UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K/A





AMENDMENT
NO. 3





x
            ANNUAL
      REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
fiscal year ended December
31, 2009





 ̈
            TRANSITION
      REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
transition period from


Commission
file number 000-53475





CYBERDEFENDER
CORPORATION








California
                        
                        65-1205833(State
      or other jurisdiction of incorporation or organization)
                        
                        (I.R.S.
      Employer Identification No.)617 West 7thStreet, 10thFloor, Los Angeles,
    California
                        
                        90017(Address
      of principal executive offices)
                        
                        (Zip
      Code)





Issuer’s
telephone number (213)
689-8631





Securities
registered pursuant to Section 12(b) of the Act:  None





Securities
registered pursuant to Section 12(g) of the Act:  Common Stock, no par
value





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  ̈ Yes x 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 x 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 Exchange Act during the last 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes
x No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  ̈ No  ̈ (The registrant is not
yet subject to this requirement.)





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 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 a smaller reporting
company)              Smaller
reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).


 ̈ Yes x 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
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter.  On June 30, 2009, the aggregate market value of the voting
and non-voting common equity held by non-affiliates was
$48,575,761.





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date. As of March 26, 2010 the number of
shares of the registrant’s classes of common stock outstanding was
25,829,675.





DOCUMENTS INCORPORATED BY
REFERENCE





Portions
of the definitive Proxy Statement to be delivered to stockholders in connection
with our 2010 Annual Meeting of Stockholders are incorporated by reference in
Part III herein.





EXPLANATORY NOTE




I.     Amendment
No. 1





On May
10, 2010, CyberDefender Corporation (the “Company”, “we”, “us”, “our”) filed
Amendment No. 1 to our Annual Report on Form 10-K/A for the year ended
December 31, 2009 ("Amendment No. 1"), originally filed with the
Securities and Exchange Commission (the "SEC") on March 31, 2010 (the
"Original Annual Report") to address a comment letter we received from the SEC
on April 29, 2010.  The items addressed in Amendment No. 1
were:





·
            Item
      7. Management’s Discussion of Financial Condition and Results of
      Operations.  We revised the disclosure to clearly label certain
      gross sales information as non-GAAP, disclose why management believes the
      information is useful and provide a table that clearly reconciles the
      non-GAAP measure to GAAP.





·
            Item
      9A. Disclosure Controls and Procedures.  We included additional
      information relating to our disclosure controls and
      procedures.





·
            Item
      15. Exhibits.  We included our amended bylaws as an exhibit to
      Amendment No. 1.





·
            Signatures.  We
      included the signature of our Principal Accounting Officer, who is also
      our Chief Financial Officer.





II.     Amendment
No. 2





On July
8, 2010, we filed Amendment No. 2 to our Annual Report on Form 10-K
for the year ended December 31, 2009 ("Amendment No. 2") to address a
comment letter we received from the SEC on July 7, 2010.  Amendment No. 2
revised the disclosure in Item 13 to include information that inadvertently was
omitted.





III.     Amendment
No. 3





This
Amendment No. 3 to the Annual Report on Form 10-K for the year ended December
31, 2009 contains restated financial statements correcting errors in the
financial statements contained in the Annual Report on Form 10-K . Note 2 to the
Financial Statements includes a description of the accounting errors which led
to the restatements.  As a result of these restatements, we are also
amending disclosures which appear in Part I, Item 1, Notes to the Financial
Statements and Item 4T. Controls and Procedures.  Amendment No. 3 also
contains currently dated certifications pursuant to Section 302 and 906 of the
Sarbanes-Oxley Act of 2002 as Exhibits 31.1, 31.2, 32.1 and
32.2.





Except
for information included in this Amendment No. 3 and any information included in
Amendment No. 1 and Amendment No. 2 that is not superseded by information
in this Amendment No. 3, the Original Annual Report continues to speak as
of the date thereof (or such other date as may be referred to in the Original
Annual Report). Events occurring subsequent to the filing of the Original Annual
Report and disclosures necessary to reflect any subsequent events are added to
Note 11 to the Financial Statements.










CONTENTS


PageForward-Looking
      Statements
                                        
                                        iPart
      IItem
      1
                                        
                                        Business
                                        
                                        1Item
      1A
                                        
                                        Risk
      Factors
                                        
                                        10Item
      2
                                        
                                        Properties
                                        
                                        16Item
      3
                                        
                                        Legal
      Proceedings
                                        
                                        16Item
      4
                                        
                                        Removed
      and Reserved
                                        
                                        16Part
      IIItem
      5
                                        
                                        Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                                        
                                        17Item
      6
                                        
                                        Selected
      Financial Data
                                        
                                        18Item
      7
                                        
                                        Management’s
      Discussion and Analysis of Financial Condition and Results Of
      Operations
                                        
                                        18Item
      7A
                                        
                                        Quantitative
      and Qualitative Disclosures About Market Risk
                                        
                                        27Item
      8
                                        
                                        Financial
      Statements and Supplementary Data
                                        
                                        27Item
      9
                                        
                                        Changes
      In and Disagreements With Accountants on Accounting and Financial
      Disclosure
                                        
                                        27Item
      9A
                                        
                                        Controls
      and Procedures
                                        
                                        27Item
      9B
                                        
                                        Other
      Information
                                        
                                        29Part
      IIIItem
      10
                                        
                                        Directors,
      Executive Officers and Corporate Governance
                                        
                                        29Item
      11
                                        
                                        Executive
      Compensation
                                        
                                        29Item
      12
                                        
                                        Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                                        
                                        30Item
      13
                                        
                                        Certain
      Relationships and Related Transactions and Director
      Independence
                                        
                                        30Item
      14
                                        
                                        Principal
      Accountant Fees and Services
                                        
                                        34








Part
      IVItem
      15
                
                Exhibits,
      Financial Statement Schedules
                
                35Signatures
      and CertificationsFinancial
      Statements
                
                F-1





Forward-Looking
Statements





This
report contains forward-looking statements throughout and in particular in the
discussion at Item 7 titled “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”.  These are statements regarding
financial and operating performance and results and other statements that are
not historical facts.  The words “expect,” “project,” “estimate,”
“believe,” “anticipate,” “intend,” “plan,” “forecast,” and similar expressions
are intended to identify forward-looking statements.  Certain
important risks, including those discussed in the risk factors set forth in Item
1A of this report, could cause results to differ materially from those
anticipated by some of the forward-looking statements.  Some, but not
all, of these risks include, among other things:





·
            our
      lack of capital and whether or not we will be able to raise capital when
      we need it;





·
            changes
      in local, state or federal regulations that will adversely affect our
      business;





·
            our
      ability to market and distribute or sell our
  products;





·
            whether
      we will continue to receive the services of certain officers and
      directors;





·
            our
      ability to protect our intellectual property and operate our business
      without infringing upon the intellectual property rights of others;
      and





·
            other
      uncertainties, all of which are difficult to predict and many of which are
      beyond our control.





We do not
intend to update forward-looking statements.  You should refer to and
carefully review the information in future documents we file with the Securities
and Exchange Commission.


i


PART
I





Item
1.  Business





Overview





CyberDefender
Corporation is a provider of Internet security software and services to the
consumer and small business market.





The
volume of online threats has continued to rise over the last several years due
in part to the personal computer becoming a major source for communication,
entertainment and e-commerce for many consumers.  Additionally, the
increase in the use of mobile devices such as laptop computers, cell phones and
“smart phones” with email and web access capabilities and the increase in
popularity of online social networking sites have put a larger percentage of the
population at risk for cyber-attacks. Consequently, online security has emerged
as a major concern for all users of devices that are capable of accessing the
Internet.





Our goal
is to be a leading provider of advanced solutions to protect consumers and small
businesses against threats such as identity theft, Internet viruses and spyware
and to provide remote technical resolution services to those who use our
products.





We were
incorporated as Network Dynamics in California on August 29, 2003, and changed
our name to CyberDefender Corporation (“the Company”, “we”, “us” or “our” in
this report) on October 21, 2005.    Individuals and small
businesses that use personal computers make up our subscriber base, therefore we
are not dependent on any single customer or on a few major
customers.  While our products are available for downloading from our
website, which makes them available to anyone in the world, we do not have a
significant customer base outside of the United States.





Business
Developments and Highlights





During
2009 we took the following actions, among others, to enhance our
business:





·
            We
      formed a strategic relationship with GR Match, LLC (“GRM”), a subsidiary
      of Guthy-Renker, one of the world's largest direct response television
      companies. This partnership has enabled us to add new marketing channels
      for our products. GRM provides direct response media campaigns for our
      products, including radio and television direct response commercials, and
      purchases media time on our behalf, subject to the terms and conditions
      defined in the Media Marketing and Services Agreement dated March 24,
      2009.





·
            We
      formed a strategic relationship with Wiley Publishing, Inc., owner of the
      For
      Dummies® trademark, for use of the For
      Dummies® trademark in connection with the development, sale,
      distribution and promotion of a new line of
  products.





·
            We
      formed a strategic relationship with Microsoft to distribute the Bing
      toolbar through our products.





·
            We
      added key members to our management team, namely, Kevin Harris as Chief
      Financial Officer and Steve Okun as Chief Revenue
  Officer.





·
            We
      improved our call center infrastructure by adding a global IVR system and
      increased total agents by over
250%.








Business
Model





Our
business is focused on two areas; computer security software and remote PC
repair services.





Firewall
and AntiVirus software currently accounts for a majority of the Security
Software and Services (“SSS”) market. However, the increasing need to counter
“zero-day” attacks, that is, viruses or other exploits that take advantage of a
newly discovered vulnerability in a program or operating system before the
software developer becomes aware of the vulnerability or fixes it, along with
the increasing popularity of “defense-in-depth” strategies, wherein coordinated
uses of multiple security countermeasures are used to protect the integrity of
information assets, will bring unified threat management solutions to the
forefront.





Five
specific product areas comprise SSS:





AntiVirus/AntiSpyware:This
software identifies and/or eliminates harmful software by scanning hard drives,
email attachments, disks, Web pages and other types of electronic traffic for
any known or potential viruses, malicious code, trojans or spyware.





Identity Protection
services:These are services oriented around credit monitoring
and identity protection insurance or guarantees.





Remote PC Repair:These
services are designed to repair users PCs via remote access. These services
incorporate manual malware removal, system restore and PC
optimization.





Online
Backup:  These are services which protect users’ data from
corruption, theft and loss.  Online backup allows for quick recovery
and remediation.





PC Optimization Software:
These products are designed to improve the speed of a PC by eliminating unwanted
files, improving memory, and reducing CPU load.





SSS
Growth Drivers





Viruses, spyware and social engineering
attacks are serious threats facing businesses and consumers today. These threats
can be used to steal personal information, enable identity theft, damage or
destroy information stored on a computer and cause damage to legitimate
software, network performance and productivity.  These types of
malicious programs are introduced to computers in a number of ways, including,
but not limited to:





·
            poor
      browser security as most browsers today are full of security holes that
      are exploited by hackers and
criminals;





·
            growing
      use of the Internet and e-mail as a business tool and preferred
      communication channel;





·
            increased
      use of mobile devices to access key
data;





·
            continued
      rapid increases in spam as the majority of spam sent today originates from
      zombie machines remotely controlled by
spammers;





·
            explosive
      growth in spyware causing theft of confidential information, loss of
      employee productivity, consumption of large amounts of bandwidth, damage
      to desktops and a spike in help desk calls;
and





·
            flaws
      in operating systems that contribute to the wide range of current Internet
      security threats, particularly if users do not update their computers with
      patches.





As a
result of the foregoing factors, the SSS market has developed and continues to
expand in order to respond to the ever-evolving threats presented by malicious
programs.


2





Current
Product Limitations





SSS
software vendors have attempted to solve Internet security problems with a
variety of software applications.  Many vendors rely heavily on the
end user to properly install and configure their own security
software.  In addition, many vendors fail to advocate optimal security
software installation because they do not offer customers proper live support
access.  Although many products exist today to address such security
issues, these solutions face many limitations, including the
following:





No Real-Time Security - Most
antivirus and antispyware software applications do not protect personal
computers against real-time threats.  If new viruses or spyware exist
on the Internet but do not reside in risk definition databases, most personal
computers exposed to the threat will be infected.  Typical virus
protection software requires frequent downloads and updates to work
properly.  If a user does not download a patch timely, the user’s
system may no longer be safe.  By the time a new virus is announced,
it may already be too late to take action, and an infection may have
occurred.  Also, new patches may take hours to install, decreasing
work productivity.





Inability to CatchallViruses and Malicious Content
– Current threat analysis systems are not capable of detecting all malicious
codes.  With current security networks, software alone cannot detect
unknown attacks – human involvement is required.  Not only are threats
not detected, but threats that are detected are resolved untimely due to
intermittent update systems delaying user alerts.





Use of Social Engineering –
The increased use of social engineering attacks by cyber criminals has created a
new level of problems for consumers and businesses. Even having adequate
security software will not necessarily prevent the attack from
happening.   Most security software does not address this
problem.





No Consumer Education – Most
security software vendors rely on consumers to install and configure their
personal online security.  This has led to incorrect security
settings, lack of manual updating and an overall disconnect between the user and
security software.  In addition, consumers are constantly faced with
configuration issues which arise as a result of the installation of 3rd party
devices and software, which further complicate security.  In order for
security to work properly, users must have their systems properly repaired and
optimized by trained technicians before security software can be installed and
made effective.  This requires education and a change in consumer
behavior.





