objective is to investigate and, if such investigation
warrants, acquire a target company or business seeking the perceived advantages
of being a publicly held corporation. Our principal business objective is to
achieve long-term growth potential through a combination with a business rather
than immediate, short-term earnings. We will not restrict our potential
candidate target companies to any specific business, industry or geographical
location and, thus, may acquire any type of business.





We do not currently engage in any
business activities and do not have any cash resources. As such, the costs of
investigating and analyzing business combinations will be paid through either
funds advanced by Mr. Page, our sole officer and director, or funds borrowed
from his father, an existing debt holder of our company.  We also
anticipate incurring costs related to the filing of quarterly, annual and other
reports with the Securities and Exchange Commission and costs relating to
consummating an acquisition.  We do not have any firm commitments,
however, for the provision of any additional capital to our company to fund
these costs.





10


We may consider a business which has
recently commenced operations, is a developing company in need of additional
funds for expansion into new products or markets, is seeking to develop a new
product or service, or is an established business which may be experiencing
financial or operating difficulties and is in need of additional capital. In the
alternative, a business combination may involve the acquisition of, or merger
with, a company which does not need substantial additional capital, but which
desires to establish a public trading market for its shares, while avoiding,
among other things, the time delays, significant expense, and loss of voting
control which may occur in a public offering.





Any target business that is selected
may be a financially unstable company or an entity in its early stages of
development or growth, including entities without established records of sales
or earnings. In that event, we will be subject to numerous risks inherent in the
business and operations of financially unstable and early stage or potential
emerging growth companies. In addition, we may effect a business combination
with an entity in an industry characterized by a high level of risk, and,
although our management will endeavor to evaluate the risks inherent in a
particular target business, there can be no assurance that we will properly
ascertain or assess all significant risks.





Our management anticipates that it will
likely be able to effect only one business combination, due primarily to our
limited financing, and the dilution of interest for present and prospective
stockholders, which is likely to occur as a result of our management’s plan to
offer a controlling interest to a target business in order to achieve a tax free
reorganization. This lack of diversification should be considered a substantial
risk in investing in us, because it will not permit us to offset potential
losses from one venture against gains from another.





We anticipate that the selection of a
business combination will be complex and extremely risky. Because of general
economic conditions, rapid technological advances being made in some industries
and shortages of available capital, our management believes that there are
numerous firms seeking even the limited additional capital which we will have
and/or the perceived benefits of becoming a publicly traded corporation. Such
perceived benefits include, among other things, facilitating or improving the
terms on which additional equity financing may be obtained, providing liquidity
for the principals of and investors in a business, creating a means for
providing incentive stock options or similar benefits to key employees, and
offering greater flexibility in structuring acquisitions, joint ventures and the
like through the issuance of stock. Potentially available business combinations
may occur in many different industries and at various stages of development, all
of which will make the task of comparative investigation and analysis of such
business opportunities extremely difficult and complex.





Going
Concern





We are a shell company.  We
do not have any revenue generating operations and have incurred net losses of
approximately $22.5 million since inception through December 31,
2008.  At December 31, 2008 we had minimal cash, no other assets and
our total liabilities were approximately $11.4 million, all of which are past
due.  The report of our independent registered public accounting firm
on our financial statements for the year ended December 31, 2008 contains an
explanatory paragraph regarding our ability to continue as a going concern based
upon  recurring operating losses and our need to obtain additional
financing to sustain operations.  Our ability to continue as a going
concern is dependent upon our ability to obtain the necessary financing to meet
our obligations and repay our liabilities when they become due and to consummate
a business combination with an operating company.  There are no
assurances that we will continue as a going concern.





Results
of Operations





2008
compared to 2007





Net
sales





For each of 2008 and 2007 we had no
revenues from operations which reflects an April 2005 decision by our then
management to discontinue all revenue producing operations.





Operating
expenses





Our operating expenses include rent,
insurance, payroll and professional fees.  Operating expenses
increased approximately $97,000, or approximately 37% for 2008 as compared to
2007.  The increase is attributable to the accrual of Mr. Page’s
salary and options granted to him under the terms of his September 2007
employment agreement.





Total
other income (expense)





Interest expense decreased
approximately $38,000, or approximately 16%, for 2008 as compared to 2007 which
reflects the decrease in accrued interest associated with the Laurus
obligation.





11


Change in fair value of derivative and
warrant liabilities expense consist of income or expense associated with the
change in the fair value of derivative liabilities associated with the Laurus
obligation and the note to Alloy Marketing and Promotions, LLC which is
described later in this section as a result of the application of EITF Issue No.
00-19 to our financial statements.  The difference in fair value of
the derivative liabilities between the date of their issuance and their
measurement date amounted to a decrease of approximately $385,000 and $1.3
million for fiscal 2008 and 2007, respectively, which has been recognized as
other income in those periods. While these are non-cash items, the application
of EITF 00-19 has a significant impact on our financial statements.





In 2007 we recognized a forbearance
expense of $129,000 related to our agreement to issue a warrant to purchase
shares of our common stock with an exercise price of $0.40 per share to Advanced
Micro Devices, at the rate of one share for every $2.00 we owed that entity, for
a total of 422,260 shares, in partial settlement of amounts owed that
entity.  We agreed to provide customary registration rights covering
the shares of common stock issuable upon the exercise of the
warrant.  We did not have a comparable expense in 2008.




Gain on debt settlement in 2007 is primarily attributable to the settlement with
Laurus.  As described elsewhere herein, in April 2007, we reached an
agreement with Laurus to extinguish $2.1 million in outstanding debt for
$200,000 in cash. Under the terms of the agreement we paid $50,000 in cash in
April 2007, and paid an additional $115,000 during 2007. The remaining $35,000
owed at December 31, 2007 is included on our balance sheet under the caption
“accrued expenses”. In addition to the cash consideration, we issued Laurus a
warrant to purchase 1,000,000 shares of our common stock at $.40 per share. In
connection with the agreement, we recognized a gain on debt relief of
approximately $1,510,000.  Gain on settlement of debt in 2008 reflects
settlements with various vendors.




Other income, net includes $18,000 of proceeds from the one-time sale of a
domain name and $42,000 in royalties received for the use of our name under a
marketing and license agreement which expired in January 2009.





Liquidity
and Capital Resources





As of December 31, 2008, we had $22 in
cash and a working capital deficit of approximately $11.3 million.  At
December 31, 2008 we had no assets and approximately $11.4 million of
liabilities, all of which are past due, and we do not have the funds necessary
to settle these obligations.  Included in our liabilities at December
31, 2008 are the following:





•           approximately
$6.4 million of accounts payable which represents obligations to various vendors
including approximately $1 million due Advanced Micro Devices, approximately
$1.2 million due American Express and approximately $1.3 due Microsoft
Licensing, Inc.,





•           approximately
$2.436 million of liquidated damages due Laurus and Alloy Marketing and
Promotions,





•           approximately
$950,000 of accrued expenses which represents approximately $511,000 of interest
on the convertible notes, unpaid payroll taxes of approximately $9,700,
approximately $122,000 of accrued wages and royalties and other accrued
expenses,





•           approximately
$1.5 million principal amount of convertible notes payable are described below
under “Past Due Notes”, and





•           approximately
$100,000 of non-cash derivative and warrant liabilities.





Our yearly cash overhead costs are
approximately $134,000, which include rent, utilities, employee compensation,
costs to maintain the company as a public entity including legal, accounting and
EDGAR filing fees and professional expenses associated with our search for a
suitable business combination.  We do not have any internal or
external sources of capital and are dependent upon advances from our sole
officer and director or his father, an existing debt holder, for funds necessary
to pay our operating expenses.  Our ability to continue our company in
the next 12 months depends on our continued ability to obtain sources of capital
to fund our continuing operations and to seek out potential merger and
acquisition partners.  There are no assurances, however, that either
party will advance funds to us as needed.  If we are not able to
access capital as necessary it is possible we will be unable to close an
acquisition which will provide operating revenues to our company.  In
that event, the likelihood that we can continue as a going concern is doubtful
and investors could lose their entire investment in our company.





Cash
Flow from Operating Activities





For 2008, net cash used by operating
activities was approximately $16,000 as compared to approximately $137,000 in
2007.  In 2008, we used cash to reduce our accounts payable which was
offset by an increase in accrued expenses, and in 2007, we used cash to reduce
our accounts payable and accrued expenses.





12


Cash
Flow from Financing Activities





For 2008, net cash provided by
financing activities was approximately $38,000 as compared to approximately
$137,000 in 2007.  In the 2008 period we generated amounts from the
proceeds of notes payables and in the 2007 period, we generated $302,000 in cash
from the issuance of a convertible note, offset by payments on notes of
$165,000.




Past
Due Notes at December 31, 2008





•           $600,000
principal amount due Alloy Marketing and Promotions, LLC under the terms of an
unsecured convertible promissory note issued to it in April 2005 in payment to
Alloy for marketing and promotional services rendered to us.  Under
the terms of this demand note which originally bore interest at the rate of 10%
per annum, the principal and interest could be converted into shares of our
common stock at any time after April 1, 2005 at a conversion price equal to 75%
of the fair market value of our common stock providing that the underlying
shares were covered by an effective registration statement.  In
connection with the issuance of the note we entered into a registration rights
agreement with Alloy whereby we agreed to file a registration statement with the
SEC to cover the resale of the shares of common stock into which the note could
be converted.  We agreed to pay Alloy liquidated damages if we did not
file the registration statement within a specified period, if we failed to
maintain an effective registration statement or if our common stock was
suspended from trading on any market.  We have not filed the
registration statement and at December 31, 2008 we have accrued liquidated
damages in the amount of $351,000 which were due Alloy.  This note
remains outstanding and interest is now being accrued at the default rate of 15%
per annum, with a late payment fee of 6% per month.  At December 31,
2008 we owed Alloy an aggregate of $816,000 under this note, which includes
principal, accrued but unpaid interest and late fees;





•           $500,000
principal amount due Mr. L.E. Smith under the terms of a convertible promissory
note issued in September 2005.  This note, which bears interest at 7%
per annum and is convertible into shares of our common stock at a conversion
price of $0.25 per share, was due in September 2006.  This note is in
default.  At December 31, 2008 we owed Mr. Smith an aggregate of
$609,000 under this note, which includes principal and accrued but unpaid
interest; and





•           $50,000
principal amount due Mr. Robert Wood under the terms of a convertible promissory
note issued in October 2005.  This note, which bears interest at 7%
per annum and is convertible into shares of our common stock at a conversion
price of $0.25 per share, was due in October 2006.  The purchaser was
also issued corresponding five warrants to purchase 40,000 shares of our common
stock common stock at an exercise price of $0.25 per share.  In
connection with both the convertible note and the warrants, we entered into a
registration rights agreement with the purchaser whereby we agreed to register
for resale the shares underlying the convertible note and
warrants.  This note is in default and we did not register the shares
underlying either the note or the warrant.  At December 31, 2008 we
owed Mr. Wood an aggregate of $66,000 under this note, which includes principal
and accrued but unpaid interest.





Recent
Accounting Pronouncements





In July 2006, the FASB issued FASB
Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement 109” (“FIN 48”), which
clarifies the accounting for uncertainty in tax positions taken or expected to
be taken in a tax return, including issues relating to financial statement
recognition and measurement. FIN 48 provides that the tax effects from an
uncertain tax position can be recognized in the financial statements only if the
position is “more-likely-than-not” to be sustained if the position were to be
challenged by a taxing authority. The assessment of the tax position is based
solely on the technical merits of the position, without regard to the likelihood
that the tax position may be challenged. If an uncertain tax position meets the
“more-likely-than-not” threshold, the largest amount of tax benefit that is more
than 50 percent likely to be recognized upon ultimate settlement with the taxing
authority, is recorded. The provisions of FIN 48 were effective for fiscal years
beginning after December 15, 2006, with the cumulative effect of the change in
accounting principle recorded as an adjustment to opening retained earnings.
Consistent with the requirements of FIN 48, we adopted FIN 48 on January 1,
2007. Adoption of FIN 48 did not have a material impact on our results of
operations or financial position. We currently have tax return periods open
beginning with December 31, 2006 through December 31, 2008.





In September 2006, the FASB issued SFAS
No. 157, Fair Value Measurements (SFAS No. 157). In the first quarter of fiscal
year 2009, we adopted the recognition and disclosure requirements of SFAS No.
157 for all financial assets and financial liabilities recognized or disclosed
at fair value in the financial statements on a recurring basis (at least
annually). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value, and enhances fair value measurement disclosure. The
adoption of this part of SFAS No. 157 did not have a material impact on our
consolidated financial statements, and the resulting fair values of our
financial assets and financial liabilities calculated under SFAS No. 157 after
adoption were not significantly different than the fair values that would have
been calculated under previous guidance. See Note 10 of the financial statements
included elsewhere herein for further details on our fair value measurements.
With respect to the recognition and disclosure requirements of SFAS No. 157
related to non-financial assets and non-financial liabilities, we will adopt
these requirements beginning in the first quarter of our fiscal year
2010.