Costly Updating - Most
antispyware and antivirus software providers use a client-server network
infrastructure to distribute new spyware and virus definitions.  Such
solutions are expensive to maintain as they rely on intensive data centers and
networks to deliver updates, thereby using a significant amount of bandwidth,
which is expensive to obtain.  Also, vendors cannot afford to send
threat updates continuously and therefore are slow to distribute
them.  In fact, many software vendors provide updates on a scheduled
basis, rather than as the updates are needed.  This may leave the PC
vulnerable since threats propagate without a schedule, and therefore a PC which
was updated on Monday may be effectively infected on Tuesday. “Freeware” or free
antivirus and antispyware software downloads offer minimal updates, leaving the
user with a false sense of security.





Every
consumer or business using any networked device needs to have some form of
Internet security. Many PC owners have two to three forms of security software
on their PCs in order to maximize protection against most threats. We provide
consumers and small business users with a platform of products and services
designed to protect against various types of security attacks.





Our
business and technology model is based on incorporating security software with
remote PC repair services.  CyberDefender believes that most consumers
cannot install and configure their security software to work properly and
usually require the help of a professional to achieve the optimal security
setting.





CyberDefender
Technology





Conventional
Internet security companies use a cumbersome manual process to identify new
threats, analyze threats in labs, and distribute threat updates to their user
base.  These security companies have to broadcast updates to each
personal computer user individually in the network.  Serious drawbacks
to conventional broadcast updates exist, including the
following:


3





·
            Due
      to the expense related to this process; the network cannot be updated in
      real-time, and instead is updated in batches which are often spaced days
      apart;





·
            Because
      broadcasting servers are a single point of distribution, they are
      vulnerable to “flooding” attacks that prevent clients from getting the
      needed updates; and





·
            A
      threat may block a client computer’s access to the broadcast server,
      disabling its ability to download an update for the
  threat.





We
believe that we have addressed these shortcomings by developing the
earlyNETWORK, our proprietary collaborative Internet security network, to
detect, analyze and quarantine new security threats. We believe the earlyNETWORK
provides a unique approach to updating personal computer security.  We
have developed the earlyNETWORK based on certain technology principles commonly
found in a peer-to-peer network infrastructure.  A peer-to-peer
network does not have the notion of clients or servers, but only equal peer
nodes that simultaneously function as both “clients” and “servers” to the other
nodes on the network.  Therefore, as system demands increase, so does
the system’s capacity.  The peer-to-peer network infrastructure allows
us to provide a fluid, distributed system for alerts and updates, and to
incorporate a universal threat definition system.





However,
the earlyNETWORK is not a conventional peer-to-peer network because the
CyberDefender Alert Server is a required checkpoint for all client activities,
thus assuring the integrity of the network.  The earlyNETWORK is a
controlled publishing network that leverages the power of distributed bandwidth
to automatically defend against a wide spectrum of software attacks and provides
users with proprietary automated processes that rapidly identify and quarantine
both known and emerging threats.  Each client has a controlled role in
relaying the threat updates to as many as 20 clients, thus allowing continuous
release of threat updates. As additional users are added our collaborative
security network works better.  With more clients, threats are picked
up faster and updates occur faster as well, because users of our software find
peers more easily than they could an update server. Our earlyNETWORK is designed
to reduce the lag time between the identification of a new security threat by
our Early Alert Center and notification to the personal computers that are part
of the earlyNETWORK. Users of our software who cannot connect with other users
will always be able to fall back on the Alert Server which is the central source
for threat analysis and notification.





Our
earlyNETWORK works as follows. Customers become a part of the earlyNETWORK by
downloading and installing one of our internet security products (i.e.
CyberDefender Early Detection Center V2.0 or, when it was offered, CyberDefender
FREE V2.0), discussed below. Unusual behavior is detected by a personal computer
that is part of our earlyNETWORK.  The potential threat may be
anything from spam to a virus.  The program puts the potential threat
on standby, and reports it to our Alert Server.  The Alert Server
compares the threat to existing threat definitions.  If the Alert
Server does not recognize the threat, the threat is sent to AppHunter for
analysis.





AppHunter
is an automated system that manages the threat analysis
process.  First, AppHunter tests the undefined threat on an isolated
computer that is automatically wiped clean after each test.  Based on
the behavior of the test computer, AppHunter ranks the threat on a scale from
one to ten.  Rankings of five and above are classified as infectious
(viruses). Additionally, AppHunter carries out a confidential set of proprietary
verifications to ensure that the threat itself is not an attempt to deceive or
hack the network.





As there
is a wide set of possible attacks that do not qualify as viruses, AppHunter is
supplemented by a team of human technicians who classify threats that rank below
5 in severity.  Threat definitions are added as quickly as possible to
our definition database, which is then updated to our users via our
earlyNETWORK.  We continually make changes to our technology to make
sure that we address as many security concerns as possible.





Using our
peer-to-peer technology, Alert Server notifies users of our software of the
threat who, in turn, notify up to 20 other users (or “peers”) in an
ever-widening circle.  This distributed notification process frees up
the Alert Server to deal with incoming alerts from clients that have encountered
unexpected behavior, and makes the network truly responsive and “in tune” with
its users.


4





This
approach is different and, we believe, significantly faster and cheaper than
traditional Internet security companies that provide manual, broadcast-updated
threat management systems. The nature of traditional Internet security
companies, which assume a single point of threat capture, a cumbersome threat
analysis system and an intermittent scheduled update system, creates a “coverage
gap” which can delay alerts on important new infectious attacks for 12 hours or
more.  However, our proprietary technology quickly distributes threat
updates to all computers that are part of the earlyNETWORK.  For
example, our system for generating threat reports, the Early Alert Center, first
reported the Sasser.E virus at 11:52 p.m. on May 7, 2004.  This was
one to two days before other security software vendors announced their
discoveries of the same virus.  We believe that our update process
occurs substantially faster than that of any competitive system and that we are
the first to provide threat updates in this manner.





Additionally,
because the cost of updating our software via the earlyNETWORK is minimal, Alert
Server can send out updates as fast as threats are confirmed, which we believe
results in superior security coverage.  In general, from the time the
first client has picked up the new threat to the updating of the network, about
an hour passes. The network responds quickly to new threats because it enlists
all the machines in the earlyNETWORK to act as listening posts for new
threats.  As the network grows, updates will grow closer and closer to
real time.  Our solution works well with existing security software
and can operate as an additional layer of security on a personal
computer.





Proprietary
Technology Overview





The
following is a description of our proprietary technologies:





1. Threat
Protection Network V1.0 / V2.0 (“TPN”)





Sophisticated
threat analysis platform which utilizes CyberDefender’s proprietary threat
analysis engine and updating technology.





A patent
application covering this technology was filed on September 22,
2005.





2. Secure
Peer to Peer Network V1.2/V2.0





Dynamic
secure peer-to-peer network which utilizes cloud computing and various
proprietary security protocols in order to update PCs against new
threats.





A patent
application covering this technology was filed on September 22,
2005.





3.  CyberHunter
V1.0





A
proprietary web crawling technology which identifies and collects malware
information found on the web and reports it to the TPN.





4.
CyberDefender Early Detection Center V2.0





Windows
PC Internet security suite designed to protect consumers and small businesses
against viruses, spyware, spam and phishing attacks.





5. Web
Access Protection – CyberDefender MyIdentityDefender V1.0/V1.5





Proprietary
anti-phishing and web access protection technology designed for the Windows
Internet Explorer browser.


5





Products





On
November 20, 2006, we began providing a suite of Internet security products
called CyberDefender Early Detection Center V2.0 (“EDC”). We also offered
CyberDefender FREE V2.0 as a free download in an ad-supported
version.  There was no trial period and no monthly or annual fee to
pay for using CyberDefender FREE V2.0.  Instead, we received payments
from the advertisers, typically at the end of each month. We stopped offering
the free version in late 2009. In addition to EDC, our core product,
CyberDefender also markets the following products and services described below.
We distribute our software via the Internet and on computer
disk.  Additionally, we offer technical support services on a one-time
basis or via an annual subscription.  These services are provided by a
combination of in-house and out-sourced technical support
representatives.  These services are also sold bundled with our
software products.





The
following is a detailed description of our products and services:





CyberDefender
Early Detection Center V2.0 (EDC)





Early
Detection Center V2.0 is a Windows PC Internet security suite designed to
protect consumers against spyware, viruses, phishing attacks and
spam.  CyberDefender Early Detection Center utilizes the earlyNETWORK
and includes unlimited threat definition updates during the subscription
term.





CyberDefender
FREE V2.0 (No longer distributed)





FREE V2.0
has the same technology features as the CyberDefender Early Detection Center
V2.0.  This version was offered free to consumers and is supported by
impeded banner advertising.  Users can upgrade to the non ad supported
version (CyberDefender Early Detection Center V2.0).  Users no longer
receive unlimited updates as CyberDefender has stopped supporting this version
of the software.





CyberDefender
Registry Cleaner V1.0





Registry
Cleaner V1.0 is Windows PC optimization software designed to improve performance
and speed up PC speed.  CyberDefender Registry Cleaner V1.0 fixes
common Windows registry errors.  Users will receive unlimited updates
during the subscription term.





CyberDefender
FamilyPak





The
FamilyPak offers the same technology as CyberDefender Early Detection Center
V2.0.  FamilyPak is designed for families with multiple PCs or small
businesses running multiple PCs.





MyIdentityDefender
V1.0





A free
Windows Internet Explorer browser plug-in designed to protect users against
phishing attacks and dangerous websites, this product is offered for free and
generates revenue through an imbedded search engine powered by
InfoSpace.





CyberDefender
Identity Protection Service





This is
an identity protection service offering users basic ID protection features and a
$25,000 identity theft insurance policy.  This is a monthly
subscription product.





CyberDefender
Identity Protection Service with Credit Monitoring





This
version of the CyberDefender Identity Protection Services includes credit
monitoring.  This is a monthly subscription product.


6





AntiSpyware
For
Dummies®





AntiSpyware
For
Dummies®is
a Windows PC Internet security suite designed to protect consumers against
spyware, viruses, phishing attacks and spam.  This product utilizes
the earlyNETWORK and includes unlimited threat definition updates during the
subscription term.





Remote
PC Repair Services





Our
support services are designed to help customers with a wide range of technical
support issues that may be affecting their desktop or laptop PCs. These services
are supported around-the-clock by our in-house and outsourced technical support
teams.





The following is a description of our
remote PC repair services:





CyberDefenderCOMPLETE





CyberDefenderCOMPLETE
is a one-time resolution service which provides a live tech-on-call service for
any technology problem.





CyberDefenderPREMIUM





CyberDefenderPREMIUM provides unlimited
live premium tech-on-call service from 5 am PST to 10 pm PST 7 days per
week.  This service includes remote PC repair of any technology
problem and is sold in annual or multi-year subscriptions.  Services
are offered primarily through our US based agents.  This service also
includes a copy of our Antivirus/Antispyware software.





CyberDefenderULTIMATE





CyberDefenderULTIMATE
provides unlimited live premium tech-on-call service 24 hours per day and 7 days
per week andincludesourAntivirus/Antispyware
software. The service is sold in annual or multi-year subscriptions. This
service gives our customers access to our offshore agents.





Growth
Strategy





Our
strategy is to continue to grow our business by increasing our customer base,
continually offering new products and services, scaling our current marketing
channels, adding new marketing channels and forming new strategic
alliances.





As a
majority of our products and services are offered on a subscription basis, it is
important for the growth of our business that customers renew their
subscriptions year after year. The majority of our products are sold on
auto-renewal subscriptions and the company continually works to improve its
retention marketing. Historically, we have seen positive renewal numbers and we
continue to work on improving the overall renewal rates through several
initiatives, most notably partnering with Vindicia, a leading provider of
on-demand billing solutions for online merchants.





In 2009,
we added new marketing channels, which helped to establish our brands and drive
new business.  We plan to scale those channels in the coming
years.  First, we started marketing our products and services under
the brands DoubleMySpeed, MyCleanPC, and MaxMySpeed, via direct response
commercials on radio and television through our strategic partnership with GRM.
Second, we launched the sale of our products in some initial retail locations
via our strategic alliance with Allianex Corporation, which will eventually give
us an opportunity to sell our products through over 195,000 retail locations
worldwide.





Our
strategic alliance with Wiley Publishing, Inc., owner of the For
Dummies® trademark, allows us to launch a new line of products and
services under an established brand name. This license is an exclusive license
in North America to brand Internet security products under the For
Dummies® brand.


7





Our
continued investment in our call center infrastructure will allow us to provide
the services that should result in increases in revenues and average revenues
per user and increased endpoint security to our customers.





Customers





Our
primary customers are consumers and small business who use personal computers
that use the Windows operating systems.  Our customers reside
primarily in the United States.  The number of our customers
fluctuates due to the fact that, while we gain new customers on a daily basis,
existing customers can cancel or may not renew their subscriptions.





Marketing





We sell
our products directly to computer users through online marketing,
direct-response marketing and retailers.  Our marketing campaigns are
designed to drive new customers to our e-commerce web sites where they purchase
our products and services.  Additionally, our sales staff and
outsourced sales team are trained on our cross-selling and up-selling
initiatives.