13


In February 2008, the FASB issued FASB
Staff Position (FSP) No. FAS 157-1, Application of FASB Statement No. 157 to
FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair
Value Measurements for Purposes of Lease Classification or Measurement under
Statement 13 (FSP FAS 152-1) and FSP No. FAS 157-2, Effective Date of FASB
Statement No. 157  (FSP FAS 152-2). Collectively, the Staff Positions defer
the effective date of SFAS No. 157 to fiscal years beginning after November 15,
2008 for nonfinancial assets and nonfinancial liabilities except for items that
are recognized or disclosed at fair value on a recurring basis at least
annually, and amend the scope of SFAS No. 157. As described in Note 8 of our
financial statements appearing elsewhere here, we have has adopted SFAS No. 157
and the related FASB staff positions except for those items specifically
deferred under FSP FAS 157-2.  We are currently evaluating the impact
of the full adoption of SFAS No. 157 on our fiscal year 2010 consolidated
results of operations and financial condition.





In December 2007, the FASB issued SFAS
No. 141 (revised 2007), “Business Combinations” (SFAS
141(R)), which replaces SFAS No. 141, “Business Combinations” (SFAS
141). SFAS 141(R) retains the underlying concepts of SFAS 141 in that all
business combinations are still required to be accounted for at fair value under
the acquisition method of accounting but SFAS 141(R) changed the method of
applying the acquisition method in a number of significant aspects. Acquisition
costs will generally be expensed as incurred; noncontrolling interests will be
valued at fair value at the acquisition date; in-process research and
development will be recorded at fair value as an indefinite-lived intangible
asset at the acquisition date, until either abandoned or completed, at which
point the useful lives will be determined; restructuring costs associated with a
business combination will generally be expensed subsequent to the acquisition
date; and changes in deferred tax asset valuation allowances and income tax
uncertainties after the acquisition date generally will affect income tax
expense. SFAS 141(R) is effective on a prospective basis for all business
combinations for which the acquisition date is on or after the beginning of the
first annual period subsequent to December 15, 2008, with the exception of
the accounting for valuation allowances on deferred taxes and acquired tax
contingencies. SFAS 141(R) amends SFAS No. 109, “Accounting for Income Taxes”
(SFAS 109) such that adjustments made to valuation allowances on deferred taxes
and acquired tax contingencies associated with acquisitions that closed prior to
the effective date of SFAS 141(R) would also apply the provisions of SFAS
141(R). Early adoption is not permitted. Upon adoption, SFAS 141(R) did not have
a significant impact on our consolidated financial position and results of
operations; however, any business combination entered into after the adoption
may significantly impact our financial position and results of operations when
compared to acquisitions accounted for under existing U.S. Generally Accepted
Accounting Principles (GAAP).





In December 2007, the FASB issued SFAS
No. 160, “Noncontrolling
Interests in Consolidated Financial Statements—an amendment of ARB No.
51.” This statement is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008, with
earlier adoption prohibited. This statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. It also amends
certain of ARB No. 51’s consolidation procedures for consistency with the
requirements of SFAS 141(R). This statement also includes expanded disclosure
requirements regarding the interests of the parent and its noncontrolling
interest. This statement did not have a significant impact on the reporting of
our financial position and results of operations.





In December 2007, the Securities
and Exchange Commission (SEC) issued Staff Accounting Bulletin
(SAB) No. 110. This guidance allows companies, in certain
circumstances, to utilize a simplified method in determining the expected term
of stock option grants when calculating the compensation expense to be recorded
under Statement of Financial Accounting Standards
(SFAS) No. 123(R),Share-Based Payment. The simplified method can be used after
December 31, 2007 only if a company’s stock option exercise experience does
not provide a reasonable basis upon which to estimate the expected option term.
Through 2007, we utilized the simplified method to determine the expected option
term, based upon the vesting and original contractual terms of the option. On
January 1, 2008, we began calculating the expected option term based on our
historical option exercise data. This change did not have a significant impact
on the compensation expense recognized for stock options granted in
2008.





In March 2008, the FASB issued SFAS
No. 161, “Disclosures
about Derivative Instruments and Hedging Activities, an amendment of FASB
Statement No. 133” (SFAS 161). This statement is intended to improve
transparency in financial reporting by requiring enhanced disclosures of an
entity’s derivative instruments and hedging activities and their effects on the
entity’s financial position, financial performance, and cash flows. SFAS 161
applies to all derivative instruments within the scope of SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” (SFAS 133) as well as related hedged
items, bifurcated derivatives, and nonderivative instruments that are designated
and qualify as hedging instruments. Entities with instruments subject to SFAS
161 must provide more robust qualitative disclosures and expanded quantitative
disclosures. SFAS 161 is effective prospectively for financial statements issued
for fiscal years and interim periods beginning after November 15, 2008,
with early application permitted. This statement did not have an impact on the
determination of our financial results.





In May 2008, the FASB issued SFAS
No. 162, “The Hierarchy
of Generally Accepted Accounting Principles” (SFAS 162). This statement
identifies the sources of accounting principles and the framework for selecting
the principles used in the preparation of financial statements of
nongovernmental entities that are presented in accordance with GAAP. With the
issuance of this statement, the FASB concluded that the GAAP hierarchy should be
directed toward the entity and not its auditor, and reside in the accounting
literature established by the FASB as opposed to the American Institute of
Certified Public Accountants (AICPA) Statement on Auditing Standards
No. 69, “The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting
Principles.” This statement is effective 60 days following the SEC’s
approval of the Public Company Accounting Oversight Board (PCAOB) amendments to
AU Section 411, “The
Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles.” This statement did not have a significant impact on the
determination or reporting of our financial results.





14


In May 2008 the FASB issued FASB Staff
Position (FSP) APB 14-1, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement).” APB 14-1 requires the issuer to separately account for the
liability and equity components of convertible debt instruments in a manner that
reflects the issuer’s nonconvertible debt borrowing rate. The guidance will
result in companies recognizing higher interest expense in the statement of
operations due to amortization of the discount that results from separating the
liability and equity components. APB 14-1 will be effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. We are currently evaluating the
impact of adopting APB 14-1 on our consolidated financial
statements.





In June 2008, the FASB issued FSP No.
EITF 03-6-1, “Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities”. This FASB Staff Position (FSP) addresses
whether instruments granted in share-based payment transactions are
participating securities prior to vesting and, therefore, need to be included in
the earnings allocation in computing earnings per share (EPS) under the
two-class method described in paragraphs 60 and 61 of FASB Statement No. 128,
Earnings per Share. This FSP provides that unvested share-based payment awards
that contain non forfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of EPS pursuant to the two-class method. The provisions of FSP
No. 03-6-1 shall be effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those years. All
prior-period EPS data presented shall be adjusted retrospectively (including
interim financial statements, summaries of earnings, and selected financial
data) to conform with the provisions of this FSP. Early application is not
permitted.  The provisions of FSP No. 03-6-1 are effective for our
retroactively in the first quarter ended March 31, 2009. We are currently
assessing the impact of FSP No. EITF 03-6-1 on the calculation and presentation
of earnings per share in its’ consolidated financial statements.





In June 2008, the FASB ratified the
consensus reached on EITF Issue No. 07-05, “Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock.” EITF Issue No.
07-05 clarifies the determination of whether an instrument (or an embedded
feature) is indexed to an entity’s own stock, which would qualify as a scope
exception under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” EITF Issue No. 07-05 is effective
for financial statements issued for fiscal years beginning after December 15,
2008. Early adoption for an existing instrument is not permitted. We are
evaluating the impact of the adoption of EITF Issue No. 07-05 on our
consolidated financial statements.





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





ITEM
      7A.
              QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.


Not applicable for a smaller reporting
company.





ITEM 8.
              FINANCIAL
      STATEMENTS AND SUPPLEMENTARY
DATA.


Please see our Financial Statements
beginning on page F-1 of this annual report.





ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.


On
December 31, 2007, KMJ Corbin & Company LLP (“Corbin”) advised the SEC that
the firm had resigned as our independent registered public accounting firm,
effective immediately.  The reports of Corbin on our financial statements
for the previous two fiscal years for which Corbin issued reports, for the years
ended December 31, 2005 and December 31, 2004, did not contain an adverse
opinion or a disclaimer of an opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles, except that such reports on
our financial statements contained explanatory paragraphs with respect to
uncertainty as to our ability to continue as a going
concern.  Our Board of Directors did not recommend a change in
accountants.





During our then most recent two fiscal
years for which Corbin performed audits on our financial statements and during
the period from December 31, 2005 through December 31, 2007 there were no
disagreements with the Corbin on any matter of accounting principles or
practices financial statements disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Corbin, would have caused
Corbin to make reference to the subject matter of the disagreements in
connection with its report.  During this time period, there were no
“reportable events” as such term is described in Item 304(a)(1)(v) of Regulation
S-K.





On May 8, 2009, we entered into a
written engagement letter with Rodefer Moss & Co, PLLC (“Rodefer Moss”) to
become our new independent accountants to audit our consolidated financial
statements for the fiscal years ending December 31, 2006, 2007 and
2008.  Our Board of Directors authorized the engagement of Rodefer
Moss.  During the two most recent fiscal years and through May 8, 2009, we
had not consulted with Rodefer Moss regarding either (i) the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements,
and neither a written report nor oral advice was provided to us that Rodefer
Moss concluded was an important factor considered by us in reaching a decision
as to the accounting, auditing or financial reporting issue; or (ii) any matter
that was the subject of either a disagreement (as defined in Item 304(a)(1)(iv)
of Regulation S-K or the related instructions thereto) or a reportable event (as
defined in Item 304(a)(1)(v) of Regulation S-K).





15


ITEM
9A(T).                                CONTROLS
AND PROCEDURES.





Evaluation of Disclosure Controls
and Procedures.  We maintain “disclosure controls and
procedures” as such term is defined in Rule 13a-15(e) under the Exchange
Act.  In designing and evaluating our disclosure controls and
procedures, our management recognized that disclosure controls and procedures,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of disclosure controls and procedures
are met.  Additionally, in designing disclosure controls and
procedures, our management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible disclosure controls and
procedures.  The design of any disclosure controls and procedures also
is based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions.  Based on his
evaluation as of the end of the period covered by this Annual Report on Form
10-K, our Chief Executive Officer who also serves as our principal financial and
accounting officer has concluded that our disclosure controls and procedures
were not effective such that the information relating to our company, required
to be disclosed in our Securities and Exchange Commission reports (i) is
recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms and (ii) is accumulated and communicated to our
management, including our Chief Executive Officer, to allow timely decisions
regarding required disclosure.





Our management concluded that our
disclosure controls and procedures were not effective as a result of a material
weakness in our disclosure controls and procedures. The material weakness
identified was that our accounting resources are not adequate to allow
sufficient time to (i) perform a review of the consolidation and supporting
financial statement disclosure schedules independent of the preparer (ii)
adequately prepare for our quarterly reviews and annual audit and (iii) research
all applicable accounting pronouncements as they relate to our financial
statements and underlying disclosures. Inadequate levels of accounting personnel
have also caused us difficulty in filing our quarterly and annual reports with
the Securities and Exchange Commission within the required time
frame.  Due to this material weakness, in preparing our financial
statements for the year ended December 31, 2008 we performed additional analysis
and other post close procedures to ensure that such financial statements were
stated fairly in all material respects in accordance with U.S. generally
accepted accounting principles.  We do not expect our disclosure
controls and procedures to be effective until such time as we complete an
acquisition of an operating company and even then there are no assurances that
our disclosure controls and procedures will be adequate in future
periods.





Management’s Report on Internal
Control over Financial Reporting.  Our management is
responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934.  Our internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.  Our internal control over financial reporting includes
those policies and procedures that:





•           pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets;





•           provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorizations of our management and directors;
and





•           provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of our assets that could have a material effect
on the financial statements.





Because of the inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements.  Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.





Our management assessed the
effectiveness of our internal control over financial reporting as of December
31, 2008.  In making this assessment, management used the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control-Integrated Framework. Management's assessment included an
evaluation of the design of our internal control over financial reporting and
testing of the operational effectiveness of these controls.  Based on
this assessment, our management has concluded that as of December 31, 2008, our
internal control over financial reporting was not effective to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
U.S. generally accepted accounting principles as a result of the material
weaknesses indentified in our disclosure controls and procedures as described
earlier in this section.





This annual report does not include an
attestation report of our registered public accounting firm regarding internal
control over financial reporting. Management's report was not subject to
attestation by our registered public accounting firm pursuant to temporary rules
of the Securities and Exchange Commission that permit us to provide only
management's report in this annual report.





16


Changes in Internal Control over
Financial Reporting.There have been no changes in our
internal control over financial reporting during our fourth fiscal quarter that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.





ITEM
      9B.
              Other
      Information.


None.


PART
III




ITEM
      10.
              DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.





Executive
officers and directors





Name
                  Age
                  PositionsKen
      Page
                  37
                  Chairman
      of the Board, Chief Executive OfficerBrad
      McNeil
                  42
                  Director





Ken Page.  Mr. Page
has served as Chairman of the Board and Chief Executive Officer of our company
since September 2007.  Prior to joining the company, in 2006 Mr. Page
was an associate broker with No. 1 Quality Realty in Tennessee. From 2002 to
2006, Mr. Page was a programmer with S &S Precision Inc., a Tennessee
manufacturer of industrial molds, tool and die material and packing. Mr. Page
devotes approximately 90% of his time to the business and affairs of our
company.





Brad McNeil.  Mr.
McNeil has been a member of our Board of Directors since October
2007.  Since 2000 Mr. McNeil has been the Plant Manager for Certified
Cylinder, Inc., a Tennessee tank refurbisher.





There are
no family relationships between our officers and directors.  Each
director is elected at our annual meeting of stockholders and holds office until
the next annual meeting of stockholders, or until his successor is elected and
qualified.





Compliance
with Section 16(a) of the Exchange Act





Section 16(a) of theSecurities Exchange Act
of 1934, as amended, requires our executive officers and directors, and persons
who beneficially own more than 10% of a registered class of our equity
securities to file with the Securities and Exchange Commission initial
statements of beneficial ownership, reports of changes in ownership and annual
reports concerning their ownership of our common shares and other equity
securities, on Forms 3, 4 and 5 respectively.  Executive officers,
directors and greater than 10% stockholders are required by the Securities and
Exchange Commission regulations to furnish us with copies of all Section 16(a)
reports they file.  Based on our review of the copies of such forms
received by us, and to the best of our knowledge, all executive officers,
directors and persons holding greater than 10% of our issued and outstanding
stock have filed the required reports in a timely manner during
2008.





Code
of Ethics and Business Conduct





We have adopted a code of ethics
applicable to our chief executive officer, who is our principal executive
officer, and our chief financial officer, who is our principal financial and
accounting officer. We will provide a copy, without charge, to any person
desiring a copy of the code of ethics, by written request to, 649 Sparta
Highway, Suite 102, Crossville, TN  38555.





Committees
of our Board of Directors





Our Board of Directors has not
established any committees, including an Audit Committee, a Compensation
Committee or a Nominating Committee, any committee performing a similar
function. The functions of those committees are being undertaken by Board of
Directors as a whole.  Because we only have two directors, one of
which is not independent, we believe that the establishment of these committees
would be more form over substance.





We do not have a policy regarding the
consideration of any director candidates which may be recommended by our
stockholders, including the minimum qualifications for director candidates, nor
has our Board of Directors established a process for identifying and evaluating
director nominees. We have not adopted a policy regarding the handling of any
potential recommendation of director candidates by our stockholders, including
the procedures to be followed.  Our Board has not considered or
adopted any of these policies as we have never received a recommendation from
any stockholder for any candidate to serve on our Board of
Directors.  Given our relative size and lack of directors and officers
insurance coverage, we do not anticipate that any of our stockholders will make
such a recommendation in the near future. While there have been no nominations
of additional directors proposed, in the event such a proposal is made, all
members of our Board will participate in the consideration of director
nominees.





17


Neither
of our directors is an “audit committee financial expert” within the meaning of
Item 401(e) of Regulation S-K. In general, an “audit committee financial expert”
is an individual member of the audit committee or Board of Directors
who:





•
              understands
      generally accepted accounting principles and financial
      statements,•
              is
      able to assess the general application of such principles in connection
      with accounting for estimates, accruals and
  reserves,


•
              has
      experience preparing, auditing, analyzing or evaluating financial
      statements comparable to the breadth and complexity to our financial
      statements,•
              understands
      internal controls over financial reporting, and•
              understands
      audit committee functions.





Our securities are not quoted on an
exchange, however, that has requirements that a majority of our Board members be
independent and we are not currently otherwise subject to any law, rule or
regulation requiring that all or any portion of our Board of Directors include
“independent” directors, nor are we required to establish or maintain an Audit
Committee or other committee of our Board of Directors.





ITEM
11.                                EXECUTIVE
COMPENSATION.





The following table summarizes all
compensation recorded by us in 2008 for our then principal executive officer,
each other executive officer serving as such whose annual compensation exceeded
$100,000, and up to two additional individuals for whom disclosure would have
been made in this table but for the fact that the individual was not serving as
an executive officer of our company at December 31, 2008. The value attributable
to any option awards is computed in accordance with FAS123R.





SUMMARY COMPENSATION
  TABLEName
      and principal position
                      (a)
                    Year
                      (b)
                    Salary
                      ($)
                      (c)
                    Bonus
                      ($)
                      (d)
                    Stock
                      Awards
                      ($)
                      (e)
                    Option
                      Awards
                      ($)
                      (f)
                    Non-Equity
      Incentive Plan Compen-sation ($)
                      (g)
                    Non-qualified
      Deferred Compen-sation Earnings ($)
                      (h)
                    All
                      Other
      Compensation
                      ($)
                      (i)
                    Total
                      ($)
                      (j)Ken
      Page 1
                    2008
                    72,000
                    0
                    0
                    247,000
                    0
                    0
                    12,000
                    331,0002007
                    18,000
                    0
                    0
                    0
                    0
                    0
                    3,000
                    21,000





1           Mr.
Page has served as our Chief Executive Officer since September
2007.  Option awards represent the grant of options to purchase
3,000,000 shares of our common stock at $0.20 per share pursuant to the terms of
his employment agreement.  All other compensation represents a monthly
expense allowance payable to Mr. Page under the terms of his employment
agreement.





Employment
Agreement with Mr. Page





On September 27, 2007, we entered into
an Employment Agreement with Mr. Page whereby he agreed to serve as our Chief
Executive Officer and Chairman of our Board of Directors. The Employment
Agreement has an initial term of one year and thereafter will automatically be
extended for two year periods unless notice of non-renewal is given by either
party no later than 30 days prior to the end of the expiration of each term.
Under the Employment Agreement, Mr. Page receives a monthly salary of $6,000,
plus $1,000 per month as an expense allowance.





In addition, under the Employment
Agreement, after six months of employment, Mr. Page received a grant of a three
year option to purchase 3,000,000 shares of our common stock at a price of $0.20
per share, which vested in six equal monthly installments from the date of
issuance. If the agreement is terminated for any reason after six months from
the effective date, Mr. Page has six months from the date of termination to
exercise all vested stock options, or such vested stock options shall be
forfeited.  Mr. Page also received a right to immediately appoint two
directors to our Board of Directors. Pursuant to the agreement, Mr. McNeil was
appointed to our Board of Directors. Mr. Page does not have any present
attention to appoint an additional director to our Board.





Outstanding
Equity Awards at Fiscal Year-End


The
following table provides information concerning unexercised options, stock that
has not vested and equity incentive plan awards for each named executive officer
outstanding as of December 31, 2008:


18


OPTION
      AWARDS
                                                    
                                                    STOCK
      AWARDSName
                                                      (a)
                                                    
                                                    Number
      of Securities Underlying Unexercised Options
                                                      (#)
      Exercisable
                                                      (b)
                                                    
                                                    Number
      of Securities Underlying Unexercised Options
                                                      (#)
      Unexercisable (c)
                                                    
                                                    Equity
      Incentive Plan Awards: Number of Securities Underlying Unexercised
      Unearned Options
                                                      (#)
                                                      (d)
                                                    
                                                    Option
      Exercise Price
                                                      ($)
                                                      (e)
                                                    
                                                    Option
      Expiration Date
                                                      (f)
                                                    
                                                    Number
      of Shares or Units of Stock That Have Not Vested (#)
                                                      (g)
                                                    
                                                    Market
      Value of Shares or Units of Stock That Have Not Vested ($)
                                                      (h)
                                                    
                                                    Equity
      Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights
      that Have Not Vested (#)
                                                      (i)
                                                    
                                                    Equity
      Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or
      Other Rights That Have Not Vested (#)
                                                      (j)Ken
      Page
                                                    
                                                    
                                                    3,000,000
                                                    
                                                    
                                                    0
                                                    
                                                    
                                                    0
                                                    
                                                    
                                                    0.20
                                                    
                                                    9/27/10
                                                    
                                                    
                                                    0
                                                    
                                                    
                                                    0
                                                    
                                                    
                                                    0
                                                    
                                                    
                                                    0





Employee
Stock Ownership Plan





On December 1, 1999, we established a
leveraged Employee Stock Ownership Plan (“ESOP”) that covered all employees who
completed 1,000 or more hours of service in a plan year. To establish the plan,
the ESOP borrowed $10,000,000 from Mr. Teng, then our majority stockholder,
which we then used to purchase all of our outstanding preferred stock (a total
of 1,350,000 shares) from Mr. Teng at the then estimated fair value, $7.41 per
share. The preferred stock was convertible into common stock at an exchange rate
of 1 share of preferred stock to 3.12828 shares of common stock, and in
September 2004, the ESOP converted all of its preferred stock to common
stock.  We received no funds from the formation of the ESOP; however,
we were required to record the ESOP’s liability on our books as we had
guaranteed the ESOP debt in accordance with the AICPA’s Statement of Position
(“SOP”) 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” Under
SOP 93-6, we recorded an unearned employee benefit expense related to the cost
basis of unreleased shares, and, as such, we recorded it as a reduction to
stockholders’ equity, “Unearned ESOP shares.”





In the aftermath of a review by the
Pension and Welfare Benefits Administration of the Department of Labor (“DOL”),
in December 2003, Mr. Teng agreed to release the ESOP from its remaining
obligations under the $10.0 million promissory note, thereby releasing us from
our guarantee of the ESOP debt. In connection with Mr. Teng’s release of the
ESOP from its obligations under the promissory note, we eliminated the guarantee
of ESOP loan payable and ESOP interest payable balances against additional
paid-in capital, as this debt release was considered a contribution of capital
to us by Mr. Teng.





In December 2003, since the ESOP was
then under investigation by the DOL Mr. Teng was not able to foreclose on the
unreleased shares upon his release of our obligation under the promissory note,
as was his right under the ESOP agreement. At that time, Mr. Teng notified us
that while he was releasing us from our obligation under the promissory note, he
was not waiving any rights he may have to foreclosure against the unreleased
shares. Although the DOL investigation has been completed, we have not yet
released the shares to the ESOP and Mr. Teng has not yet exercised any right he
may have to foreclose on the unreleased shares. If Mr. Teng is able to foreclose
on the ESOP shares, the value of the unearned ESOP shares will be eliminated
against additional paid-in capital, which will reduce our additional paid-in
capital balance by approximately $6,207,000, with no net change to our
stockholders’ deficit.  In the event a terminated ESOP participant
desires to sell his or her shares of our common stock, or for certain employees
who elect to diversify their account balances, we may be required to purchase
the shares from the participant at their fair market value.  During
2008 we did not purchase any stock from ESOP participants nor did we have any
obligation to do so at any time during this period.





2004
Stock Incentive Plan





On March 22, 2004 our Board of
Directors adopted, subject to stockholder approval, the 2004 Stock Incentive
Plan (the “2004 Plan”). The 2004 Plan was approved by our stockholder in May
2004.  No award could be granted under the 2004 Plan subsequent to the
10th anniversary of the date on which the plan was approved by our stockholders.
The number of shares of our common stock available for issuance under the 2004
Plan was 3,500,000. At each of December 31, 2008 and June 30, 2009 there were
outstanding options to purchase 3,000,000 shares of our common stock at an
exercise price of $0.18 per share.





Compensation
of Directors





We have not established standard
compensation arrangements for our directors and the compensation, if any,
payable to each individual for their service on our Board will be determined
from time to time by our Board of Directors based upon the amount of time
expended by each of the directors on our behalf.  None of our
directors received any compensation for their services as directors for
2008.