Competition





Internet
security markets are competitive and subject to continuous technological
innovation.  Our competitiveness depends on our ability to offer
products that meet customers’ needs on a timely basis.  The principal
competitive factors of our products are time to market, quality, price,
reputation, terms of sales, customer support and breadth of product
line.





Some of
our competitors include Webroot Software, Sunbelt Software, Kaspersky Labs,
McAfee, Symantec, TrendMicro and Computer Associates.  In addition, we
may face potential competition from operating system providers and network
equipment and computer hardware manufacturers.  These competitors may
provide various security solutions in their current and future products and may
limit our ability to penetrate these markets.  These competitors have
significant advantages due to their ability to influence and control computing
platforms and security layers in which our products operate.  At this
time, we do not represent a competitive presence in the SSS
industry.





Intellectual
Property





Our
software is proprietary and we make every attempt to protect our software
technology by relying on a combination of copyright, patent, trade secret and
trademark laws and restrictions on disclosure.





On
September 22, 2005 we filed two international patent applications with the U.S.
Receiving Office under the Patent Cooperation Treaty (PCT). The application
titles and serial numbers are "Threat Protection Network", Application No.
US2005/034205 and "System for Distributing Information Using a Secure Peer to
Peer Network", Application No. US2005/034069. PCT Application No.
US2005/034069 was intentionally abandoned. On April 23, 2007, we filed
a national stage application for PCT Application No. US2005/034205 in the
European Patent Office (EPO). The EPO Application No. is
05821356.2.





On June
29, 2009, we submitted a provisional application to the U.S. Patent and
Trademark Office entitled, "System and Method for Operating an Anti-Malware
Network on a Cloud Computing Platform", Provisional Application No.
61/221,477.





Our name,
CyberDefender, is a registered trademark.





We also
license intellectual property from third parties for use in our products and, in
the future, we may license our technology to third parties.  We face a
number of risks relating to intellectual property, including unauthorized use
and copying of our software solutions.  Litigation may be necessary to
enforce our intellectual property rights or to protect trade secrets or
trademarks rights.


8





Employees





We
currently employ 181 full time employees and 4 independent
contractors.  Our employees are segmented by the following functions:
corporate, development, engineering, information technology, marketing, customer
service, support services, sales and finance and accounting.





Government
Regulation and Probability of Affecting Business





The
development of our products is generally not subject to government
regulation.  However, laws and regulations that apply to Internet
communications, commerce and advertising are becoming more
prevalent.  These regulations could affect the costs of communicating
on the Internet and adversely affect the demand for our products or otherwise
harm our business, results of operations and financial condition.  The
United States Congress has enacted Internet legislation regarding children’s
privacy, copyrights, sending of unsolicited commercial email and
spyware.  Other laws and regulations, including laws or regulations
that could attempt to tax Internet commerce transactions, may be adopted in the
future.  This legislation could hinder growth in the use of the
Internet generally and decrease the acceptance of the Internet as a
communications, commercial and advertising medium.





In
addition, the growth and development of the market for Internet commerce may
prompt calls for more stringent consumer protection laws, such as laws against
identity theft, which may impose additional burdens on companies conducting
business over the Internet.





While
none of the current laws governing Internet commerce has imposed significant
burdens on us to date, in the future our business, results of operations and
financial condition could be materially and adversely affected by the adoption
or modification of laws or regulations relating to the Internet, or the
application of existing laws to the Internet or Internet-based
advertising.


9


Item
1A.  Risk Factors




Our
operations and financial results are subject to various risks and uncertainties
that could adversely affect our business, financial condition, results of
operations, cash flows, and the trading price of our common
stock.  Discussion about important operational risks that our business
encounters can be found in Item 1 and in Item 7 of this report, as well as in
the discussion below.





Risks
Related to Our Business





We
have been in business only since August 2003.  Our limited operating
history makes evaluation of our business difficult.





We were
incorporated in the State of California as Network Dynamics in August 2003 and
have limited historical financial data upon which to base planned operating
expenses or to accurately forecast our future operating results.  We
have a limited operating history which makes it difficult to evaluate our
performance.  You must consider our prospects in light of the risks,
expenses and difficulties we face as an early stage company with a limited
operating history.  These risks include uncertainty as to whether we
will be able to:





·
            increase
      revenues from sales of our suite of Internet security products and support
      services;





·
            successfully
      protect our Collaborative Internet Security Network from all security
      attacks;





·
            successfully
      protect personal computers or networks against all Internet
      threats;





·
            respond
      effectively to competitive
pressures;





·
            protect
      our intellectual property rights;





·
            continue
      to develop and upgrade our technology;
and





·
            continue
      to renew our customers’ subscriptions to current and future products and
      services.





We
incurred net losses for our last four fiscal years.  We are not
certain that our operations will ever be profitable.





We
incurred a net loss of $5,507,600 for the fiscal year ended December 31, 2006, a
net loss of $5,866,123 for the fiscal year ended December 31, 2007, a net loss
of $11,251,772 for the fiscal year ended December 31, 2008 and a net loss of
$19,841,756 for the fiscal year ended December 31, 2009.  We can
provide no assurance as to when, or if, we will be profitable in the
future.  Even if we achieve profitability, we may not be able to
sustain it.





We
will need additional capital in the future to meet our obligations and financing
may not be available.





We
currently anticipate that our available capital resources, including our
operating cash flows, will be sufficient to meet our expected working capital
and capital expenditure requirements through the period March 31, 2011. However,
such resources will not be sufficient to fund the repayment of the obligation to
GRM due on March 31, 2011, which is described below. We intend to obtain
additional financing prior to March 31, 2011 to satisfy the obligation. However,
there can be no assurance that we will be able to secure the additional
financings on terms favorable to us, or at all. In the event we are unable to
obtain additional financing, we expect we would be able to renegotiate the terms
of the GRM obligation, however, there can be no assurance that this would
occur.  Failure to obtain additional funding or an amendment to the
GRM credit facility may require the Company to significantly curtail its
operations which could have a material adverse impact on the Company’s results
of operations and financial position.  In addition, in the event of a
default, GRM has the right, but not the obligation, at our sole cost and
expense, to require us to retain a consultant or hire an executive who would be
senior to the Company’s Chief Executive Officer and Chief Financial Officer.
This consultant would oversee the management and operations of the Company,
subject to the direction of the Company’s Board of Directors.


10





Regulations under
the Securities Exchange Act of 1934 require public companies to maintain
“disclosure controls and procedures.” Our disclosure controls and procedures are
not effective at the reasonable assurance level due to a significant deficiency.
Additionally, we have been unable to maintain effective internal controls over
our financial reporting in accordance with section 404 of the Sarbanes-Oxley Act
of 2002 due to a material weakness.  This could have a material
adverse effect on our business and stock price.





Included
in this Annual Report are reports on our disclosure controls and procedures and
on our internal control over financial reporting.  As a result of
deficiencies in our disclosure controls and procedures and in our internal
control over financial reporting, we concluded that neither was effective as of
December 31, 2009. In order to remedy these deficiencies we must appoint
independent directors and engage in specific compliance training of our
directors, officers and employees. We should also modify our existing accounting
systems (such as by recruiting and hiring additional employees to assist with
accounting functions, purchasing and installing special software and training
employees in the use of it, paying for the costs of continuing education for our
employees involved with accounting functions, etc.), which will entail
substantial costs and take a significant period of time to
complete.  We anticipate the costs of implementing these remediation
initiatives will be approximately $100,000 to $125,000 per year in increased
salaries and $50,000 to $100,000 per year in increased legal and accounting
expenses.





Failure
to achieve and maintain an effective internal control environment could have a
material adverse effect on our stock price and could result in our financial
statements being unreliable or loss of investor confidence in our financial
reports.  Additionally, failure to maintain effective internal control
over our financial reporting could result in government investigation or
sanctions by regulatory authorities.





We
sell our products over the Internet, however such activities may not be secure.
If a breach of security occurred, our reputation could be damaged and our
business and results of operations could be adversely affected.





A
significant barrier to online commerce and communications is the secure
transmission of confidential information over public networks.  Our
customers authorize us to bill their credit card accounts directly for the
purchase price of our products.  We rely on encryption and
authentication technology licensed from third parties to provide the security
and authentication technology to effect secure transmission of confidential
information, including customer credit card numbers.  There can be no
assurance that advances in computer capabilities, new discoveries in the field
of cryptography, or other events or developments will not result in a compromise
or breach of the technology used by us to protect customer transaction
data.  If any such compromise of our security were to occur, it could
have a material adverse affect on our reputation and, therefore, on our business
and results of operations.





During
the past year our business has grown rapidly. If we do not manage this growth
carefully, our business and results of operations could be adversely
affected.





Since
January 1, 2009, our business has grown rapidly.  Our sales increased
285% for the year ended December 31, 2009 as compared to the year ended December
31, 2008.  Also, the number of full-time employees and consultants we
employ grew from 22 full-time employees and 2 independent contractors as of
December 31, 2008 to 69 full-time employees and 50 independent contractors as of
December 31, 2009.  Growth of our business at this pace places a
strain on our management and resources and has required, and may continue to
require, the implementation of new operating systems, procedures and controls
and the expansion of our facilities.  Our failure to manage our growth
and expansion could adversely affect our business, results of operations and
financial condition.  Failure to implement new systems effectively or
within a reasonable period of time could adversely affect our business and
results of operations.





We
have made a significant investment in personnel and overhead in anticipation
that our growth will continue. If the projections about our growth are
mistaken, our operating results could be adversely affected.





During
the past two years we have experienced significant growth and we believe that
our growth will continue for the immediate future.  For
that reason we have made significant investments in personnel and
overhead.  If our growth does not continue, our operating expenses may
exceed our revenue, significantly affecting our ability to continue
operating.  Although we may be able to eliminate or reduce some of the
expenses through a reduction in workforce or a reduction in costs, some costs
such as rent could not be easily reduced. As a result, our operating results
could be adversely affected.


11





Our
Media and Marketing Services Agreement with GRM could be terminated. The
termination of this agreement could adversely affect our operating
results.




Pursuant
to the terms of the Media and Marketing Services Agreement we entered into with
GRM, GRM may terminate the agreement if there is a breach or default in
performance of any obligation, unless the breach or default is cured within 15
business days following receipt of written notice from the non-breaching party;
upon the discontinuance, dissolution, liquidation or winding up of the other
party’s business or the insolvency of the other party; or by either party for
any reason by giving the other party written notice of the termination at least
30 days prior to the effective date of termination. Additionally, after May
30, 2009, GRM is entitled to terminate the agreement upon 5 days written notice
to us in the event that the average media placement costs for any 3 consecutive
months during the term are less than $250,000 per month.  If we earn
significant revenues from our agreement with GRM, but GRM decides to terminate
the agreement, our operating results could be adversely affected.





We
market our products and services through search engines (for example, Google and
Yahoo!), e-mail and display advertising, affiliate marketing and direct response
television and radio commercials. If we fail to market our products effectively,
our sales could decline and our results of operations would be adversely
affected.





We market
our products and related services over the Internet, primarily through space
purchased from Internet-based marketers and search engines, and via direct
response television and radio commercials.  During 2009, we spent
approximately 75% of our advertising budget on Internet
advertising.  We cannot assure you that our advertising will perform
as we anticipate or that our advertising costs will not increase significantly.
If either of these events were to occur, it would have a material, adverse
effect on our results of operations.





We
face intense competition from other providers of Internet security
software.  If we cannot offer consumers a reason to use our software
instead of the software marketed by our competitors, our business and the
results of our operations will be adversely affected.





We have
many competitors in the markets for our products.  Our competitors
include software companies that offer products that directly compete with our
products or that bundle their software products with Internet security software
offered by another company.  End-user customers may prefer purchasing
Internet security software that is manufactured by the same company that
provides its other software programs because of greater product breadth offered
by the company, perceived advantages in price, technical support, compatibility
or other issues.





Some of
our competitors include WebRoot Software, Kaspersky Labs and Sunbelt
Software.  Many of our competitors, such as TrendMicro, McAfee and
Symantec and Computer Associates have greater brand name recognition and
financial, technical, sales, marketing and other resources than we do and
consequently may have an ability to influence customers to purchase their
products rather than ours.  Our future and existing competitors could
introduce products with superior features, scalability and functionality at
lower prices than our products and could also bundle existing or new products
with other more established products in order to compete with us.  Our
competitors could also gain market share by acquiring or forming strategic
alliances with our other competitors.  Finally, because new
distribution methods offered by the Internet and electronic commerce have
removed many of the barriers to entry historically faced by start-up companies
in the software industry, we may face additional sources of competition in the
future.





If
we are unable to develop and maintain new and enhanced Internet security or
identity protection products and support services to meet emerging industry
standards, our operating results could be adversely affected.





Our
future success depends on our ability to address the rapidly changing needs of
our customers by developing, acquiring and introducing new products, product
updates and services on a timely basis. The success of our business depends on
our ability to keep pace with technological developments and emerging industry
standards.  We intend to commit a portion of our resources to
developing new applications for threat research and new security applications
for Web 2.0 and social networking environments.  However, if we are
unable to successfully develop such products or if we develop these products but
demand for them does not materialize or occurs more slowly than we expect, we
will have expended resources (such as personnel and equipment) and capital
without realizing sufficient revenue to recover these costs, and our operating
results could be adversely affected.


12





If
we fail to adapt our technologies to new Internet technologies, we could lose
customers and key technology partners.  This would have a material
adverse effect on our revenues, our business and the results of our
operations.