ITEM
      12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





At August
20, 2009, we had 32,223,975 shares of our common stock issued and outstanding.
The following table sets forth information regarding the beneficial ownership of
our common stock as of August 20, 2009 by:





19


•
            each person known by us to be the
      beneficial owner of more than 5% of our common
    stock;


•
            each of our
      directors;


•
            each of our named executive
      officers; and


•
            our named executive officers,
      directors and director nominees as a
  group.





Unless otherwise indicated, the
business address of each person listed is in care of 649 Sparta Highway, Suite
102, Crossville, TN  38555. The percentages in the table have been
calculated on the basis of treating as outstanding for a particular person, all
shares of our common stock outstanding on that date and all shares of our common
stock issuable to that holder in the event of exercise of outstanding options,
warrants, rights or conversion privileges owned by that person at that date
which are exercisable within 60 days of that date. Except as otherwise
indicated, the persons listed below have sole voting and investment power with
respect to all shares of our common stock owned by them, except to the extent
that power may be shared with a spouse.





Name
      of Beneficial Owner
                    Amount
      and Nature of Beneficial Ownership
                    %
      of ClassKen
      Page 1
                    3,000,000
                    8.5%Brad
      McNeil
                    0
                    n/aAll
      officers and directors as a group (two persons)1
                    3,000,000
                    8.5%Dan
      Page 2
                    2,615,931
                    7.7%





1           The
number of shares beneficially owned by Mr. Ken Page includes options to purchase
3,000,000 shares of our common stock with an exercise price of $0.20 per
share.





2           The
number of shares beneficially owned by Mr. Dan Page includes 1,564,079 shares of
our common stock issuable upon the conversion of principal and interest due
under the 7.5% convertible promissory notes.





ITEM 13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE.





None.





Director
Independence





Mr. McNeil is considered “independent”
within the meaning of FINRA Marketplace Rule 4200.








ITEM
14.                                PRINCIPAL
ACCOUNTING FEES AND SERVICES.





Rodefer Moss served as our independent
registered public accounting firm for 2008 and 2007.  The following
table shows the fees that were billed for the audit and other services provided
by such firm for 2008 and 2007.


2008
                      
                      
                      2007Audit
      Fees
                      
                      $
                      9,000
                      
                      
                      $
                      9,000Audit-Related
      Fees
                      
                      
                      0
                      
                      
                      
                      0Tax
      Fees
                      
                      
                      0
                      
                      
                      
                      0All
      Other Fees
                      
                      
                      0
                      
                      
                      
                      0Total
                      
                      $
                      9,000
                      
                      
                      $
                      9,000


Audit Fees — This category
includes the audit of our annual financial statements, review of financial
statements included in our Quarterly Reports on Form 10-Q and services that are
normally provided by the independent registered public accounting firm in
connection with engagements for those fiscal years. This category also includes
advice on audit and accounting matters that arose during, or as a result of, the
audit or the review of interim financial statements.
 
 Audit-Related Fees — This
category consists of assurance and related services by the independent
registered public accounting firm that are reasonably related to the performance
of the audit or review of our financial statements and are not reported above
under “Audit Fees.” The services for the fees disclosed under this category
include consultation regarding our correspondence with the Securities and
Exchange Commission and other accounting consulting.
 
 Tax Fees — This category
consists of professional services rendered by our independent registered public
accounting firm for tax compliance and tax advice. The services for the fees
disclosed under this category include tax return preparation and technical tax
advice.
 
 All Other Fees — This
category consists of fees for other miscellaneous items.
 
 20


Our Board of Directors has adopted a
procedure for pre-approval of all fees charged by the our independent registered
public accounting firm.  Under the procedure, the Board approves the
engagement letter with respect to audit, tax and review
services.  Other fees are subject to pre-approval by the Board, or, in
the period between meetings, by a designated member of Board.  Any
such approval by the designated member is disclosed to the entire Board at the
next meeting.  The audit and tax fees paid to the auditors with
respect to 2008 were pre-approved by the entire Board of Directors.





ITEM
15.                      EXHIBITS,
FINANCIAL STATEMENT SCHEDULES.





Exhibit
      No.
                Description3.1
                Restated
      Certificate of Incorporation (1)3.2
                Certificate
      of Designation of Series A Preferred Stock (2)3.2
                Amended
      and Restated By-Laws (2)4.1
                Specimen
      stock certificate for common stock (2)4.2
                Warrant
      issued on November 29, 2004 to Laurus Master Fund, Ltd.
  (1)4.3
                Convertible
      Promissory Note dated April 1, 2005 issued to Alloy Marketing and
      Promotions, LLC (3)4.4
                Form
      of convertible promissory note issued to Mr. L.E. Smith in September 2005
      (4)4.5
                Form
      of common stock purchase warrant issued to Mr. L.E. Smith in connection
      with convertible promissory note (4)4.6
                Form
      of $250,000 principal amount 7.5% convertible promissory note issued to
      Mr. Dan Page in April 2007 (9)4.7
                Form
      of warrant issued to Mr. Dan Page in connection with $250,000 principal
      amount 7.5% convertible promissory note issued in April 2007
      (8)4.8
                Amendment
      to Convertible Line of Credit Note (9)10.1
                2004
      Stock Incentive Plan (2)10.2
                Form
      of registration rights agreement in favor of Mr. L.E. Smith
      (4)10.3
                Merger
      Agreement, dated March 8, 2006, by and among Digital Lifestyles Group,
      Inc., Protron Acquisition, Inc., Protron Digital Corporation, Leo Chen and
      Alex Chung (5)10.4
                Form
      of Registration Rights Agreement with Laurus Master Fund, Ltd.
      (1)10.6
                Promissory
      Note dated August 7, 2006 in the principal amount of $40,000 to Andy Teng
      (7)10.7
                Form
      of Registration Rights Agreement $250,000 principal amount 7.5%
      convertible promissory note issued in April 2007 (8)10.8
                Employment
      Agreement with Ken Page (9)21.1
                Subsidiaries
      of the registrant (10)31.1
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive Officer
    *31.2
                Rule
      13a-14(a)/15d-14(a) Certification of principal financial and accounting
      officer *32.1
                Section
      1350 Certification of Chief Executive Officer and principal financial and
      accounting officer *





*           filed
herewith.





(1)
                Incorporated
      by reference to the Annual Report on Form 10-K for the year ended December
      31, 2004.(2)
                Incorporated
      by reference to the Annual Report on Form 10-K for the year ended December
      31, 2003.(3)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on April 7,
      2005.(4)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on October 4,
      2005.(5)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on March 13,
      2006.(6)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on September 15,
      2004.(7)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on August 14,
      2006.(8)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on April 26,
      2007.(9)
                Incorporated
      by reference to the Current Report on Form 8-K as filed on October 9,
      2007.(10)
                Incorporated
      by reference to the Annual Report on Form 10-K for the year ended December
      31, 2006.





21


SIGNATURES





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








Digital
      Lifestyles Group Inc.August
      21, 2009
                  By:
                  /s/ Ken
      PageKen
      Page, Chief Executive Officer





Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant in the capacities and on the dates
indicated.





Name
                  
                  Positions
                  
                  Date/s/Ken
      Page
                  
                  
                  Chief
      Executive Officer, Chief Financial Officer, President, Secretary,
      Treasurer,
                  
                  August
      21, 2009Ken
      Page
                  
                  
                  director,
      principal executive officer and principal financial and accounting
      officer/s/ Brad
      McNeil
                  
                  
                  Director
                  
                  August
      21, 2009Brad McNeil













TABLE
OF CONTENTS








Report
      of Independent Registered Public Accounting Firm
                F-1Financial
      Statements:Consolidated
      Balance Sheets
                
                
                F-2Consolidated
      Statements of Operations
                
                F-3Consolidated
      Statements of  Stockholders' Deficit
                F-4Consolidated
      Statements of Cash Flows
                
                F-5Notes
      to Consolidated Financial Statements
                F-6






REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 Board of
Directors and Stockholders
 Digital
Lifestyles Group, Inc.
 Crossville,
Tennessee
  We have
audited the accompanying consolidated balance sheets of Digital Lifestyles
Group, Inc. as of December 31, 2008 and December 31, 2007 and the related
consolidated statements of operations, changes in stockholders’ equity (deficit)
and cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
has determined that it is not required to have, nor were we engaged to perform,
an audit of internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referenced above present fairly,
in all material respects, the financial position of Digital Lifestyles Group,
Inc. as of December 31, 2008 and 2007, and the results of its operations and
cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
  The
accompanying consolidated financial statements have been prepared assuming that
Digital Lifestyles Group, Inc. will continue as a going concern. As more fully
described in Note 1, the Company has incurred recurring operating losses and
will have to obtain additional financing to sustain operations. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 1. The
accompanying consolidated financial statements do not include any
adjustments to reflect the possible effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
 
 Rodefer
Moss & Co, PLLC
 
 Knoxville,
Tennessee
 August
21, 2009


F-1




DIGITAL
      LIFESTYLES GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
      BALANCE SHEETSDecember
      31, 2008 and 2007(In
      thousands)ASSETS2008
                                                              
                                                              
                                                              2007CURRENT
      ASSETSCash
      and cash equivalents
                                                              
                                                              $
                                                              22
                                                              
                                                              
                                                              $
                                                              -TOTAL
      CURRENT ASSETS
                                                              
                                                              
                                                              22
                                                              
                                                              
                                                              
                                                              -Total
      Assets
                                                              
                                                              $
                                                              22
                                                              
                                                              
                                                              $
                                                              -LIABILITIES
      AND STOCKHOLDERS' DEFICITCURRENT
      LIABILITIESAccounts
      payable
                                                              
                                                              $
                                                              6,378
                                                              
                                                              
                                                              $
                                                              6,390Liquidated
      damages payable
                                                              
                                                              
                                                              2,436
                                                              
                                                              
                                                              
                                                              2,436Accrued
      expenses
                                                              
                                                              
                                                              950
                                                              
                                                              
                                                              
                                                              722Convertible
      notes payable, net of debt discount
                                                              
                                                              
                                                              1,490
                                                              
                                                              
                                                              
                                                              1,452TOTAL
      CURRENT LIABILITIES
                                                              
                                                              
                                                              11,254
                                                              
                                                              
                                                              
                                                              11,000Derivitave
      and warrant liabilities
                                                              
                                                              
                                                              100
                                                              
                                                              
                                                              
                                                              485Total
      Liabilities
                                                              
                                                              
                                                              11,354
                                                              
                                                              
                                                              
                                                              11,485STOCKHOLDERS'
      EQUITYCommon
      stock, $.03 par value: 50,000 shares authorized,33,224
      and 33,224 shares issued and outstanding
                                                              
                                                              
                                                              996
                                                              
                                                              
                                                              
                                                              996Additional
      paid-in capital
                                                              
                                                              
                                                              16,348
                                                              
                                                              
                                                              
                                                              16,101Accumulated
      deficit
                                                              
                                                              
                                                              (22,469
                                                              )
                                                              
                                                              
                                                              (22,375
                                                              )(5,125
                                                              )
                                                              
                                                              
                                                              (5,278
                                                              )Less:
      Unearned ESOP shares
                                                              
                                                              
                                                              (6,207
                                                              )
                                                              
                                                              
                                                              (6,207
                                                              )Total
      stockholders' deficit
                                                              
                                                              
                                                              (11,332
                                                              )
                                                              
                                                              
                                                              (11,485
                                                              )Total
      liabilities and stockholders' deficit
                                                              
                                                              $
                                                              22
                                                              
                                                              
                                                              $
                                                              -


See
accompanying notes to consolidated financial statements




F-2
 
  DIGITAL
      LIFESTYLES GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF OPERATIONSFor
      the Years ended December 31, 2008 and 2007(In
      thousands, except per share data)2008
                                                              
                                                              
                                                              2007Net
      sales
                                                              
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              -Cost
      of sales
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -GROSS
      PROFIT
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -OPERATING
      EXPENSES
                                                              
                                                              
                                                              356
                                                              
                                                              
                                                              
                                                              259Operating
      loss
                                                              
                                                              
                                                              (356
                                                              )
                                                              
                                                              
                                                              (259
                                                              )OTHER
      INCOME (EXPENSE)Interest
      expense
                                                              
                                                              
                                                              (193
                                                              )
                                                              
                                                              
                                                              (231
                                                              )Liquidation
      damages expense
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -Change
      in fair value of derivative and warrant liabilities
                                                              
                                                              
                                                              385
                                                              
                                                              
                                                              
                                                              1,266Forbearance
      expense
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              (129
                                                              )Gain
      on debt settlement
                                                              
                                                              
                                                              10
                                                              
                                                              
                                                              
                                                              1,539Other,
      net
                                                              
                                                              
                                                              
                                                              60
                                                              
                                                              
                                                              
                                                              6TOTAL
      OTHER INCOME (EXPENSE)
                                                              
                                                              
                                                              262
                                                              
                                                              
                                                              
                                                              2,451INCOME
      (LOSS) BEFORE INCOME TAXES
                                                              
                                                              
                                                              (94
                                                              )
                                                              
                                                              
                                                              2,192INCOME
      TAX EXPENSEProvision
      for income taxes
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -NET
      INCOME (LOSS)
                                                              
                                                              $
                                                              (94
                                                              )
                                                              
                                                              $
                                                              2,192Basic
      income (loss) per share
                                                              
                                                              $
                                                              (0.00
                                                              )
                                                              
                                                              $
                                                              0.07Diluted
      income (loss) per share
                                                              
                                                              $
                                                              0.00
                                                              
                                                              
                                                              $
                                                              0.06Weighted
      average shares of common stock outstanding:Basic
                                                              
                                                              
                                                              
                                                              33,024
                                                              
                                                              
                                                              
                                                              33,024Diluted
                                                              
                                                              
                                                              
                                                              33,024
                                                              
                                                              
                                                              
                                                              43,812
 See
accompanying notes to consolidated financial statements
  F-3




DIGITAL
      LIFESTYLES GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)For
      the years ended December 31, 2008 and 2007(In
      thousands)Additional
                                                                                              
                                                                                              
                                                                                              UnearnedCommon
      Stock
                                                                                              
                                                                                              
                                                                                              Paid-In
                                                                                              
                                                                                              
                                                                                              ESOP
                                                                                              
                                                                                              
                                                                                              AccumulatedShares
                                                                                              
                                                                                              
                                                                                              Amount
                                                                                              
                                                                                              
                                                                                              Capital
                                                                                              
                                                                                              
                                                                                              Shares
                                                                                              
                                                                                              
                                                                                              Deficit
                                                                                              
                                                                                              
                                                                                              TotalBalance,
      January 1, 2007
                                                                                              
                                                                                              32,866
                                                                                              
                                                                                              
                                                                                              $
                                                                                              986
                                                                                              
                                                                                              
                                                                                              $
                                                                                              15,916
                                                                                              
                                                                                              
                                                                                              $
                                                                                              (6,207
                                                                                              )
                                                                                              
                                                                                              $
                                                                                              (24,567
                                                                                              )
                                                                                              
                                                                                              $
                                                                                              (13,872
                                                                                              )Issuance
      of optionsto
      employees
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              33
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              33Coversion
      of note payable andunpaid
      compensation
                                                                                              
                                                                                              358
                                                                                              
                                                                                              
                                                                                              
                                                                                              10
                                                                                              
                                                                                              
                                                                                              
                                                                                              152
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              162Net
      Income
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,192
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,192Balance,
      December 31, 2007
                                                                                              
                                                                                              33,224
                                                                                              
                                                                                              
                                                                                              
                                                                                              996
                                                                                              
                                                                                              
                                                                                              
                                                                                              16,101
                                                                                              
                                                                                              
                                                                                              
                                                                                              (6,207
                                                                                              )
                                                                                              
                                                                                              
                                                                                              (22,375
                                                                                              )
                                                                                              
                                                                                              
                                                                                              (11,485
                                                                                              )Issuance
      of optionsas
      compensation
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              247
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              247Net
      (Loss)
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              (94
                                                                                              )
                                                                                              
                                                                                              
                                                                                              (94
                                                                                              )Balance,
      December 31, 2008
                                                                                              
                                                                                              33,224
                                                                                              
                                                                                              
                                                                                              $
                                                                                              996
                                                                                              
                                                                                              
                                                                                              $
                                                                                              16,348
                                                                                              
                                                                                              
                                                                                              $
                                                                                              (6,207
                                                                                              )
                                                                                              
                                                                                              $
                                                                                              (22,469
                                                                                              )
                                                                                              
                                                                                              $
                                                                                              (11,332
                                                                                              )


See
accompanying notes to consolidated financial statements




F-4




DIGITAL
      LIFESTYLES GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWSFor
      the years ended December 31, 2008 and 2007(In
      thousands)2008
                                                    
                                                    
                                                    2007Cash
      flows from operating activities:Net
      (Loss) Income
                                                    
                                                    $
                                                    (94
                                                    )
                                                    
                                                    $
                                                    2,192Adjustments
      to reconcile net (loss) income to net cashused
      by operating activitiesGain
      on debt settlement
                                                    
                                                    
                                                    (10
                                                    )
                                                    
                                                    
                                                    (1,539
                                                    )Change
      in fair value of derivative and warrant liabilities
                                                    
                                                    
                                                    (385
                                                    )
                                                    
                                                    
                                                    (1,266
                                                    )Stock
      and stock rights issued for services
                                                    
                                                    
                                                    247
                                                    
                                                    
                                                    
                                                    116Forebearance
      expense
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    129Accounts
      payable
                                                    
                                                    
                                                    (2
                                                    )
                                                    
                                                    
                                                    (20
                                                    )Liquidation
      damages payable
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    270Accrued
      expenses
                                                    
                                                    
                                                    228
                                                    
                                                    
                                                    
                                                    (19
                                                    )Net
      cash used in operating activities
                                                    
                                                    
                                                    (16
                                                    )
                                                    
                                                    
                                                    (137
                                                    )Cash
      flows from investing activities:Proceeds
      from sale of fixed assets
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Purchase
      of equipment and software development costs
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Net
      cash provided by investing activities
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Cash
      flows from financing activities:Proceeds
      from convertible note payable, net of issuance costs
                                                    
                                                    
                                                    38
                                                    
                                                    
                                                    
                                                    302Payments
      on notes payable
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (165
                                                    )Net
      cash provided by financing activities
                                                    
                                                    
                                                    38
                                                    
                                                    
                                                    
                                                    137Net
      Change in cash and cash equivalents
                                                    
                                                    
                                                    22
                                                    
                                                    
                                                    
                                                    -Cash
      and cash equivalents, beginning of year
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Cash
      and cash equivalents, end of year
                                                    
                                                    $
                                                    22
                                                    
                                                    
                                                    $
                                                    -


See
accompanying notes to consolidated financial statements




F-5
 
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 For the
Years Ended December 31, 2008 and 2007
 
 NOTE
1 - ORGANIZATION AND BASIS OF PRESENTATION
 
 The
accompanying consolidated financial statements include the accounts of Digital
Lifestyles Group, Inc. ("Digital" "we," "our," "us," or the "Company") (formerly
Northgate Innovations, Inc. or "Northgate") and Digital's wholly owned
subsidiaries. All significant intercompany transactions have been
eliminated.
 
 In late
2004, we focused our resources on the development, marketing and sale of our
then-new hip-eTM brand product line, which was designed and targeted to the teen
market. In April 2005, we received notice from Microsoft Corporation
("Microsoft") that it had terminated our license to use its proprietary
Windows(R) operating system, due to our failure to make required royalty
payments. Due to the loss of the license, we were unable to ship our products,
the majority of which use Microsoft's proprietary Windows(R) operating system
and as a result we were unable to fill any orders for our hip-eTM brand desktop
computers.
 
 As we
lacked sufficient funds required to renew our license with Microsoft and were
unable to distribute or sell our products, our management team decided to cease
all ongoing operations, except for operations related to helping our secured
creditor, Laurus Master Fund, Ltd. ("Laurus"), liquidate their collateral. As a
result of the liquidation effort, the Company generated cash to repay $1,063,000
of the outstanding principal owed to Laurus, resulting in a loss on disposition
of assets of $4,553,000.
 
 In April
2007, we reached an agreement with Laurus to extinguish $2.1 million in
outstanding debt for $200,000 in cash. Under the terms of the agreement we paid
$50,000 in cash in April 2007, and paid an additional $115,000 during the year
ended December 31, 2007. The remaining $35,000 owed at December 31, 2007 is
included on the balance sheet under the caption “accrued expenses”. In addition
to the cash consideration, we issued a warrant to Laurus to purchase one million
shares of our common stock at $.40 per share. In connection with the agreement,
we recognized a gain on debt relief of approximately $1,510,000 and a derivative
liability of $358,612 during the year ended December 31, 2007.
 
 As of
December 31, 2008, we continue to have no business operations. Currently, we
have approximately $11 million in unsecured debt, virtually all of which is past
due, and we have  insignificant assets. During the fiscal year ending
December 31, 2008, we incurred cash costs of approximately $35,000 primarily
related to operating costs, such as rent for office space, utilities, employee
compensation, costs of maintaining the business as a public entity, professional
expenses (including legal and accounting fees) related to attempting to
negotiate a business combination and bringing the Company current in its SEC
filings. In addition we have accrued approximately $193,000 as interest expense,
$71,000 in unpaid wages and $247,000 in stock option compensation.
  F-6
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
1 - ORGANIZATION AND BASIS OF PRESENTATION – (Continued)
 
 We
currently have capital resources sufficient to meet our operating and capital
needs for approximately the next two months. However, as we have no current
sales or other sources of revenue, we depend upon the
cessation of our business operations, we have a severe shortage of capital,
significant debt, and are under default under existing credit and loan
agreements, and we may not be able to arrange for debt or equity financing from
third parties on favorable terms, or at all.
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 CASH AND CASH
EQUIVALENTS
 
 Cash and
cash equivalents consist of cash on hand, cash on deposit and all highly liquid
investments with original maturities at the date of purchase of less than three
months. Cash equivalents consist primarily of cash deposited in money market
accounts. While our cash and cash equivalents are on deposit with financial
institutions, at times deposits may exceed federally insured limits. We have not
experienced any losses in such accounts.
 
 USE OF
ESTIMATES
 
 The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make 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 and the recorded amount of
revenues and expenses during the reporting periods. On an on-going basis, we
evaluate our estimates including but not limited to, those related to (i)
valuation of derivative instruments, (ii) fair value of stock transactions,
and  (iii) deferred tax asset valuation allowances. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis of making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions, and such differences
may be material to the consolidated financial statements.
 
 FAIR VALUE OF FINANCIAL
INSTRUMENTS
 
 Our
derivative and warrant liabilities are presented on our balance sheets at fair
value. For other liabilities it is not practical to estimate the fair value
because there is no established market for these instruments as we do not
currently have the resources to settle them and it is inappropriate to estimate
future cash flows, which are largely dependent on the need for additional
capital.
 
 F-7
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 EQUIPMENT
 
 As a
result of our shut down of operations in the second quarter of 2005, we wrote
down equipment balances to the amounts ultimately realized upon their
liquidation. We have no equipment as of December 31, 2008 and 2007.
 
 CONCENTRATIONS
 
 There are
no financial instruments that potentially subject us to a concentration of
credit risk. Due to the shutdown of business operations in the second quarter of
2005, we have insignificant amount of cash and no accounts receivable as of
December 31, 2008 and 2007.
 
 We had a
nonexclusive licensing agreement with Microsoft for various operating system and
application software for which we were obligated to pay Microsoft a licensing
fee. Microsoft terminated this license in April 2005 due to the Company's
failure to pay outstanding licensing fees totaling $1,377,895 at December 31,
2008 and 2007.
 
 DERIVATIVE FINANCIAL
INSTRUMENTS
 
 Our
derivative financial instruments consist of embedded and free-standing
derivatives related primarily to the Laurus notes entered into on November 30,
2004 and the Alloy note (see Note 3). The embedded derivatives include the
conversion features, and liquidated damages clauses in the registration rights
agreement. In addition, under the provisions of Emerging Issues Task Force
("EITF") Issue No. 00-19, "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company’s Own Stock," the Company is
required to classify certain other non-employee stock options and warrants
(free-standing derivatives) as liabilities. The accounting treatment of
derivative financial instruments requires that the Company record the
derivatives and related warrants at their fair values as of the inception date
of the agreement and at fair value as of each subsequent balance sheet date. The
fair value of all derivatives at December 31, 2008 and 2007 totaled
approximately $100,000 and $485,000, respectively. Any change in fair value of
these instruments will be recorded as non-operating, non-cash income or expense
at each reporting date. If the fair value of the derivatives is higher at the
subsequent balance sheet date, the Company will record a non-operating, non-cash
charge. If the fair value of the derivatives is lower at the subsequent balance
sheet date, the Company will record non-operating, non-cash income. At December
31, 2008 and 2007 derivatives were valued primarily using the Black-Scholes
Option Pricing Model with the following assumptions: dividend yield of 0%,
annual volatility of 179% - 364%, risk free interest rate of 2.11% - 4.83%, and
expected life of 3-10 years.
 
 F-8
 
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 The
derivatives are classified as long-term liabilities.
 