Internet
technology is constantly evolving to make the user's experience easier and more
comprehensive.  Our products use Internet technologies.  We
must constantly monitor new technologies and adapt our technologies to them as
appropriate.  If we fail to keep our products compatible with the
latest Internet technologies, they may not perform adequately and we may lose
not only our customers, but those suppliers and partners whose Internet
technologies support our products.  The loss of our customers or our
suppliers and partners would have a material adverse effect on our revenues, our
business and the results of our operations.





Because
of the constant development of new or improved products in the software
industry, we must continually update our products or create new products to keep
pace with the latest advances. While we do our best to test these products prior
to their release, they may nevertheless contain significant errors and failures,
which could adversely affect our operating results.





With the
introduction of Windows 7, the most recent operating system from Microsoft, and
constant changes in the software industry as new standards and processes emerge,
we are required to continually update our suite of Internet security products.
While we do our best to test these products prior to their release, due to the
speed with which we are required to release new or updated products to remain
competitive, they could be released with errors or they may fail altogether.
These errors or failures may put the users of our software at risk because their
computers will not be adequately protected against spyware, viruses, spam or
phishing attacks. We try to reduce this risk by constantly upgrading our
software and by working closely with the creators of the operating platforms,
particularly Microsoft, to make sure that our software works with the operating
platform. However, if our existing suite of Internet security products and our
future products fail to perform adequately or fail entirely, our operating
results could be adversely affected.




Our
ability to effectively recruit and retain qualified officers and directors could
be adversely affected if we experience difficulty in maintaining directors' and
officers' liability insurance.




We may be
unable to maintain insurance as a public company on terms affordable to us to
cover liability for claims made against our officers and directors. If we are
unable to adequately insure our officers and directors, we may not be able to
retain or recruit qualified officers and directors to manage our
business.





Loss
of any of our key management personnel, particularly our CEO, could negatively
impact our business and the value of our common stock.





Our
ability to execute our business strategy will depend on the skills, experience
and performance of key members of our management team. We depend heavily on the
services of Gary Guseinov, our Chief Executive Officer, Igor Barash, our Chief
Product Officer and Secretary, Kevin Harris, our Chief Financial Officer, and
Steve Okun, our Chief Revenue Officer. We believe that the skills of Mr.
Guseinov would be particularly difficult to replace. We have long-term
employment agreements with Mr. Guseinov and Mr. Harris. We have entered into an
employment agreement with Mr. Barash, but it is “at-will” and does not preclude
him from leaving us. While Mr. Barash and Mr. Okun continue to provide services
to us, we have no guarantee that they will continue to do so for any particular
period of time.





If we
lose members of our key management personnel, we may be forced to expend
significant time and money in the pursuit of replacements, which could result in
both a delay in the expansion of our business and the diversion of limited
working capital. We cannot assure you that we will find satisfactory
replacements for these key management personnel at all, or on terms that are not
unduly expensive or burdensome to our company. We do not maintain key man
insurance policies on any of our key officers or employees.


13





To
date, our business has been developed assuming that laws and regulations that
apply to Internet communications and e-commerce will remain
minimal.  Changes in government regulation and industry standards may
adversely affect our business and operating results.





We have
developed our business assuming that the current state of the laws and
regulations that apply to Internet communications, e-commerce and advertising
will remain minimal.  At this time, complying with these laws and
regulations is not burdensome.  However, as time exposes various
problems created by Internet communications and e-commerce, laws and regulations
may become more prevalent.  These regulations may address issues such
as user privacy, spyware, pricing, intellectual property ownership and
infringement, taxation, and quality of products and services.  This
legislation could hinder growth in the use of the Internet generally and
decrease the acceptance of the Internet as a communications, commercial and
advertising medium.  Changes in current regulations or the addition of
new regulations could affect the costs of communicating on the Internet and
adversely affect the demand for our products or otherwise harm our business,
results of operations and financial condition.




A large portion
of our business is the development and distribution of
software.  If we do not
protect our proprietary information and prevent third parties from unauthorized
use of our technology, our business could be harmed.





We rely
on a combination of copyright, patent, trademark and trade secret laws,
confidentiality procedures, contractual provisions and other measures to protect
our proprietary information, especially our software codes.  All of
these measures afford only limited protection.  These measures may be
invalidated, circumvented or challenged, and others may develop technologies or
processes that are similar or superior to our technology.  We may not
have the proprietary information controls and procedures in place that we need
to protect our proprietary information adequately.  Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy our software or obtain or use information that we regard as proprietary,
which could harm our business.




Third
parties claiming that we infringe their proprietary rights could cause us to
incur significant legal expenses and prevent us from selling our
products.





As the
number of products in the software industry increases and the functionality of
these products further overlap, we believe that we may become increasingly
subject to infringement claims, which could include patent, copyright and
trademark infringement claims.  In addition, former employers of our
former, current or future employees may assert claims that such employees have
improperly disclosed to us the confidential or proprietary information of these
former employers.  Any such claim, with or without merit,
could:





·
            be
      time consuming to defend;





·
            result
      in costly litigation;





·
            divert
      management’s attention from our core
business;





·
            require
      us to stop selling, delay providing or redesign our product;
      and





·
            require
      us to pay monetary amounts as damages or for royalty or licensing
      arrangements.





Risks
Related to Ownership of Our Securities




Our
common stock began to be quoted on the OTC Bulletin Board on August 2,
2007.  We cannot assure you that an active public trading market for
our common stock will develop or be sustained.  Even if an active
market develops, it may not be possible to sell shares of our common stock in a
timely manner.


14


While our
common stock began to be quoted on the OTC Bulletin Board on August 2, 2007, to
date an active trading market has not developed and we cannot guarantee you that
an active trading market will ever develop.  This situation may be
attributable to a number of factors, including the fact that we are a small
company that is relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community that generate or
influence sales volume, and that even if we came to the attention of such
persons, they tend to be risk averse and may be reluctant to follow a relatively
unproven company such as ours or purchase or recommend the purchase of our
shares until such time as we became more seasoned and viable.  As a
consequence, even though our common stock is quoted on the OTC Bulletin Board,
there may be periods of several days or more when trading activity in our shares
is minimal or nonexistent, as compared to a seasoned issuer that has a large and
steady volume of trading activity that will generally support continuous sales
without an adverse effect on share price.  Because an active trading
market may not develop, it may not be possible to sell shares of our common
stock in a timely manner.




Our
common stock is considered a “penny stock”.  The application of the
“penny stock” rules to our common stock could limit the trading and liquidity of
the common stock, adversely affect the market price of our common stock and
increase transaction costs to sell those shares.




Our
common stock is a “low-priced” security or “penny stock” under rules promulgated
under the Securities Exchange Act of 1934.  In accordance with these
rules, broker-dealers participating in transactions in low-priced securities
must first deliver a risk disclosure document which describes the risks
associated with such stocks, the broker-dealer’s duties in selling the stock,
the customer’s rights and remedies and certain market and other
information.  Furthermore, the broker-dealer must make a suitability
determination approving the customer for low-priced stock transactions based on
the customer’s financial situation, investment experience and
objectives.  Broker-dealers must also disclose these restrictions in
writing to the customer, obtain specific written consent from the customer, and
provide monthly account statements to the customer.  The effect of
these restrictions will probably decrease the willingness of broker-dealers to
make a market in our common stock, will decrease liquidity of our common stock
and will increase transaction costs for sales and purchases of our common stock
as compared to other securities.




The
stock market in general and the market prices for penny stocks in particular,
have experienced volatility that often has been unrelated to the operating
performance of such companies.  These broad fluctuations may be the
result of unscrupulous practices that may adversely affect the price of our
stock, regardless of our operating performance.





Shareholders
should be aware that, according to SEC Release No. 34-29093 dated April 17,
1991, the market for penny stocks has suffered in recent years from patterns of
fraud and abuse.  Such patterns include (1) control of the market for
the security by one or a few broker-dealers that are often related to the
promoter or issuer; (2) manipulation of prices through prearranged matching of
purchases and sales and false and misleading press releases; (3) boiler room
practices involving high-pressure sales tactics and unrealistic price
projections by inexperienced sales persons; (4) excessive and undisclosed
bid-ask differential and markups by selling broker-dealers; and (5) the
wholesale dumping of the same securities by promoters and broker-dealers after
prices have been manipulated to a desired level, along with the resulting
inevitable collapse of those prices and with consequent investor
losses.  The occurrence of these patterns or practices could increase
the volatility of our share price.  In the past, plaintiffs have often
initiated securities class action litigation against a company following periods
of volatility in the market price of its securities.  We may in the
future be the target of similar litigation.  Securities litigation
could result in substantial costs and liabilities and could divert management's
attention and resources.




Our executive
officers and directors, along with their friends and family, own or control
approximately 31% of our issued
and outstanding common stock, which may limit the ability of our non-management
shareholders, whether acting alone or together, to influence our
management.  Additionally, this concentration of ownership could
discourage or prevent a potential takeover that might otherwise result in our
shareholders receiving a premium over the market price for our common
stock.





Approximately
31% of the issued and outstanding shares of our common stock is owned and
controlled by a group of insiders, including current directors and executive
officers and their friends and family.  Mr. Guseinov, our Chief
Executive Officer and President, owns 23% of our issued and outstanding common
stock.  Such concentrated control may adversely affect the price of
our common stock.  These insiders may be able to control matters
requiring approval by our shareholders, including the election of directors,
mergers or other business combinations.  Such concentrated control may
also make it difficult for our shareholders to receive a premium for their
shares of our common stock in the event we merge with a third party or enter
into different transactions that require shareholder approval.  These
provisions could also limit the price that investors might be willing to pay in
the future for shares of our common stock.  Our non-management
shareholders may have no effective voice in our management.


15





We
do not expect to pay dividends for the foreseeable future, and we may never pay
dividends.





We
currently intend to retain any future earnings to support the development of our
business and do not anticipate paying cash dividends in the foreseeable
future.  Our payment of any future dividends will be at the discretion
of our board of directors after taking into account various factors, including
but not limited to our financial condition, operating results, cash needs,
growth plans and the terms of any credit agreements that we may be a party to at
the time.  In addition, our ability to pay dividends on our common
stock may be limited by California state law.  Accordingly, investors
must rely on sales of their common stock after price appreciation, which may
never occur, as the only way to realize a return on their
investment.  Investors seeking cash dividends should not purchase our
common stock.





Limitations
on director and officer liability and our indemnification of officers and
directors may discourage shareholders from bringing suit against a
director.





Our
articles of incorporation and bylaws provide, with certain exceptions as
permitted by California law, that a director or officer shall not be personally
liable to us or our shareholders for breach of fiduciary duty as a director,
except for acts or omissions which involve intentional misconduct, fraud or
knowing violation of law, or unlawful payments of dividends.  These
provisions may discourage shareholders from bringing suit against a director for
breach of fiduciary duty and may reduce the likelihood of derivative litigation
brought by shareholders on our behalf against a director.  In
addition, our articles of incorporation and bylaws provide for mandatory
indemnification of directors and officers to the fullest extent permitted by
California law.  We have also entered into indemnity agreements with
our directors and executive officers.





Future
sales of our common stock could put downward selling pressure on our shares, and
adversely affect the stock price.  There is a risk that this downward
pressure may make it impossible for an investor to sell his shares at any
reasonable price, if at all.





Future
sales of substantial amounts of our common stock in the public market, or the
perception that such sales could occur, could put downward selling pressure on
our shares, and adversely affect the market price of our common
stock.





Item
2.  Properties





Our corporate office is located at 617
West 7th Street, 10th Floor,
Los Angeles, California.  We hold the premises under the terms of a
second amendment to a lease that was signed on September 30, 2009.  We
commenced occupancy of our current space on February 1, 2010. The monthly rent
for the initial 14 month period is abated.  The base rent starting in
month 15 is $36,111 with increases of 3% per year thereafter through
2020.  Aside from the monthly rent, we are required to pay our share
of the “Common Operating Expenses”, which are all costs and expenses (including
property taxes) incurred by the landlord with respect to the operation,
maintenance, protection, repair and replacement of the building in which the
premises are located and the parcel of land on which the building is
located.  We occupy approximately 15,876 square feet of office space,
or approximately 8.26% of the building.





Item
3.  Legal Proceedings





On February 4, 2010, Scott Wade, a
former employee, filed an action against the Company in the Superior Court of
the State of California, County of Los Angeles, alleging wrongful termination,
disability discrimination, failure to pay wages and breach of
contract.  Mr. Wade seeks an unspecified amount of damages (general
and special, statutory and punitive) as well as injunctive relief and attorney’s
fees and court costs.  The Company believes the threatened claim is
without merit and intends to vigorously defend it.





Item
4.  Removed and Reserved


16





PART
II





Item
5.  Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities





Market
Information





On August
2, 2007 our common stock was approved for quotation on the OTC Bulletin Board
under the symbol “CYDE”.  As of March 26, 2010 we have 25,829,675
shares of common stock issued and outstanding and we have approximately 175
record holders of our common stock.  This does not include an
indeterminate number of shareholders whose shares are held by brokers in street
name.




The
following table sets forth, for the periods indicated, the high and low bid
information per share of our common stock as reported by the OTC Bulletin
Board.  These quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual
transactions.