 For the
years ended December 31, 2008 and 2007, the net decrease in the derivative and
warrant liabilities were approximately $385,000 and $1,266,000, respectively,
which are recorded as components of other income in the accompanying
consolidated statements of operations.
 
 RECLASSIFICATIONS
 
 Certain
amounts from prior periods have been reclassified to conform to the current year
presentation.
 
 REVENUE
RECOGNITION
 
 We ceased
all operations in April 2005 and have no significant current
revenues.
 
 INCOME
TAXES
 
 We follow
the provisions of SFAS No. 109, "Accounting for Income Taxes," which requires
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements and
tax returns. Deferred tax assets and liabilities are determined based upon the
difference between the financial statement and tax bases of assets and
liabilities, using the enacted tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is provided when it
is more likely than not that deferred tax assets will not be
realized.
 
 STOCK-BASED
COMPENSATION
 
 Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS No.
123(R), SHARE BASED PAYMENT, using the modified-prospective transition method.
Under this transition method, compensation cost recognized in the year ended
December 31, 2006 includes: (a) compensation cost for all share-based payments
granted and not yet vested prior to January 1, 2006, based on the grant date
fair value estimated in accordance with the original provisions of SFAS No. 123,
and (b) compensation cost for all share-based payments granted subsequent to
December 31, 2005 based on the grant-date fair value estimated in accordance
with the provisions of SFAS No. 123(R). Results for prior periods have not been
restated. Since stock-based compensation expense recognized in the statement of
operations for the years ended December 31, 2008 and 2007 is based on awards
ultimately expected to vest, the compensation expense has been reduced for
estimated pre-vesting forfeitures. SFAS No. 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. We estimated forfeitures to
be 0% of the options issued.
  F-9
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 NET (LOSS) INCOME PER
SHARE
 
 Basic net
(loss) income per share excludes dilution and is computed by dividing net (loss)
income by the weighted average number of common shares outstanding during the
reported periods. Diluted net (loss) income per share reflects the potential
dilution that could occur if other commitments to issue common stock were
exercised.
 
 The
company’s potentially dilutive securities consist of options and warrants as
well as convertible debt. For the years ended, December 31, 2008 and 2007, about
600 options and warrants, respectively, are dilutive, under the provisions of
SFAS 128, since, for all other issuances, the average market price of the common
stock during the period was less than the exercise price of the options or
warrants (they were “out of the money”).
 
 The
company’s convertible debt consists of notes payable which are considered
dilutive whenever their interest (net of tax and nondiscretionary adjustments)
per common share obtainable on conversion is less than basic EPS. For the year
ended December 31, 2007, approximately 10,558,000 convertible shares were
included in the denominator and earnings were adjusted by about $334,000 for the
effects of convertible securities. During the year ended December 31, 2008, the
shares are considered anti-dilutive and thus not included in the
demoninater.
 
 RECENT ACCOUNTING
PRONOUNCEMENTS
  In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No.
157). In the first quarter of fiscal year 2009, the Company adopted the
recognition and disclosure requirements of SFAS No. 157 for all financial assets
and financial liabilities recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). SFAS No. 157 defines fair
value, establishes a framework for measuring fair value, and enhances fair value
measurement disclosure. The adoption of this part of SFAS No. 157 did not have a
material impact on the Company's consolidated financial statements, and the
resulting fair values of the Company's financial assets and financial
liabilities calculated under SFAS No. 157 after adoption were not significantly
different than the fair values that would have been calculated under previous
guidance. See Note 10 for further details on the Company's fair value
measurements. With respect to the recognition and disclosure requirements of
SFAS No. 157 related to non-financial assets and non-financial liabilities, the
Company will adopt these requirements beginning in the first quarter of its
fiscal year 2010.
  F-10
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 In July
2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement 109” (“FIN 48”), which
clarifies the accounting for uncertainty in tax positions taken or expected to
be taken in a tax return, including issues relating to financial statement
recognition and measurement. FIN 48 provides that the tax effects from an
uncertain tax position can be recognized in the financial statements only if the
position is “more-likely-than-not” to be sustained if the position were to be
challenged by a taxing authority. The assessment of the tax position is based
solely on the technical merits of the position, without regard to the likelihood
that the tax position may be challenged. If an uncertain tax position meets the
“more-likely-than-not” threshold, the largest amount of tax benefit that is more
than 50 percent likely to be recognized upon ultimate settlement with the taxing
authority, is recorded. The provisions of FIN 48 were effective for fiscal years
beginning after December 15, 2006, with the cumulative effect of the change in
accounting principle recorded as an adjustment to opening retained earnings.
Consistent with the requirements of FIN 48, we adopted FIN 48 on January 1,
2007. Adoption of FIN 48 did not have a material impact on our results of
operations or financial position. We currently have tax return periods open
beginning with December 31, 2006 through December 31, 2008.
 
 In
February 2008, the FASB issued FASB Staff Position (FSP) No. FAS
157-1,Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement under Statement 13 (FSP FAS 152-1) and FSP
No. FAS 157-2, Effective Date of FASB Statement No. 157  (FSP FAS
152-2). Collectively, the Staff Positions defer the effective date of SFAS No.
157 to fiscal years beginning after November 15, 2008 for nonfinancial assets
and nonfinancial liabilities except for items that are recognized or disclosed
at fair value on a recurring basis at least annually, and amend the scope of
SFAS No. 157. As described in Note 8, the Company has adopted SFAS No. 157 and
the related FASB staff positions except for those items specifically deferred
under FSP FAS 157-2. The Company is currently evaluating the impact of the full
adoption of SFAS No. 157 on its fiscal year 2010 consolidated results of
operations and financial condition.In July 2006, the FASB issued FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement 109” (“FIN 48”), which clarifies the accounting
for uncertainty in tax positions taken or expected to be taken in a tax return,
including issues relating to financial statement recognition and measurement.
FIN 48 provides that the tax effects from an uncertain tax position can be
recognized in the financial statements only if the
position is “more-likely-than-not” to be sustained if the position were to be
challenged by a taxing authority. The assessment of the tax position is based
solely on the technical merits of the position, without regard to the likelihood
that the tax position may be challenged. If an uncertain tax position meets the
“more-likely-than-not” threshold, the largest amount of tax benefit that is more
than 50 percent likely to be recognized upon ultimate settlement with the taxing
authority, is recorded. The provisions of FIN 48 were effective for fiscal years
beginning after December 15, 2006, with the cumulative effect of the change in
accounting principle recorded as an adjustment to opening retained earnings.
Consistent with the requirements of FIN 48, we adopted FIN 48 on January 1,
2007. Adoption of FIN 48 did not have a material impact on our results of
operations or financial position. The Company currently has tax return periods
open beginning with December 31, 2006 through December 31, 2008.
  F-11
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS 141(R)), which replaces SFAS No. 141, “Business
Combinations” (SFAS 141). SFAS 141(R) retains the underlying concepts of SFAS
141 in that all business combinations are still required to be accounted for at
fair value under the acquisition method of accounting but SFAS 141(R) changed
the method of applying the acquisition method in a number of significant
aspects. Acquisition costs will generally be expensed as incurred;
noncontrolling interests will be valued at fair value at the acquisition date;
in-process research and development will be recorded at fair value as an
indefinite-lived intangible asset at the acquisition date, until either
abandoned or completed, at which point the useful lives will be determined;
restructuring costs associated with a business combination will generally be
expensed subsequent to the acquisition date; and changes in deferred tax asset
valuation allowances and income tax uncertainties after the acquisition date
generally will affect income tax expense. SFAS 141(R) is effective on a
prospective basis for all business combinations for which the acquisition date
is on or after the beginning of the first annual period subsequent to
December 15, 2008, with the exception of the accounting for valuation
allowances on deferred taxes and acquired tax contingencies. SFAS 141(R) amends
SFAS No. 109, “Accounting for Income Taxes” (SFAS 109) such that
adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of SFAS 141(R) would also apply the provisions of SFAS 141(R). Early
adoption is not permitted. Upon adoption, SFAS 141(R) will not have a
significant impact on our consolidated
financial position and results of operations; however, any business combination
entered into after the adoption may significantly impact our financial position
and results of operations when compared to acquisitions accounted for under
existing U.S. Generally Accepted Accounting Principles (GAAP).
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51.” This
statement is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008, with earlier
adoption prohibited. This statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net income
attributable to the noncontrolling interest will be included in consolidated net
income on the face of the income statement. It also amends certain of ARB
No. 51’s consolidation procedures for consistency with the
requirements of SFAS 141(R). This statement also includes expanded disclosure
requirements regarding the interests of the parent and its noncontrolling
interest. We have evaluated this new
statement and have determined that the statement will not have a significant
impact on the reporting of our financial position and results of
operations.
 
 In
December 2007, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (SAB) No. 110. This guidance allows
companies, in certain circumstances, to utilize a simplified method in
determining the expected term of stock option grants when calculating the
compensation expense to be recorded under Statement of Financial Accounting
Standards (SFAS) No. 123(R),Share-Based
Payment. The simplified method can be used after December 31, 2007
only if a company’s stock option exercise experience does not provide a
reasonable basis upon which to estimate the expected option term. SAB 110 had no
impact on our financial statements.
  F-12
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
(SFAS 161). This statement is intended to improve transparency in financial
reporting by requiring enhanced disclosures of an entity’s derivative
instruments and hedging activities and their effects on the entity’s financial
position, financial performance, and cash flows. SFAS 161 applies to all
derivative instruments within the scope of SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” (SFAS 133) as well as related hedged items,
bifurcated derivatives, and nonderivative instruments that are designated and
qualify as hedging instruments. Entities with instruments subject to SFAS 161
must provide more robust qualitative disclosures and expanded quantitative
disclosures. SFAS 161 is effective prospectively for financial statements issued
for fiscal years and interim periods beginning after November 15, 2008,
with early application permitted. We are currently evaluating the disclosure
implications of this statement; however, the new statement will not have an
impact on the determination of our financial results.
 
 In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (SFAS 162). This statement identifies the sources of
accounting principles and the framework for selecting the principles used
in the preparation of financial statements of nongovernmental entities that
are presented in accordance with GAAP. With the issuance of this statement, the
FASB concluded that the GAAP hierarchy should be directed toward the entity and
not its auditor, and reside in the accounting literature established by the FASB
as opposed to the American Institute of Certified Public Accountants (AICPA)
Statement on Auditing Standards No. 69, “The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles.” This statement
is effective 60 days following the SEC’s approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, “The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting Principles.” We
have evaluated the new statement and have determined that it will not have a
significant impact on the determination or reporting of our financial
results.
 
 In May
2008 the FASB issued FASB Staff Position (FSP) APB 14-1, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement).” APB 14-1 requires the issuer to separately account for
the liability and equity components of convertible debt instruments in a manner
that reflects the issuer’s nonconvertible debt borrowing rate. The guidance will
result in companies recognizing higher interest expense in the statement of
operations due to amortization of the discount that results from separating the
liability and equity components. APB 14-1 will be effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The Company is currently evaluating
the impact of adopting APB 14-1 on its consolidated financial
statements.
  F-13
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)
 
 In June
2008, the FASB issued FSP No. EITF 03-6-1, "Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities". This
FASB Staff Position (FSP) addresses whether instruments granted in share-based
payment transactions are participating securities prior to vesting and,
therefore, need to be included in the earnings allocation in computing earnings
per share (EPS) under the two-class method described in paragraphs 60 and 61 of
FASB Statement No. 128, Earnings
per Share. This FSP provides that unvested share-based payment awards that
contain non forfeitable rights to dividends or dividend equivalents (whether
paid or unpaid) are participatingsecurities and shall be included in the
computation of EPS pursuant to the two-class method. The provisions of FSP No.
03-6-1 shall be effective for financial statements issued for fiscal years
beginning after
December 15, 2008, and interim periods within those years. All prior-period EPS
data presented shall be adjusted retrospectively (including interim financial
statements, summaries of earnings, and selected financial data) to conform with
the provisions of this FSP. Early application is not permitted. The
provisions of FSP No. 03-6-1are effective for the Company retroactively in the
first quarter ended March 31, 2009. The Company is currently assessing the
impact of FSP No. EITF 03-6-1 on the calculation and presentation of earnings
per share in its consolidated financial statements.
 
 In June
2008, the FASB ratified the consensus reached on EITF Issue No. 07-05,
Determining Whether an Instrument (or Embedded Feature) Is indexed to an
Entity's Own Stock. EITF Issue No. 07-05 clarifies the determination of whether
an instrument (or an embedded feature) is indexed to an entity's own stock,
which would qualify as a scope exception under SFAS No. 133, Accounting for
Derivative Instruments
and Hedging Activities. EITF Issue No. 07-05 is effective for financial
statements issued for fiscal years beginning after December 15, 2008. Early
adoption for an existing instrument is not permitted. The Company is evaluating
the impact of the adoption of EITF Issue No. 07-05 on its consolidated financial
statements.
 
 Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies that do not require adoption until a future date are
not expected to have a material impact on the consolidated financial statements
upon adoption.
 
 NOTE
3 - CONVERTIBLE NOTES PAYABLE
 
 In April
2007 we executed an agreement with Mr. Dan Page whereby we received $250,000 in
funds to be advanced through the issuance of a promissory line of credit note.
The convertible promissory note issued
bears interest at a rate of 7.5% per annum and had a maturity date of April 23,
2008. The convertible note is convertible at any time from the date of issuance
into shares of our common stock at a price per share equal to
$0.35.  We pay interest only payments until the maturity date of the
convertible note, unless it is converted or prepaid.   We also
agreed to issue to the purchaser a four year warrant to purchase shares of
common stock. The number of shares that the purchaser was eligible to purchase
pursuant to the warrant was equal to 20% of the total share amount issued upon
conversion of the note, with an exercise price of $0.35 per share. In connection
with both the convertible note and the warrant, we entered into a registration
rights agreement with the purchaser whereby we agreed to register for resale the
shares underlying the convertible note and warrants. We have not filed the
required registration statement.
  F-14
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
3 - CONVERTIBLE NOTES PAYABLE – (Continued)
 
 On
September 27, 2007, Mr. Page agreed to amend the note and provide an additional
$100,000 of working capital to us. Under the terms of the amendment, the
additional $100,000 is convertible into shares of our common stock at a price
per share equal to $0.18. As consideration for this extension, we agreed to
issue to the purchaser a warrant to purchase shares of common stock. The number
of sharesthat the purchaser will be eligible to purchase pursuant to the
warrant will be equal to 20% of the total share amount issued upon conversion of
the note, with an exercise price of $0.18 per share, solely as it relates to
this additional $100,000. The warrant will expire four years from the date of
issuance, which shall be deemed to be on the earlier of (i) the maturity date of
the Note; (ii) the date on which the funds are advanced in full and owing by us;
or (iii) the date on which we elect to pay off the note in full during the term.
In connection with both the convertible note and the warrant, we agreed to
register for resale the shares underlying the convertible note and warrants. As
of December 31, 2008 and 2007, we owe a total of $339,850 and $302,150,
respectively to Mr. Page.
 
 On
November 30, 2004, we entered into a $7,500,000 secured credit facility with
Laurus. The facility consisted of a $4,750,000 convertible revolving note and a
$2,750,000 convertible term note. We initially borrowed approximately $3,542,000
under this facility, for proceeds of $3,255,000 net of issuance costs of
$287,000. The proceeds represented $2,750,000 under the convertible term note
and $792,000
under the convertible revolving note. These funds were used to fund the
repayment of existing short-term financing. The outstanding balance of the
revolving note and the principal balance of the term note are convertible into
shares of our common stock, subject to certain limitations set forth in the
agreement based upon the stock's trading volume and Laurus' ownership position.
The conversion price of the notes is $0.39 per share, which is a premium over
the average closing price of our common stock over the ten trading days
preceding the execution of the agreement, with conversion reset rights if we
issue any shares for less than the initial conversion price. In connection with
the credit facility, we also issued to Laurus warrants to purchase up to
3,846,154 shares of our common stock at $0.44 per share We agreed
to file a registration statement with the Securities and Exchange Commission
registering the resale of
the shares of our common stock issuable to Laurus upon conversion of the term
note and exercise of the warrants. Failure to file such a registration statement
timely and to maintain its effectiveness will subject us to liquidated damages
as defined in the registration rights agreement. Because we did not have a
currently effective registration statement, in accordance with EITF 0019-2 we
recorded a liability of $2,165,625 as liquidated damages for failure to register
the underlying shares.
 
 In April
2007, we reached an agreement with Laurus to extinguish $2.1 million in
outstanding debt for $200,000
in cash. Under the terms of the agreement we paid $50,000 in cash in April 2007,
and paid an additional $150,000 during the years ended December 31, 2007 and
2008. In addition to the cash consideration, we issued a warrant to Laurus to
purchase one million shares of our common stock at $.40 per share. In connection
with the agreement, we recognized a gain on debt relief of approximately
$1,510,000 and a derivative liability of $358,612 during the year ended December
31, 2007.
  F-15
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
3 - CONVERTIBLE NOTES PAYABLE – (Continued)
 
 On April
1, 2005, we issued to Alloy Marketing and Promotions, LLC ("Alloy") an unsecured
subordinated convertible promissory note in the principal amount of
approximately $600,000 in payment of services provided to us by Alloy in 2004.
The note matured upon demand by Alloy and could have been converted into shares
of our common stock at any time after April 1, 2005 at a conversion price equal to
75% of fair market value of the common stock, defined as the lesser of (i) the
average of the closing prices of the common stock for the five trading days
immediately prior to the first to occur of (A)the date on which we
include the registration of the resale of the common stock issuable upon
conversion of the note in a registration statement filed with the Securities and
Exchange Commission and (B) any date on which Alloy delivers to us a notice of
conversion, or (ii) the closing price of the common stock for the trading day
immediately prior to the first to occur of such dates. The note is in default.
In connection with the subordinated convertible promissory note, we entered into
a registration rights agreement with Alloy, pursuant to which we agreed to use
our commercially reasonable efforts to file with the SEC a registration
statement for offerings to be made on a continuous basis pursuant to Rule 415
under the Securities Act of 1933, as amended, with respect to the resale of the
shares of common stock issuable upon the conversion of the note. We are
obligated to pay Alloy a cash fee, as liquidated damages, equal to 1.50% of the
original principal amount of the note for each thirty day period, beginning
April 1, 2005, until the registration statement is declared effective. We would
also have to make similar payments if the registration statement, after it is
declared effective, ceases to be effective
for more than twenty consecutive calendar days or more than thirty days in the
aggregate during a year,
or the common stock is not listed or quoted or is suspended from trading on any
trading market for three
consecutive trading days, and such suspension shall not have been lifted within
thirty days or the common stock is not listed on another trading
market.
 
 Through
December 31, 2005, we had accrued $81,000 of liquidated damages as interest
expense under this agreement. Under the provisions of SFAS 5, “Accounting for
Contingencies” and FSP EITF 00-19-2 “Accounting for Registration Payment
Arrangements” as of December 31, 2006, because the previously recognized
contingent liability increased in subsequent periods, the change was recognized
in earnings in 2006, and we accrued additional penalties for failure to perform
under the terms of the registration agreement through 2008, of $270,000
($351,000 total) included on our balance sheet under the caption “Liquidated
damages payable” as of December 31, 2008 and 2007 as a result.
 
 Convertible
notes payable are summarized as follows at December 31,:
  2008
                                  
                                  
                                  2007Convertible
      note payable to a third party with an interest rateof
      7% per annum, due September 19, 2006, net of unamortizeddebt
      discount of $0
                                  
                                  $
                                  500,000
                                  
                                  
                                  $
                                  500,000Convertible
      note payable to a third party with an interest rateof
      7% per annum, due October 27, 2006, net of unamortizeddebt
      discount of $0
                                  
                                  
                                  50,000
                                  
                                  
                                  $
                                  50,000Convertible
      line of credit note payable to a third party with an interest
      rateof
      7.5% per annum, due April 23, 2008
                                  
                                  
                                  339,850
                                  
                                  
                                  
                                  302,150Convertible
      note payable to Alloy, payable upon demand
                                  
                                  
                                  600,000
                                  
                                  
                                  
                                  600,000$
                                  1,489,850
                                  
                                  
                                  $
                                  1,452,150
  F-16
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
4 - INCOME TAXES
 
 The
components of the income tax provision (benefit) were as follows for the years
ended December 31 2008 and 2007 (in thousands):
 
  2008
                          
                          
                          2007Current
                          
                          $
                          -
                          
                          
                          $
                          -Deferred
                          
                          
                          -
                          
                          
                          
                          -$
                          -
                          
                          
                          $
                          -
 For the
years ended December 31, 2008 and 2007, income tax provision (benefit) differed
from the amounts computed applying the federal statutory rate of 34% to pre-tax
loss as follows (in thousands):
 
  2008
                                          
                                          
                                          2007Computed
      "expected" tax provision (benefit)
                                          
                                          $
                                          (16
                                          )
                                          
                                          $
                                          748Increase
      in income taxes resulting fromexpenses
      not deductible for tax purposes
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Decrease
      in income taxes resulting fromnontaxable
      income
                                          
                                          
                                          385
                                          
                                          
                                          
                                          (1,266
                                          )State
      and local income taxes, net of federal effect
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Increase
      in valuation allowance
                                          
                                          
                                          (369
                                          )
                                          
                                          
                                          518$
                                          -
                                          
                                          
                                          $
                                          -2008
                                          
                                          
                                          2007Deferred
      tax assets:Net
      operating loss carryforward
                                          
                                          $
                                          9,988
                                          
                                          
                                          $
                                          9,848Other
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Less
      valuation allowance
                                          
                                          
                                          (10,373
                                          )
                                          
                                          
                                          (8,582
                                          )Total
      deferred tax assets
                                          
                                          
                                          (385
                                          )
                                          
                                          
                                          1,266Deferred
      tax liabilities:Change
      in fair value of derivativeand
      warrant liabilities
                                          
                                          
                                          385
                                          
                                          
                                          
                                          1,266Total
      deferred tax liabilities
                                          
                                          
                                          385
                                          
                                          
                                          
                                          1,266$
                                          -
                                          
                                          
                                          $
                                          -
  F-17
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
4 – INCOME TAXES – (Continued)
 
 For the
years ended December 31, 2008 and 2007, we have federal and state net operating
loss carryforwards of approximately $34,200,000 and $34,100,000, respectively.
Utilization of the net operating loss carryforwards is subject to a substantial
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986, as amended and similar state provisions. As a result,
we have not recorded approximately $10,000,000 of carryforwards in the
accompanying table of deferred
taxes. The remaining net operating loss carryforwards will expire at various
dates through 2028 for federal purposes and 2018 for state purposes, if not
utilized. As of December 31, 2008 and 2007 all such loss carryforwards have been
reserved, due to the likelihood that such amounts will not be utilized before
expiration.
 
 NOTE
5 – STOCK WARRANTS AND OPTIONS
 
 Stock
Option Plan
 
 Terms and
conditions of our option plans, including exercise price and the period in which
options are exercisable, generally are at the discretion of our board of
directors; however, no options are exercisable for more than 10 years after the
date of grant.
 
 In
February 2000, our board of directors approved the 1999 Stock Option Plan (the
"1999 Plan") for issuance of common stock to eligible participants. In February
2002, our stockholders approved the Mcglen Internet Group, Inc. 2000 Stock
Option Plan for issuance of our common stock to eligible participants (the "2000
Plan"). On March 2004, our board of directors terminated the 1999 Plan and
effective May 2004 our board of directors terminated the 2000 Plan. We will not
make any further grants under
either the 1999 Plan or the 2000 Plan. Our stockholders adopted the Company's
2004 Stock Incentive Plan in May 2004 (the "2004 Plan"). Each of the 1999 Plan,
2000 Plan and 2004 Plan provides for the granting of incentive stock options and
non-qualified stock options. Options under each of the plans generally expire 10
years after the date of grant.
 
 
 F-18
 
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
5 – STOCK WARRANTS AND OPTIONS – (Continued)
 
 A summary
of our stock option  and warrant activity, and related information for
the years ended December 31 follows:
  2008
                                              
                                              
                                              2007Weighted
                                              
                                              
                                              
                                              
                                              
                                              WeightedAverage
                                              
                                              
                                              
                                              
                                              
                                              AverageShares
                                              
                                              
                                              Exercise
      Price
                                              
                                              
                                              Shares
                                              
                                              
                                              Exercise
      PriceOutstanding,
      beginning of year
                                              
                                              
                                              20,963,212
                                              
                                              
                                              $
                                              0.43
                                              
                                              
                                              
                                              18,879,000
                                              
                                              
                                              $
                                              0.44Granted
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              8,684,212
                                              
                                              
                                              
                                              0.25Exercised
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Expired/cancelled
                                              
                                              
                                              (178,668
                                              )
                                              
                                              
                                              0.44
                                              
                                              
                                              
                                              (6,600,000
                                              )
                                              
                                              
                                              0.23Outstanding
      and exercisable,end of year
                                              
                                              
                                              20,784,544
                                              
                                              
                                              $
                                              0.43
                                              
                                              
                                              
                                              20,963,212
                                              
                                              
                                              $
                                              0.43Exercisable,
      end of year
                                              
                                              
                                              20,784,544
                                              
                                              
                                              $
                                              0.43
                                              
                                              
                                              
                                              17,863,212
                                              
                                              
                                              $
                                              0.47
  Compensation
expense of $247,000 related to stock options was recognized in 2008 and $32,000
in 2007.
 