PERIOD
                      
                      HIGH
                      
                      
                      LOWFiscal
      Year Ended December 31, 2009
                      
                      First
      Quarter
                      
                      $
                      1.23
                      
                      
                      $
                      0.51Second
      Quarter
                      
                      $
                      3.49
                      
                      
                      $
                      1.15Third
      Quarter
                      
                      $
                      3.20
                      
                      
                      $
                      1.80Fourth
      Quarter
                      
                      $
                      4.79
                      
                      
                      $
                      2.04Fiscal
      Year Ended December 31, 2008
                      
                      First
      Quarter
                      
                      $
                      1.06
                      
                      
                      $
                      0.61Second
      Quarter
                      
                      $
                      2.00
                      
                      
                      $
                      0.63Third
      Quarter
                      
                      $
                      1.77
                      
                      
                      $
                      0.75Fourth
      Quarter
                      
                      $
                      1.40
                      
                      
                      $
                      0.70





Dividends





We
anticipate that any future earnings will be retained for the development of our
business and we do not anticipate paying any dividends on our common stock in
the foreseeable future.





Sales
of Unregistered Securities





For information relating to
unregistered securities that were sold during the three months ended December
31, 2009, please see our Current Report on Form 8-K, which was filed with the
Securities and Exchange Commission on November 6, 2009.





Securities
Authorized for Issuance under Equity Compensation Plans





Our Board
of Directors has adopted, and our shareholders have approved, two equity
incentive plans for directors, officers, consultants and
employees.  The CyberDefender Corporation 2005 Equity Incentive Plan
(sometimes referred to as the 2005 Stock Option Plan) was adopted by our
directors and approved by our shareholders on December 31, 2004 and includes
753,609 shares of our authorized common stock.  As of December 31,
2009 there were 18 awards covering a total of 753,233 shares of our common stock
outstanding under this plan.  The CyberDefender Corporation 2006
Equity Incentive Plan was adopted by our board of directors and approved by our
shareholders on October 30, 2006 and includes 2,401,509 shares of our authorized
common stock.  As of December 31, 2009 there were fifty-three awards
covering a total of 1,103,060 shares of our common stock outstanding under this
plan.


17





The following table illustrates
information about the securities issued from these plans:




Number of securities to be
              issued upon exercise of
              outstanding options,
              warrants and rights
            
            
            Weighted average exercise
              price of outstanding
              options warrants and
              rights
            
            
            Number of securities
              remaining available for
              future issuance under the
              equity compensation plan
              (excluding securities
              reflected in column (a)Plan
      Category
            
            (a)
            
            
            (b)
            
            
            (c)Shareholder
      Approved(1)
            
            
            1,856,293
            
            
            $
            1.09
            
            
            
            1,298,825Non-ShareholderApproved
            
            
            N/A
            
            
            
            N/A
            
            
            
            N/A


(1)
Includes the CyberDefender Corporation 2005 Equity Incentive Plan (also known as
the CyberDefender Corporation 2005 Stock Option Plan) and the CyberDefender
Corporation 2006 Equity Incentive
Plan.





Item
6.  Selected Financial Data





The registrant is a smaller reporting
company and is not required to provide this information.





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





The
following discussion of our financial condition and results of operations should
be read in conjunction with our financial statements and the notes to those
statements included elsewhere in this report.  In addition to the
historical financial information, the following discussion and analysis contains
forward-looking statements that involve risks and uncertainties.  Our
actual results may differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth under “Risk Factors” at Item 1A of this report.




Overview




We are a
provider of security software and services to the consumer and small business
market. We are located in Los Angeles, California.  Our mission is to
bring to market advanced solutions to protect computer users against identity
theft, Internet viruses, spyware and related security threats and provide
support services to assist customers with their technology needs.





We have
developed a collaborative Internet security network, which we refer to as
earlyNETWORK, which is based on certain technology principles commonly found in
a peer-to-peer network infrastructure.  A peer-to-peer network does
not have the notion of clients or servers, but only equal peer nodes that
simultaneously function as both “clients” and “servers” to the other nodes on
the network.  This means that when a threat is detected from a
computer that is part of the earlyNETWORKTM, the threat is relayed to our Early
Alert Center.  The Early Alert Center tests, grades and ranks the
threat, automatically generates definition and signature files based on the
threat, and relays this information to the Alert Server, in some cases after a
human verification step.  The Alert Server will relay the information
it receives from the Early Alert Center to other machines in the earlyNETWORKTM,
and each machine that receives the information will, in turn, relay it to other
machines that are part of the earlyNETWORKTM.  This protocol allows us
to rapidly distribute alerts and updates regarding potentially damaging viruses,
e-mails and other threats to members of the earlyNETWORKTM, without regard for
the cost of the bandwidth involved.  Because cost is not a factor,
updates can be continuous, making our approach significantly faster than the
client/server protocols used by traditional Internet security companies that
provide manual broadcast-updated threat management systems.  Computer
users join the earlyNETWORKTM simply by downloading and installing our
software.


18


Historically,
our revenues were derived from subscriptions to our single software product,
CyberDefender Anti-Spyware 2006, which included the initial download and one
year of updates.  The license to use the software was renewed
annually, with incentives for early renewals.  On November 20, 2006 we
stopped licensing this product to new subscribers (although we continue to
support and upgrade it for existing users).  We now offer several
products and services including our core product, CyberDefender Early Detection
Center V2.0.  EDC is a complete Internet security suite that protects
home computer users against spam, spyware, viruses and scams.  The
annual license fee varies depending on the marketing and distribution channels
that we use.





On
September 27, 2007, we announced the launch of CyberDefenderULTIMATE and
CyberDefenderCOMPLETE. These are bundled products that include EDC as well as
support services. CyberDefenderULTIMATE provides year round support for any
software or hardware connected to a subscriber’s computer while
CyberDefenderCOMPLETE provides a one time live technical support call. These
products also include 2 gigabytes of online backup. We also offer a free
Internet security toolbar called MyIdentityDefender (“MyID”). MyID is free to
use and generates revenue through search advertising. On November 20, 2008, the
Company announced the launch of CyberDefender Registry Cleaner. CyberDefender
Registry Cleaner eliminates clutter and junk that builds up within a computer's
registry due to the installation and removal of programs, deletion and creation
of files and cached records from Web surfing. The annual subscription rate
varies depending on the marketing or distribution channels we use. Additionally,
we offer stand alone technical support services available as a one-time call or
as an annual subscription.




CyberDefender
Early Detection Center V2.0 is typically marketed to consumers via a free
download of a trial version of the software.  Using the trial version,
users scan their computer for threats for free and then have the option to
upgrade to a fully featured version of the software to remove the threats from
their PCs, for a fee.





In the
past, we marketed solely online.  The offer, to scan a computer for
spyware and then pay for removal of the spyware found, was broadcast in e-mails,
banners and search ads.  In 2009, we migrated to off-line marketing
channels as we believe these channels are more effective in driving new
business.  Specifically, we are selling our products through direct
response marketing by partnering with other businesses, such as Guthy-Renker, a
leader in the direct response industry and Allianex, a leader in retail
distribution.  Additionally, we have been expanding our product
offering through the licensing of the For Dummies®brand.





The
development of our newer products and services combined with the use of off-line
marketing channels has resulted in a significant growth in sales, which
increased 285% for the year ended December 31, 2009 as compared to the year
ended December 31, 2008.  Accompanying this growth was an expected
increase in our related operating expenses as more fully described below in
Result of Operations.  We engaged in five offerings of our debt and/or
equity securities during the 2009 fiscal year to expand our business. On March
15, 2010, we executed a non-binding term sheet with GRM, for a strategic
investment of $5 million. This investment will be used to continue to grow
our business.





Critical
Accounting Policies and Estimates





The
discussion and analysis of our financial condition and results of operations is
based on our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the U.S.  The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses for
each period.  The following represents a summary of our critical
accounting policies, defined as those policies that we believe are the most
important to the portrayal of our financial condition and results of operations
and that require management’s most difficult, subjective or complex judgments,
often as a result of the need to make estimates about the effects of matters
that are inherently uncertain.





Revenue
recognition.  The Company sells products and services and
packages that include both.





The
Company recognizes revenue from the sale of software licenses under the guidance
of the Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 985, “Software.”





Specifically,
the Company recognizes revenues from its products when all of the following
conditions for revenue recognition are met:





i.
              
              persuasive
      evidence of an arrangement exists,ii.
              
              the
      product or service has been
delivered,


19





iii.
              
              the
      fee is fixed or determinable, andiv.
              
              collection
      of the resulting receivable is reasonably
  assured.





As part
of the sales price of its software licenses, the Company provides renewable
product support and content updates, which are separate components of product
licenses and sales. Term licenses allow customers to use the Company’s products
and receive product support coverage and content updates for a specified period,
generally twelve months. The Company invoices for product support, content
updates and term licenses at the beginning of the term. These revenues contain
multiple element arrangements where “vendor specific objective evidence”
(“VSOE”) may not exist for one or more of the elements. EDC is in substance a
subscription and the entire fee is deferred and is recognized ratably over the
term of the arrangement.





Revenue
is recognized immediately for the sale of products that do not require product
updates and services that are performed when purchased.  Additionally,
the Company recognizes the portion of the sale of bundled products and one of
its services at the time of purchase when all of the elements necessary for
revenue recognition have occurred.





The
Company also uses third parties to sell its software and therefore evaluates the
criteria of FASB ASC Topic 605, “Revenue Recognition,” in
determining whether it is appropriate to record the gross amount of revenue and
related costs or the net amount earned as commissions. The Company is the
primary obligor, is subject to inventory risk, has latitude in establishing
prices and selecting suppliers, establishes product specifications, and has the
risk of loss. Accordingly, the Company's revenue is recorded on a gross
basis.





During
2009, the Company also offered two products which were free to the subscriber,
CyberDefender FREE 2.0 and MyIdentityDefender Toolbar. Revenues are earned from
advertising networks which pay the Company to display advertisements inside the
software or through the toolbar search. The Company recognizes revenue from the
advertising networks monthly based on a rate determined either by the quantity
of the ads displayed or the performance of the ads based on the amount of times
the ads are clicked by the user. Furthermore, advertising revenue is recognized
provided that no significant Company obligations remain at the end of a period
and collection of the resulting receivable is probable. The Company’s
obligations do not include guarantees of a minimum number of
impressions.





The
Company’s policy with respect to refunds is to offer refunds within the first 30
days after the date of purchase. The Company may voluntarily issue refunds to
customers after 30 days of purchase, however the majority are issued within 30
days of the original sale and are charged against the associated sale or
deferred revenues (as applicable).


Advertising Costs.The
Company expenses advertising costs as they are incurred. As described in detail
in Note 5 below, the Company issued warrants for media and marketing
services.  The non-cash value of those warrants is included in media
and marketing services on the accompanying statements of
operations.  For the years ended December 31, 2009 and 2008, the
Company recorded non-cash expense of $5.9 million and $0.4 million,
respectively.





Software Development
Costs.The Company
accounts for software development costs in accordance with FASB ASC Topic 985,
“Software.” Such costs
are expensed prior to achievement of technological feasibility and thereafter
are capitalized. There have been very limited software development costs
incurred between the time the software and its related enhancements have reached
technological feasibility and its general release to customers. As a result, all
software development costs have been charged to product development
expense.


20


Stock Based Compensation and Fair
Value of our Shares.The Company applies FASB
ASC Topic 718, “Compensation –
Stock Compensation,”which requires companies to measure and recognize
the cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value. For non-employee stock based
compensation, the Company recognizes an expense in accordance with FASB ASC
Topic 505, “Equity,”
and values the equity securities based on the fair value of the security on the
date of grant. For stock-based awards the value is based on the market value of
the stock on the date of grant or the value of services, whichever is more
readily available. Stock option awards are valued using the Black-Scholes
option-pricing model.





The
Company accounts for equity instruments issued to consultants and vendors in
exchange for goods and services in accordance with the provisions of FASB ASC
Topic 505, “Equity.”
The measurement date for the fair value of the equity instruments issued is
determined at the earlier of (i) the date at which a commitment for performance
by the consultant or vendor is reached or (ii) the date at which the consultant
or vendor’s performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized over the term
of the consulting agreement. An asset acquired in exchange for the issuance of
fully vested, non-forfeitable equity instruments should not be presented or
classified for accounting purposes as an offset to equity on the grantor’s
balance sheet once the equity instrument is granted. Accordingly, the Company
records the fair value of the fully vested, non-forfeitable common stock issued
for future consulting services as prepaid expense in its balance
sheet.





Contractual
Obligations




We are
committed under the following contractual obligations:





Payments Due By PeriodTotal
                  
                  
                  Less than 1
                    year
                  
                  
                  1 to 3 Years
                  
                  
                  3 to 5 Years
                  
                  
                  Over 5 YearsLong-term
      debt obligations
                  
                  $
                  2,214,000
                  
                  
                  $
                  —
                  
                  
                  $
                  2,214,000
                  
                  
                  $
                  —
                  
                  
                  $
                  —Capital
      lease obligations
                  
                  $
                  22,391
                  
                  
                  $
                  9,447
                  
                  
                  $
                  12,944
                  
                  
                  $
                  —
                  
                  
                  $
                  —Operating
      lease obligations
                  
                  $
                  4,449,789
                  
                  
                  $
                  24,503
                  
                  
                  $
                  772,475
                  
                  
                  $
                  925,315
                  
                  
                  $
                  2,727,496


Off-Balance
Sheet Arrangements





We do not
have off-balance sheet arrangements.  As part of our ongoing business,
we do not participate in transactions that generate relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, often established
for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes.





Indemnities





During
the normal course of business, we have agreed to certain
indemnifications.  In the future, we may be required to make payments
in relation to these commitments.  These indemnities include
agreements with our officers and directors which may require us to indemnify
these individuals for liabilities arising by reason of the fact that they were
or are officers or directors.  The duration of these indemnities
varies and, in certain cases, is indefinite.  There is no limit on the
maximum potential future payments we could be obligated to make pursuant to
these indemnities.  We hedge some of the risk associated with these
potential obligations by carrying general liability
insurance.  Historically, we have not been obligated to make any
payments for these obligations and no liabilities have been recorded for these
indemnities in our financial statements.


21


Trends,
Events and Uncertainties





As
described above in the discussion of revenue recognition, we receive payment
upon the sale of our products and defer the revenue over the life of the license
agreement, which is generally one year.





The
following table summarizes our GAAP revenue and deferred revenue for each
quarter of the two most recently completed fiscal years.





Quarter Ended
                    
                    Net Revenue
                    
                    
                    Deferred
                      Revenue31-Mar-08
                    
                    $
                    475,046
                    
                    
                    $
                    1,019,07130-Jun-08
                    
                    
                    742,862
                    
                    
                    $
                    1,673,88930-Sep-08
                    
                    
                    1,202,715
                    
                    
                    $
                    3,220,73831-Dec-08
                    
                    
                    2,467,136
                    
                    
                    $
                    4,552,953Fiscal
      Year 2008 Totals
                    
                    $
                    4,887,75931-Mar-09
                    
                    $
                    3,191,630
                    
                    
                    $
                    6,687,19830-Jun-09
                    
                    
                    3,686,644
                    
                    
                    $
                    8,139,38430-Sep-09
                    
                    
                    4,427,404
                    
                    
                    $
                    9,656,35231-Dec-09
                    
                    
                    7,536,215
                    
                    
                    $
                    10,779,146Fiscal
      Year 2009 Totals
                    
                    $
                    18,841,893





The
following table summarizes our gross sales by category for each quarter of the
two most recently completed fiscal years. Gross sales are a non-GAAP measure
that we use in assessing our operating performance. We define gross sales as
total sales before refunds and before deferring revenue for GAAP purposes. We
reference this non-GAAP financial measure frequently in our decision-making
because it gives a better indication of our operating performance and the
profitability of our marketing initiatives. We include this non-GAAP financial
measure in our earnings announcement in order to provide transparency to our
investors and enable investors to better understand our operating performance.
However, we do not, and do not recommend that gross sales are solely used to
assess our financial performance or to formulate investment
decisions.




Quarter
      Ended
                    
                    Software
                    
                    
                    
                    
                    
                    Services
                    
                    
                    
                    
                    
                    Ancillary
                    
                    
                    
                    
                    
                    Renewals
                    
                    
                    
                    
                    
                    Total31-Mar-08
                    
                    $
                    147,423
                    
                    
                    
                    25
                    %
                    
                    $
                    68,597
                    
                    
                    
                    11
                    %
                    
                    $
                    72,858
                    
                    
                    
                    12
                    %
                    
                    
                    311,470
                    
                    
                    
                    52
                    %
                    
                    $
                    600,34830-Jun-08
                    
                    
                    680,606
                    
                    
                    
                    41
                    %
                    
                    
                    300,939
                    
                    
                    
                    18
                    %
                    
                    
                    225,910
                    
                    
                    
                    14
                    %
                    
                    
                    445,790
                    
                    
                    
                    27
                    %
                    
                    
                    1,653,24530-Sep-08
                    
                    
                    1,652,904
                    
                    
                    
                    49
                    %
                    
                    
                    853,629
                    
                    
                    
                    26
                    %
                    
                    
                    475,971
                    
                    
                    
                    14
                    %
                    
                    
                    358,434
                    
                    
                    
                    11
                    %
                    
                    
                    3,340,93831-Dec-08
                    
                    
                    2,107,307
                    
                    
                    
                    49
                    %
                    
                    
                    1,493,234
                    
                    
                    
                    35
                    %
                    
                    
                    669,477
                    
                    
                    
                    16
                    %
                    
                    
                    -
                    
                    
                    
                    0
                    %
                    
                    
                    4,270,018Fiscal
      Year 2008 Totals
                    
                    $
                    4,588,240
                    
                    
                    
                    47
                    %
                    
                    $
                    2,716,399
                    
                    
                    
                    28
                    %
                    
                    $
                    1,444,216
                    
                    
                    
                    15
                    %
                    
                    $
                    1,115,694
                    
                    
                    
                    11
                    %
                    
                    $
                    9,864,54931-Mar-09
                    
                    $
                    2,475,095
                    
                    
                    
                    40
                    %
                    
                    $
                    2,645,857
                    
                    
                    
                    43
                    %
                    
                    $
                    606,051
                    
                    
                    
                    10
                    %
                    
                    $
                    463,948
                    
                    
                    
                    7
                    %
                    
                    $
                    6,190,95130-Jun-09
                    
                    
                    2,501,266
                    
                    
                    
                    40
                    %
                    
                    
                    2,678,978
                    
                    
                    
                    43
                    %
                    
                    
                    584,144
                    
                    
                    
                    9
                    %
                    
                    
                    466,747
                    
                    
                    
                    8
                    %
                    
                    
                    6,231,13530-Sep-09
                    
                    
                    2,666,274
                    
                    
                    
                    40
                    %
                    
                    
                    2,915,731
                    
                    
                    
                    43
                    %
                    
                    
                    461,120
                    
                    
                    
                    7
                    %
                    
                    
                    699,068
                    
                    
                    
                    10
                    %
                    
                    
                    6,742,19331-Dec-09
                    
                    
                    4,401,569
                    
                    
                    
                    45
                    %
                    
                    
                    3,705,830
                    
                    
                    
                    38
                    %
                    
                    
                    982,460
                    
                    
                    
                    10
                    %
                    
                    
                    717,949
                    
                    
                    
                    7
                    %
                    
                    
                    9,807,808Fiscal
      Year 2009 Totals
                    
                    $
                    12,044,204
                    
                    
                    
                    42
                    %
                    
                    $
                    11,946,396
                    
                    
                    
                    41
                    %
                    
                    $
                    2,633,775
                    
                    
                    
                    9
                    %
                    
                    $
                    2,347,712
                    
                    
                    
                    8
                    %
                    
                    $
                    28,972,087





The
tables above indicate an upward trend in gross sales, GAAP revenue and deferred
revenue resulting from our focus on promoting our new products and services and
the addition of our new marketing channels, as discussed below.  We
cannot guarantee that this upward trend will continue, even with increased
spending on advertising.


22





The
following is a reconciliation of gross sales to net revenue for the years ended
December 31, :





2009
                    
                    
                    2008Gross
      Sales
                    
                    
                    28,972,087
                    
                    
                    
                    9,864,549Less:
      Refunds
                    
                    
                    (3,904,001
                    )
                    
                    
                    (1,053,279
                    )Less:
      Change in deferred revenue
                    
                    
                    (6,226,193
                    )
                    
                    
                    (3,923,511
                    )Net
      revenue
                    
                    
                    18,841,893
                    
                    
                    
                    4,887,759





Other
trends, events and uncertainties that may impact our liquidity are included in
the discussion below.





RESULTS
OF OPERATIONS





Fiscal
Year Ended December 31, 2009 Compared to the Fiscal Year Ended December 31,
2008





Revenue




Change
      in2009
                    
                    
                    2008
                    
                    
                    $
                    
                    
                    %Revenue
                    
                    $
                    18,841,893
                    
                    
                    $
                    4,887,759
                    
                    
                    $
                    13,954,134
                    
                    
                    
                    285
                    %





This
increase in net revenue was primarily attributable to the increase in new
product sales and services that have resulted from our expanded product
offerings as well as an increase in direct advertising expenditures associated
with customer acquisition and an increase in renewals as a result of our larger
customer base.





Cost
of Sales





Change in2009
                  
                  
                  2008
                  
                  
                  $
                  
                  
                  %Cost
      of Sales
                  
                  $
                  4,182,462
                  
                  
                  $
                  767,115
                  
                  
                  $
                  3,415,347
                  
                  
                  
                  445
                  %




This
increase in cost of sales was primarily attributable to the increase in sales of
our technical support service products which were primarily serviced by a third
party, an increase in sales of the CD-ROMs that backup our EDC software and
sales of third party products that require a per sale royalty.





Operating
Expenses





Media
and marketing services




Change in2009
                    
                    
                    2008
                    
                    
                    $
                    
                    
                    %Media
      and marketing services
                    
                    $
                    21,308,667
                    
                    
                    $
                    7,487,053
                    
                    
                    $
                    13,821,614
                    
                    
                    
                    185
                    %




Media and
marketing services expense is comprised of direct response advertising costs,
for both offline and online channels and related functional resources and
non-cash expense related to the Media Services Warrant and other warrants issued
to GRM.  The increase in media and marketing services expense is due
to increased direct response advertising efforts as well as an increase in
non-cash expense related to the Media Services Warrant and other warrants issued
to GRM. Direct advertising costs were $14.2 million and $6.8 million for the
years ended December 31, 2009 and 2008, respectively. Non-cash expense related
to the Media Services Warrant and other warrants issued to GRM were $5.9 million
and $0.4 million for the years ended December 31, 2009 and 2008,
respectively.


23





Product
Development




Change in2009
                  
                  
                  2008
                  
                  
                  $
                  
                  
                  %Product
      Development
                  
                  $
                  1,851,931
                  
                  
                  $
                  530,010
                  
                  
                  $
                  1,321,921
                  
                  
                  
                  249
                  %




Product
development expenses are primarily comprised of research and development costs
associated with the continued development of our products. This increase is
primarily attributable to the increase in the number of products offered and the
ongoing support and improvement of these products.





Selling,
General and Administrative




Change in2009
                  
                  
                  2008
                  
                  
                  $
                  
                  
                  %S,G
      & A
                  
                  $
                  6,566,661
                  
                  
                  $
                  3,346,655
                  
                  
                  $
                  3,220,006
                  
                  
                  
                  96
                  %




Selling,
general and administrative expenses are primarily comprised of salaries and
wages, third party credit card processing fees, legal and professional fees,
rent and other normal operating expenses.





This
increase was primarily attributable to two factors.  The first is an
increase in third party credit card processing fees due to the increase in
sales. The second is an increase in salaries and wages due to the increase in
staffing required as a result of the increase in sales.  Additionally,
there was an overall increase in all areas due to the increased sales activities
in the current period.  S,G & A has decreased as a percentage of
net sales to 35% for the year ended December 31, 2009 from 68% for the year
ended December 31, 2008.





Investor
Relations and Other Related Consulting




Change in2009
                  
                  
                  2008
                  
                  
                  $
                  
                  
                  %Investor
      relations and other related consulting
                  
                  $
                  2,473,345
                  
                  
                  $
                  1,265,616
                  
                  
                  $
                  1,207,729
                  
                  
                  
                  95
                  %




This
increase was primarily attributable to the value of warrants issued to various
consultants for investor relation services and creative services during the
period as more fully described in the notes to the financial
statements.





Loss
From Operations




Change in2009
                    
                    
                    2008
                    
                    
                    $
                    
                    
                    %Loss
      from operations
                    
                    $
                    17,578,290
                    
                    
                    $
                    8,548,098
                    
                    
                    $
                    9,030,192
                    
                    
                    
                    106
                    %




This
increase in loss from operations is primarily attributable to the value of the
Media Services Warrant and other warrants issued to GRM. The warrants were
valued using the Black-Scholes option-pricing model and is valued at each
vesting date. The calculated value of the warrants increased significantly at
each new vesting date as the stock price increased.  The Black-Scholes
option-pricing model does not factor in the illiquidity of the underlying shares
when calculating the value of the warrants. The Company recorded non-cash
expense of $5.9 million to media and marketing services for the year ended
December 31, 2009 as compared to $0.4 million for the year ended December 31,
2008. There were also increases in selling, general and administrative costs,
product development costs and the value of warrants granted for investor
relations and consulting services, as more fully described above, offset by an
increase in net revenues.


24





Other
Income/(Expense)





Change
in fair value of derivative liabilities




Change in2009
                  
                  
                  2008
                  
                  
                  $
                  
                  
                  %Change
      in fair value of derivative liabilities
                  
                  $
                  109,058
                  
                  
                  $
                  -0-
                  
                  
                  $
                  109,058
                  
                  
                  
                  100
                  %





As more
fully described in the notes to the financial statements, on January 1,
2009 we adopted the provisions of FASB ASC Topic 815, “Derivatives and Hedging,”
that apply to any freestanding financial instruments or embedded features that
have the characteristics of a derivative.  As such, we were required
to reclassify certain amounts from the equity section of the balance sheet to
the liabilities section.  In addition, the value of these instruments
must be reassessed by us as of each balance sheet date.  During August
2009, the Company obtained waivers from the warrant and note holders that
forever waive, as of and after April 1, 2009, any and all conversion or exercise
price adjustments that would otherwise occur, or would have otherwise occurred
on or after April 1, 2009, as a result of certain price protection provisions
included in the warrants and notes. As a result of obtaining the waivers, the
warrants and notes are now afforded equity treatment. The change in fair value
of these instruments for the year ended December 31, 2009 resulted in a gain of
$109,058.