 The
following table summarizes our stock options outstanding at December 31,
2008:
  Weighted-average
                          
                          
                          Weighted-remaining
                          
                          
                          averageExercise
      Price Range
                          
                          
                          Shares
                          
                          
                          contractual
      life
                          
                          
                          Exercise
      price$
                          0.18-$.39
                          
                          
                          
                          4,476,952
                          
                          
                          
                          1.68
                          
                          
                          $
                          0.24$
                          .40-$.49
                          
                          
                          
                          13,467,593
                          
                          
                          
                          2.79
                          
                          
                          $
                          0.47$
                          .50-$1.49
                          
                          
                          
                          2,739,999
                          
                          
                          
                          1.76
                          
                          
                          $
                          0.50$
                          1.50
                          
                          
                          
                          100,000
                          
                          
                          
                          0.27
                          
                          
                          $
                          1.50Total
                          
                          
                          
                          20,784,544
 During
the year ended December 31, 2008, we issued options valued at $247,000 to our
Chief Executive Officer.
  F-19
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
5 – STOCK WARRANTS AND OPTIONS – (Continued)
 
 During
the year ended December 31, 2007, we issued 358,000 shares of common stock in
exchange for $84,000 payable to a related party referred to above and $79,000 in
unpaid compensation.
  Terms and
conditions of our option plans, including exercise price and the period in which
options are exercisable, generally are at the discretion of our board of
directors; however, no options are exercisable for more than 10 years after the
date of grant.
 
 The
Company’s employee stock option activity is included in the above tables. The
activity for the year ended December 31, 2007 includes the expiration of
6,600,000 employee options with an weighted average exercise price of $0.25 and
the grant of 6,000,000 options with an exercise price of $0.20. Total
outstanding employee options at December 31, 2008 and 2007 were 3,000,000 with
an exercise price of $0.20 and a remaining contractual life of 2.74 years. In
2008, all 3,000,000 of these share became vested.
  NOTE 6 – EMPLOYEE STOCK
OWNERSHIP PLAN
  On
December 1, 1999, we established a leveraged ESOP that covered all employees who
completed 1,000 or more hours of service in a Plan year. To establish the plan,
the ESOP borrowed $10,000,000 from Mr. Teng, then our majority stockholder,
which we then used to purchase all of our outstanding preferred
stock (a total of 1,350,000 shares) from Mr. Teng at the then estimated fair
value, $7.41 per share. The preferred stock was convertible into common stock at
an exchange rate of 1 share of preferred stock to
3.12828 shares of common stock, and in September 2004, the ESOP converted all of
its preferred stock to common stock. We received no funds from the formation of
the ESOP; however, we were required to record the ESOP's liability on our books
as we had guaranteed the ESOP debt (see below), in accordance with the SOP 93-6,
"Employers' Accounting for Employee Stock Ownership Plans." Under SOP 93-6, we
recorded an unearned employee benefit expense related to the cost basis of
unreleased shares (determined based on the portion of the ESOP loan obligation
not yet repaid by the ESOP – see below), and, as such, we recorded it as a
reduction to stockholders' equity, "Unearned ESOP shares."
 
 In the
aftermath of a review by the Pension and Welfare Benefits Administration of the
Department of Labor
("DOL"), in December 2003, Mr. Teng agreed to release the ESOP from its
remaining obligations under the $10.0 million promissory note, thereby releasing
us from our guarantee of the ESOP debt. In connection with Mr. Teng's release of
the ESOP from its obligations under the promissory note, we eliminated the
guarantee of ESOP loan and interest payable balances against additional paid-in
capital, as this debt release was considered a contribution of capital to us by
Mr. Teng.
 
 F-20
 
 DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
6 – EMPLOYEE STOCK OWNERSHIP PLAN – (Continued)
 
 In
December 2003, since the ESOP was then under investigation by the DOL, Mr. Teng
was not able to foreclose on the unreleased shares upon his release of our
obligation under the promissory note, as was his right
under the ESOP agreement. At that time, Mr. Teng notified us that while he was
releasing us from our obligation under the promissory note, he was not waiving
any rights he may have to foreclosure against
the unreleased shares. Although the DOL investigation has been completed, we
have not yet released the shares to the ESOP and Mr. Teng has not yet exercised
any right he may have to foreclose on the unreleased shares. If Mr. Teng is able
to foreclose on the ESOP shares, the value of the unearned ESOP
shares will be eliminated against additional paid-in capital, which will reduce
our additional paid-in capital balance by approximately $6,207,000, with no net
change to our stockholders' deficit.
 
 Common
shares held by the ESOP as of December 31:
  (in
      thousands)2008
                          
                          
                          2007Allocated
      shares
                          
                          
                          1,613
                          
                          
                          
                          1,613Shares
      released from allocation
                          
                          
                          0
                          
                          
                          
                          0Unreleased
      (unearned) shares
                          
                          
                          2,641
                          
                          
                          
                          2,641Total
      ESOP shares
                          
                          
                          4,254
                          
                          
                          
                          4,254
  The fair
value of unreleased (unearned shares) at December 31, 2008 and 2007 (based on
closing price of our stock was $26,000 and $128,000.
 
 In the
event a terminated ESOP participant desires to sell his or her shares of our
common stock, or for certain
employees who elect to diversify their account balances, we may be required to
purchase the shares from the participant at their fair market value. During the
years ended December 31, 2008 and 2007, we did not purchase any stock from ESOP
participants nor did we have any obligation to do so at any time during this
period. Our ESOP plan did not have an effect on our calculation of diluted
earnings per share for the years ended December 31, 2008 and 2007.
 
 NOTE
7 - SEGMENT INFORMATION
 
 SFAS No.
131 "Disclosure about Segments of an Enterprise and Related Information,"
requires companies to report financial and descriptive information about its
reportable operating segments, including segment profit or loss, certain
specific revenue and expense items, and segment assets, as well as information
about the revenues derived from products or services, the countries in which the
companies earn revenues and holds assets, and major customers. SFAS No. 131 also
requires companies that have a single reportable segment to disclose information
about products and services, information about geographic areas, and information
about major customers. SFAS No. 131 requires the use of the management
approach to determine the information to be reported. The management approach is
based on the way management organizes the enterprise to assess performance and
make operating decisionsregarding
the allocation of resources. It is management's opinion that we have only one
reportable segment, and have no concentration of customers in one specific
geographic area within the United States.
  F-21
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  NOTE
8 – SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
  (in
      thousands)
                        
                        2008
                        
                        
                        2007Cash
      paid during year ended:Interest
                        
                        $
                        -
                        
                        
                        $
                        92Income
      taxes
                        
                        $
                        -
                        
                        
                        $
                        -Non-cash
      investing and financing activities:Conversion
      of credit facility payable to warrants andresulting
      gain on debt relief
                        
                        $
                        -
                        
                        
                        $
                        1,539Issuance
      of options as compensation
                        
                        $
                        247
                        
                        
                        $
                        33Conversion
      of note payable and unpaid compensation
                        
                        $
                        -
                        
                        
                        $
                        162
  NOTE
9 - COMMITMENTS AND CONTINGENCIES
 
 We lease
office space under a month-to-month operating lease agreement. Minimum annual
operating lease commitments at December 31, 2008 are approximately $3,600. Rent
expense for the years ended December
31, 2008 and 2007 totaled approximately $4,000 and $10,566,
respectively.
 
 We have
made certain indemnities and guarantees, under which we may be required to make
payments to a
guaranteed or indemnified party, in relation to certain transactions. We
indemnify our directors, officers, employees and agents to the maximum extent
permitted under the laws of the State of California. In connection with our
facility leases, we have indemnified our lessors for certain claims arising from
the use of the facilities. In connection with certain of our debts, management
and stock purchase agreements, have indemnified lenders, buyers and others for
certain claims arising from our breach of representations and warranties
contained in the corresponding agreements. The duration of the guarantees
and indemnities varies, and in many cases is indefinite. These guarantees and
indemnities do not provide for any limitation of the maximum potential future
payments we could be obligated to make. Historically,
we have not been obligated to make any payments for these obligations and no
liabilities have been recorded for these indemnities and guarantees in the
accompanying consolidated balance sheets.
 
  
 F-22
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
9 - COMMITMENTS AND CONTINGENCIES – (Continued)
 
 We may
become involved in various litigation and claims, government investigations and
other legal proceedings that arise from time to time in the ordinary course of
business. We could in the future incur judgments or enter into settlements of
claims that could have a material adverse effect on our financial condition,
liquidity and results of operations.
 
 NOTE
10 – FAIR VALUE
 
 On June
28, 2008, the Company adopted the provisions of SFAS No. 157 for all financial
assets and financial liabilities. SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and
enhances disclosures about fair value measurements. SFAS No. 157 does not
require any new fair value measurements, but applies to other accounting
pronouncements that require or permit fair value measurements. The adoption of
SFAS No. 157 did not have a material impact on the Company's consolidated
financial statements.
 
 In
February 2008, the FASB issued FASB Staff Position (FSP) 157-2,Effective Date of
FASB Statement No. 157, which delays the effective date of SFAS No.157 for all
non-financial assets and non-financial liabilities, except for items recognized
or disclosed at fair value on a recurring basis. Accordingly, the Company will
not apply the provisions of SFAS No. 157 to non-financial assets and
non-financial liabilities until the first quarter of fiscal year
2010.
 
 Measurement of Fair
Value
 
 SFAS No.
157 defines fair value as the price that would be received from selling an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. When determining the fair value
measurements for assets and liabilities required to be recorded at fair value,
the Company considers the principal or most advantageous market in which it
would transact and it considers assumptions that market participants would use
when pricing the asset or liability.
  Fair Value
Hierarchy
 
 SFAS No.
157 establishes a fair value hierarchy based on whether the market participant
assumptions used in determining fair value are obtained from independent sources
(observable inputs) or reflect the Company's own assumptions of market
participant valuation (unobservable inputs). A financial instrument's
categorization within the fair value hierarchy is based upon the lowest level of
input that is significant to the fair value measurement. SFAS No. 157
establishes three levels of inputs that may be used to measure fair
value:
 
 Level
1—Quoted prices in active markets that are unadjusted and accessible at the
measurement date for identical, unrestricted assets or liabilities;
 
 Level
2—Quoted prices for identical assets and liabilities in markets that are
inactive; quoted prices for similar assets and liabilities in active markets or
financial instruments for which significant inputs are observable, either
directly or indirectly; or
 
 F-23
  DIGITAL
LIFESTYLES GROUP, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 NOTE
10 – FAIR VALUE – (Continued)
  Level
3—Prices or valuations that require inputs that are both unobservable and
significant to the fair value measurement.
 
 The
Company considers an active market to be one in which transactions for the asset
or liability occur with sufficient frequency and volume to provide pricing
information on an ongoing basis, and views an inactive
market as one in which there are few transactions for the asset or liability,
the prices are not current, or price quotations vary substantially either over
time or among market makers. Where appropriate the Company's or the
counterparty's non-performance risk is considered in determining the fair values
of liabilities and assets, respectively.
 
 The
adoption of SFAS No. 157 did not have a material impact on the Company's
consolidated net loss for the fiscal year ended July 3, 2009.
 
 The fair
value of our financial instruments at December 31, 2008 follows:
  (
      in thousands)
                        
                        
                        
                        
                        Fair
      Value Measurements at Reporting Date UsingDescription
                        
                        12/31/2008
                        
                        
                        Quoted
      Prices in Active Markets for Identical Assets
                          (Level
      1)
                        
                        
                        Signifcant
      Other Observable Inputs (Level 2)
                        
                        
                        Significant
      Unobservable Inputs (Level 3)Derivative
      securities
                        
                        $
                        100
                        
                        
                        $
                        -
                        
                        
                        $
                        100
                        
                        
                        $
                        -Total
                        
                        $
                        100
                        
                        
                        $
                        -
                        
                        
                        $
                        100
                        
                        
                        $
                        -
  Derivative
warrant and conversion liabilities have generally been valued using the
Black-Scholes method using as inputs: a) expected life of one-half  to
eight  years, b) 0% expected dividend yield, c) 4.83% bond equivalent
yield, and d) expected future volatility of 179%.
 
  
 F-24