Interest
expense, net




Change in2009
                  
                  
                  2008
                  
                  
                  $
                  
                  
                  %Interest
      expense, net
                  
                  $
                  2,371,724
                  
                  
                  $
                  2,486,334
                  
                  
                  $
                  (114,610
                  )
                  
                  
                  (5
                  %)





The
decreased interest expense was attributable to the decrease in the interest and
amortization expense related to our 10% Secured Debentures and our 7.41%
Original Issue Discount Notes offset by the issuance of additional warrants as
part of a warrant tender offer that we completed on August 17, 2009, the
amortization of debt discounts and deferred financing costs and interest on the
10% Convertible Promissory Notes.





Liquidity
and Capital Resources





In
November 2006 we changed our operating strategy by deciding to introduce a suite
of security products instead of just a single
product.    This change in our business resulted in a
significant decrease in our revenues from 2006 to 2007 since we stopped selling
our CyberDefender AntiSpyware 2006 product while we developed and rolled-out our
new products.  Since late 2007, we have launched several new products
and services and subsequently our revenues have been increasing on a quarterly
basis since January 2008, with the Company reporting positive operating income
for the quarter ended December 31, 2009.





To help
with our cash flow, we occasionally sell our debt or equity
securities.  We currently have outstanding $2,214,000 in principal
amount of our 8% convertible debt securities.  According to the terms
of these debentures, the principal amount and all accrued interest is due on
April 1, 2011.


25


At
December 31, 2009, we had cash totaling $3,357,510.  In the fiscal
year ended December 31, 2009, we generated positive cash flows of $2.6 million
primarily through financing activities as described below.  On March
31, 2010, we issued to GRM a 9% Secured Convertible Promissory Note in the
aggregate principal amount of $5.3 million (the “GR Note”), due March 31,
2012.  Additionally, as described in Note 11 to the Financial
Statements, we entered into a revolving credit facility with GRM effective as of
December 3, 2010.  The revolving credit facility permits us to borrow
up to $5 million, and the initial principal amount of the facility includes
$4,287,660 of outstanding trade payables owed by us to GRM on December 3, 2010
pursuant to the Media Services Agreement.  As described in Note 11
below, all outstanding principal and accrued but unpaid interest is due and
payable in full at the earlier of either March 31, 2011 or the closing of the
sale and issuance of our debt or equity securities in an aggregate amount
exceeding $10 million. We intend to obtain additional financing in order to
satisfy the obligation.  However, there can be no assurances that we
will obtain additional financing on terms acceptable to us, or at all. In
the event we are unable to obtain additional financing, we expect we would be
able to renegotiate the terms of the revolving credit facility, however, there
can be no assurance that this would occur.  Failure to obtain
additional funding or an amendment to the revolving credit facility may require
us to significantly curtail our operations which could have a material adverse
impact on our results of operations and financial position.





Cash
provided/(used) during the fiscal year ended December 31, 2009
included:





Operating
Activities





Net cash
used in operating activities during the fiscal year ended December 31, 2009 was
primarily the result of our net loss of $19.8 million.  Net loss for
the fiscal year ended December 31, 2009 was adjusted for non-cash items such as
amortization of debt discount of $1.2 million, compensation expense for vested
stock options of $0.3 million, amortization of deferred financing fees of $0.4
million, warrants issued for media and marketing services of $5.3 million,
shares and warrants issued for services of $3.0 million and warrants issued in
connection with our warrant tender offer of $0.5 million. Other changes in
working capital accounts include an increase in restricted cash of $1.6 million,
an increase in accounts receivable of $0.3 million, an increase in prepaid and
other assets of $0.2 million, an increase in deferred charges of $ 2.9 million,
an increase in accounts payable and accrued expenses of $1.7 million and an
increase of $6.2 million in deferred revenue resulting from higher new customer
and renewal sales.





Our
primary source of operating cash flow is the collection of license fee revenues
from our customers and the timing of payments to our vendors and service
providers.  In 2009 and 2008, we did not make any significant changes
to our payment terms for our customers, which are generally credit card
based.





The
increase in cash related to accounts payable and accrued expenses was $1.7
million.  Our operating cash flows, including changes in accounts
payable and accrued liabilities, are impacted by the timing of payments to our
vendors for accounts payable.  We typically pay our vendors and
service providers in accordance with invoice terms and
conditions.  The timing of cash payments in future periods will be
impacted by the nature of accounts payable arrangements.  In the
fiscal years ended December 31, 2009 and 2008, we did not make any significant
changes to the timing of payments to our vendors.





Our
working capital deficit at December 31, 2009, defined as current assets minus
current liabilities, was $6.2 million as compared to a working capital deficit
of $7.8 million at December 31, 2008.  The increase in working
capital of approximately $1.6 million from December 31, 2008 to December 31,
2009 was primarily attributable to an increase in cash of $2.6 million, an
increase in restricted cash of $1.6 million, an increase in deferred charges of
$2.5 million, a decrease in the current portion of notes payable of $2.4 million
offset by an increase in accounts payable and accrued expenses of $1.6 million
and an increase in the current portion of deferred revenue of $5.6 million,
resulting from increased sales.





Investing
Activities





Net cash
used in investing activities during the fiscal year ended December 31, 2009 was
$0.2 million, which was used for property and equipment purchases.  We
expect to continue to purchase property and equipment in the normal course of
our business.  The amount and timing of these purchases and the
related cash outflows in future periods is difficult to predict and is dependent
on a number of factors, including but not limited to any increase in the number
of our employees and changes in computer hardware and software used in our
business.  Net cash used in investing activities during the fiscal
year ended December 31, 2008 was $0 and also related to the purchase of property
and equipment.


26





Financing
Activities





Cash
provided by financing activities during the fiscal year ended December 31, 2009
was primarily the result of the sale of common stock of $3.6 million, issuances
of notes payable, net of commissions, totaling $2.7 million and the exercise of
common stock warrants and options totaling $2.5 million.  Cash used in
financing activities was for payments on capital lease
obligations.  Cash provided by financing activities during the fiscal
year ended December 31, 2008 was primarily the result of issuances of notes
payable, net of commissions, totaling $1.0 million and the sale of stock net of
offering costs totaling $1.0 million.  Cash used in financing
activities was primarily used for payment of notes payable totaling $0.3 million
and payments on capital lease obligations.




Other
than as discussed above, we know of no trends, events or uncertainties that are
reasonably likely to impact our future liquidity.





Item
7A.  Quantitative and Qualitative Disclosures About Market
Risk





The registrant is a smaller reporting
company and is not required to provide this information.





Item
8.  Financial Statements and Supplementary Data





The
financial statements and supplementary data required to be included in this Item
8 are set forth at page F-1 of this report.





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





Not applicable.





Item
9A. Controls and Procedures





Disclosure
Controls and Procedures





Regulations
under the Securities Exchange Act of 1934 (the “Exchange Act”) require public
companies to maintain “disclosure controls and procedures,” which are defined as
controls and other procedures that are designed to ensure that information
required to be disclosed by the issuer in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules and
forms.  Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by an issuer in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the issuer's management,
including its principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure.





We
initially conducted an evaluation, with the participation of our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure
controls and procedures as of December 31, 2009.  The company disclosed in
the Original Annual Report that, based on that evaluation, our Chief
Executive Officer and Chief Financial Officer had concluded that as of December
31, 2009, our disclosure controls and procedures were not effective at the
reasonable assurance level due to a significant deficiency described
below;





1.           Internal
control policies and procedures are not documented in a formalized
manner.  Written documentation of disclosure controls and procedures
is a requirement of Section 404 of the Sarbanes-Oxley Act.  Management
evaluated the impact of our failure to have formalized documentation of our
internal controls and procedures on our assessment of our disclosure controls
and procedures and has concluded that the control deficiency that resulted
represented a significant deficiency.





In
connection with the restatements of certain of our financial statements
described in more detail elsewhere in this Amendment No. 3, management of
the company re-evaluated the effectiveness of the company's disclosure controls
and procedures as of December 31, 2009. As a result of that reevaluation,
management of the company has determined that due to the material weakness in
internal control over financial reporting, the company's disclosure controls and
procedures were not effective as of such date. Additional information regarding
the restatement is contained in Note 2 in the Notes to the Financial
Statements included in this Amendment No. 3.


27





Management's
Report on Internal Control Over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting.  Internal control over financial
reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the
Exchange Act as a process designed by, or under the supervision of, the issuer’s
principal executive and principal financial officers and effected by the
issuer’s board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America and
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 the assets of the
      issuer;





·
            Provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with accounting
      principles generally accepted in the United States of America and that
      receipts and expenditures of the Company are being made only in accordance
      with authorizations of management and directors of the issuer;
      and





·
            Provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the issuer’s assets that
      could have a material effect on the financial
  statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  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.  All internal control
systems, no matter how well designed, have inherent
limitations.  Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation.  Because of the inherent limitations of
internal control, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting.  However, these inherent limitations are known features of
the financial reporting process.  Therefore, it is possible to design
into the process safeguards to reduce, though not eliminate, this
risk.





As of the
end of our most recent fiscal year, management assessed the effectiveness of our
internal control over financial reporting based on the criteria for effective
internal control over financial reporting established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission ("COSO") and SEC guidance on conducting such
assessments.  Based on that evaluation, we initially concluded that,
as of December 31, 2009, such internal control over financial reporting was not
effective.  This was due to a deficiency that existed in the design or
operation of our internal control over financial reporting that adversely
affected our internal controls and that may be considered to be material
weakness.





The
matter involving internal control over financial reporting that our management
considered to be a material weakness under the standards of the Public Company
Accounting Oversight Board was the lack of a functioning audit committee due to
a lack of a majority of independent members and a lack of a majority of outside
directors on our board of directors, resulting in ineffective oversight in the
establishment and monitoring of required internal controls and
procedures.  The aforementioned material weakness was identified by
our Chief Financial Officer in connection with the review of our financial
statements as of December 31, 2009.





Management
believes that the lack of a functioning audit committee and the lack of a
majority of outside directors on our board of directors results in ineffective
oversight in the establishment and monitoring of required internal controls and
procedures, which could result in a material misstatement in our financial
statements in future periods.


28




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





Management's
Remediation Initiatives





In an
effort to remediate the identified material weakness and enhance our internal
controls, we have initiated, or plan to initiate, the following series of
measures:





1.
            Ensure that
      personnel responsible forthe company's internal control
      over financial reportinganddisclosure controls and procedures participate in ongoing
      continuing profession education;
and





2.
            Use
      external resources when deemed necessary to assist in ensuring the company'sinternal control over financial reporting and disclosure controls
      and procedures are
effective.





We are
committed to a strong internal control environment, and believe that, when fully
implemented, these remediation actions will represent significant improvements.
The company anticipates that it will complete its testing of the additional
internal control processes designed to remediate the previously disclosed
material weakness in 2011; however, additional measures may be required, which
may require additional implementation time. We will continue to assess the
effectiveness of our remediation efforts in connection with management's future
evaluations of internal control over financial reporting.





Changes
in Internal Control over Financial Reporting





There
have been no changes in our internal control over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15 (f) under the Exchange Act) during
the fourth quarter of 2009 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
However, as
described above, there have been changes to our internal control over financial
reporting subsequent to December 31, 2009 that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.





Item
9B. Other Information





Not
applicable





PART
III





Item
10. Directors, Executive Officers and Corporate Governance





The
information required by this item is incorporated by reference to our Proxy
Statement for our 2010 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended December 31,
2009.




Item
11. Executive Compensation





The
information required by this item is incorporated by reference to our Proxy
Statement for our 2010 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended December 31,
2009.


29





Item
12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters





The
information required by this item is incorporated by reference to our Proxy
Statement for our 2010 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended December 31,
2009.





Item
13. Certain Relationships and Related Transactions and Director
Independence





Using the
definition of “independent” as that term is defined under the rules of the
NASDAQ Capital Market, we determined that none of our directors qualified as an
independent director on April 30, 2010.





For the
period from January 1, 2008 through April 30, 2010, described below are certain
transactions or series of transactions between us and our executive officers,
directors and the beneficial owners of 5% or more of our common stock, on an as
converted basis, and certain persons affiliated with or related to these
persons, including family members, in which they had or will have a direct or
indirect material interest in an amount that exceeds the lesser of $120,000 or
1% of the average of our total assets as of year-end for the last two completed
fiscal years, other than compensation arrangements that are otherwise required
to be described under “Executive Compensation.”





Beginning
on October 30, 2006 and continuing thereafter, we entered into Indemnification
Agreements with all persons who have provided services to us as directors and
with certain of our officers, all of whom are sometimes collectively referred to
in this discussion as the “indemnified parties” or individually referred to as
an “indemnified party”. The agreements require us to provide indemnification for
the indemnified parties for expenses (including attorneys’ fees, expert fees,
other professional fees and court costs, and fees and expenses incurred in
connection with any appeals), judgments (including punitive and exemplary
damages), penalties, fines and amounts paid in settlement (if such settlement is
approved in advance by us, which approval shall not be unreasonably withheld)
actually and reasonably incurred by the indemnified parties in connection with
any threatened, pending or completed action or proceeding (including actions
brought on our behalf, such as shareholder derivative actions), whether civil,
criminal, administrative or investigative, to which he is or was a party, a
witness or other participant (or is threatened to be made a party, a witness or
other participant) by reason of the fact that he is or was a director, officer,
employee or agent of ours or of any of our subsidiaries. The indemnification
covers any action or inaction on the part of the indemnified party while he was
an officer or director or by reason of the fact that he is or was serving at our
request as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise. We must advance the costs
of the fees and expenses within 20 days following the delivery of a written
request from an indemnified party. The indemnified parties have agreed to
promptly repay the advances only if, and to the extent that, it is ultimately
determined by the court (as to which all rights of appeal therefrom have been
exhausted or lapsed) that the indemnified party is not entitled to the
indemnity. The indemnified parties’ obligations to repay us for any such amounts
are unsecured and no interest will be charged thereon. We also agreed to
indemnify the indemnified parties to the fullest extent permitted by law,
notwithstanding that such indemnification is not specifically authorized by the
other provisions of the Indemnification Agreements, our articles of
incorporation, our bylaws or by statute. In the event of any change, after the
date of the Indemnification Agreements, in any applicable law, statute or rule
which expands the right of a California corporation to indemnify a member of its
board of directors or an officer, such changes shall be within the purview of
the indemnified parties’ rights and our obligations under the Indemnification
Agreements. In the event of any change in any applicable law, statute or rule
which narrows the right of a California corporation to indemnify a member of its
board of directors or an officer, such changes, to the extent not otherwise
required by such law, statute or rule to be applied to the Indemnification
Agreements will have no effect on the rights and obligations of the indemnified
parties and the company under them. The indemnification provided by the
Indemnification Agreements is not exclusive of any rights to which the
indemnified parties may be entitled under our articles of incorporation, bylaws,
any agreement, any vote of shareholders or disinterested directors or the
California Corporations Code. The indemnification provided under the
Indemnification Agreements continues for any action taken or not taken while an
indemnified party serves in an indemnified capacity, even though he may have
ceased to serve in such capacity at the time of any action or other covered
proceeding. If the indemnification provided for in the Indemnification Agreement
is unavailable to an indemnified party, in lieu of indemnifying the indemnified
party we will contribute to the amount incurred by him, whether for judgments,
fines, penalties, excise taxes, amounts paid or to be paid in settlement and/or
for expenses, in connection with any claim relating to an indemnifiable event,
in such proportion as is deemed fair and reasonable by the court before which
the action was brought. We are not obligated to provide indemnification pursuant
to the terms of the Indemnification Agreements


30





•
            for
      any acts or omissions or transactions from which a director may not be
      relieved of liability under the California General Corporation Law; or for
      breach by an indemnified party of any duty to us or our shareholders as to
      circumstances in which indemnity is expressly prohibited by Section 317 of
      the California General Corporation Law;
or




•
            with
      respect to proceedings or claims initiated or brought voluntarily by an
      indemnified party not by way of defense, (except with respect to
      proceedings or claims brought to establish or enforce a right to
      indemnification) although such indemnification may be provided if our
      Board of Directors has approved the initiation or bringing of such
      proceeding or claim; or




•
            with
      respect to any proceeding instituted by the indemnified party to enforce
      or interpret the Indemnification Agreement, if a court of competent
      jurisdiction determines that each of the material assertions made by the
      indemnified party in such proceeding was not made in good faith or was
      frivolous; or




•
            for
      expenses or liabilities of any type whatsoever which have been paid
      directly to an indemnified party by an insurance carrier under a policy of
      directors’ and officers’ liability insurance maintained by us;
      or




•
            for
      expenses and the payment of profits arising from the purchase and sale by
      an indemnified party of securities in violation of Section 16(b) of the
      Securities Exchange Act of 1934, as amended, or any similar successor
      statute.





The
Indemnification Agreements are effective as of the date they were signed and may
apply to acts or omissions of the indemnified parties which occurred prior to
such date if the indemnified party was an officer, director, employee or other
agent of our company, or was serving at our request as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, at the time such act or omission occurred. All of obligations
under the Indemnification Agreements will continue as long as an indemnified
party is subject to any actual or possible matter which is the subject of the
Indemnification Agreement, notwithstanding an indemnified party’s termination of
service as an officer or director.





On March
4, 2008 we entered into an Independent Contractor Agreement with Mr. Bing Liu, a
former director and employee, for his services as a software architect. The term
of the agreement was five months, but the agreement could be terminated by
either party upon 30 days notice, or immediately if Mr. Liu failed to discharge
his obligations under the agreement. We agreed to pay Mr. Liu the sum of $8,000
per month in exchange for his services and we agreed to reimburse Mr. Liu for
expenses incurred by him in rendering services under the agreement.





On August
1, 2008 we entered into another Independent Contractor Agreement with Mr. Liu.
The term of the agreement was five months, but the agreement could be terminated
by either party upon 30 days notice, or immediately if Mr. Liu failed to
discharge his obligations under the agreement. We agreed to pay Mr. Liu the sum
of $8,000 per month for the month of August and $9,000 per month for the
remaining term of the agreement in exchange for his services. We agreed to
reimburse Mr. Liu for expenses incurred by him in rendering services under the
agreement.


31


From
time-to-time, Unionway International, LLC, an entity controlled by Mr. Liu,
provides software development services to us.  On January 1, 2009, we
entered into a three-month Consulting Agreement with Unionway International,
LLC. As part of the agreement, Mr. Liu was granted a 10-year option to purchase
18,000 shares of our Common Stock at an exercise price of $1.00 per share
vesting in equal monthly increments over the term of the agreement as
compensation for 2008 achievements. In addition, Mr. Liu was granted a 10-year
option to purchase 5,000 shares of our Common Stock at an exercise price of
$1.00 per share vesting 2,500 shares on January 1, 2009, 1,250 shares on
February 1, 2009 and 1,250 shares on March 1, 2009. On April 1, 2009, we entered
into a three-month consulting agreement with Unionway International, LLC, again
for consulting services. As part of the agreement, Mr. Liu was granted a 10-year
option to purchase 15,000 shares of Common Stock at an exercise price of $1.25
per share vesting over the term of the agreement. During the fiscal year ended
December 31, 2009, we paid a total of $49,500 to Unionway International, LLC for
the services provided to us. During the fiscal year ended December 31, 2008, we
paid Unionway International, LLC $92,000 for software development services.
Because Mr. Liu was a director during 2008, the negotiation of the compensation
for these services was not done “at arm’s length”. However, we believe that we
received fair value in the services provided to us by Unionway International,
LLC and that if we were to pay an independent provider for the services, we
would pay approximately the same amount per month. Mr. Liu resigned as a
director in June 2009.





On
February 4, 2008 our board of directors approved an independent contractor
agreement with Mr. Michael Barrett. The term of the agreement was six months.
Pursuant to the agreement, Mr. Barrett provided consulting services to us as our
Chief Financial Officer. We agreed to pay Mr. Barrett the sum of $6,000 per
month for the months of February and March 2008. Beginning on April 1, 2008, Mr.
Barrett’s cash compensation was reduced to $4,000 per month. We also issued to
Mr. Barrett an option to purchase 20,000 shares of our Common Stock at a price
of $1.00 per share. The right to purchase 10,000 shares vested on April 30,
2008. The right to purchase the remaining 10,000 shares of Common Stock vested
at the end of the term. On April 16, 2008, we granted to Mr. Barrett an option
to purchase 20,000 shares of Common Stock at a price of $1.00 per share. On
August 6, 2008 our board of directors approved a second independent contractor
agreement with Mr. Barrett. Pursuant to the agreement, Mr. Barrett continued to
provide services to us as our Chief Financial Officer through September 30,
2008. We agreed to pay Mr. Barrett at the rate of $6,000 per month for his
services. We also agreed to grant to Mr. Barrett options to purchase 10,000
shares of our Common Stock at a price of $1.30 per share. The right to purchase
the Common Stock vested in equal increments of 5,000 shares per month over the
term of the contract. In exchange for this compensation, Mr. Barrett provided
his services to us for 10 to 15 hours per week. On October 1, 2008, we extended
Mr. Barrett’s agreement through November 30, 2008 and we granted to Mr. Barrett
an option to purchase 10,000 shares of Common Stock at a price of $1.00 per
share. On December 1, 2008, we extended Mr. Barrett’s agreement through December
15, 2008 and granted to Michael Barrett an option to purchase 2,500 shares of
Common Stock at a price of $1.20 per share. On January 17, 2009, we entered into
a two-month consulting agreement with Michael Barrett for consulting services
relating to financial management and reporting. As part of the agreement, Mr.
Barrett was granted an option to purchase 2,500 shares of Common Stock at an
exercise price of $1.25 per share, per month for the term of the
agreement.





In March
2008, Mr. Guseinov pledged 750,000 shares of his Common Stock to Michael and
Casey DeBaecke in exchange for a loan of $160,000 made to us. The pledge was
non-recourse to Mr. Guseinov in the event the collateral was foreclosed upon due
to our failure to pay the loan. So long as there was no event of default in
connection with the loan, Mr. Guseinov could continue to vote the shares at any
annual or special meeting of the shareholders. The loan was due to be repaid on
the earlier of two months following execution of the loan document or two days
following our receipt of over $500,000 in new equity capital.





Additionally,
we issued warrants to purchase 40,000 shares of our Common Stock to the lenders.
The warrants may be exercised at a price of $1.25 per share for a period of 5
years. The loan plus accrued interest was paid in full on July 30,
2008.





During
the fiscal year ended December 31, 2009, we purchased promotional items with the
Company’s name and logo on them from VK Productions, an entity controlled by Mr.
Guseinov’s spouse. During the year ended December 31, 2009, VK Productions
invoiced us $36,453.





On
October 1, 2009, we granted to Igor Barash, Chief Product Officer, in accordance
with the terms of his employment agreement dated July 1, 2008, an option to
purchase 150,000 shares of Common Stock under the 2006 Plan at a price of $1.00
per share vesting over four years from the date of the employment agreement. In
addition, we granted to Mr. Barash an option to purchase 47,000 shares of Common
Stock under the 2006 Plan, at a price of $1.00 per share in accordance with the
terms of his prior employment agreement dated November 23,
2005.


32





On March
24, 2009 we entered into a Media and Marketing Services Agreement (the
“Agreement”) with GR Match, LLC (“GRM”), the beneficial owner of more than 5% of
our common stock.  In conjunction with this transaction, we granted
three warrants to GRM (the “GRM Warrants”).  Information regarding the
Agreement and the GRM Warrants is incorporated herein by reference to Item No. 1
of our Annual Report on Form 10-K for the year ended December 31, 2008 which was
filed with the Securities and Exchange Commission on March 31,
2009.





On June
4, 2009 we and GRM signed the First Amendment to Media and Marketing Services
Agreement which extended the term from August 31, 2010 to June 1,
2011.





In order
to extend the benefits of the Agreement to the advertising, marketing and sale
of certain private label products, on October 26, 2009 GRM executed the Second
Amendment to Media and Marketing Services Agreement (the “Second Amendment”),
which we received on November 2, 2009.  In conjunction with executing
the Second Amendment, we also agreed to modify the GRM
Warrants.  Information regarding the Second Amendment and the
modifications to the GRM Warrants is included in the Current Report on Form 8-K
filed with the Securities and Exchange Commission on November 6, 2009, which we
incorporate herein by reference.I





On June
4, 2009, pursuant to a Securities Purchase Agreement dated June 3, 2009 (the
“Securities Purchase Agreement”), we closed the sale and issuance to GRM of
1,142,860 shares of common stock for an aggregate purchase price of
$2,000,005.  Information regarding this transaction is included in the
Current Report on Form 8-K filed with the Securities and Exchange Commission on
June 10, 2009, which we incorporate herein by reference.





On
November 2, 2009 we received from GRM an executed copy of the First Amendment to
the Securities Purchase Agreement, which was dated October 26,
2009.  Information regarding this transaction is included in the
Current Report on Form 8-K filed with the Securities and Exchange Commission on
November 6, 2009, which we incorporate herein by reference.





On March
31, 2010, pursuant to the terms of a Loan and Securities Purchase Agreement, we
sold and issued in a private placement to GRM a 9% Secured Convertible
Promissory Note in the aggregate principal amount of $5,300,000, due March 31,
2012.  We received net proceeds of $5,000,000 after payment of an
issuance fee of $300,000 to GRM.  During the period from the date of
the loan to April 30, 2010, the largest amount of principal outstanding was
$5,300,000 and no principal or interest payments had been made.  The
amount of principal and interest outstanding on April 30, 2010 was
$5,339,750.  Information regarding this transaction is included in the
Current Report on Form 8-K filed with the Securities and Exchange Commission on
April 6, 2010, which we incorporate herein by reference.





On April
1, 2010, we and GRM entered into a License Agreement whereby we granted to GRM
an exclusive royalty-bearing license to market, sell and distribute, in the
United States through retail channels of distribution (such as retail stores,
online retail storefronts, kiosks, counters and other similar retail channels)
and television shopping channels (such as QVC and Home Shopping Network), and in
certain foreign countries through retail channels, television shopping channels,
direct response television and radio, and Internet websites associated with such
marketing channels (other than www.cyberdefender.com), our line of antivirus and
Internet security products or services.  Information regarding this
transaction is included in the Current Report on Form 8-K filed with the
Securities and Exchange Commission on April 7, 2010, which we incorporate herein
by reference.





Pursuant
to the terms of the Agreement we entered into on March 24, 2009 with GRM, GRM is
permitted to appoint one member to our board of directors.  On July
21, 2009 GRM appointed Mr. Bennet Van de Bunt to our board of
directors.  On January 1, 2010 Mr. Van de Bunt resigned from our board
of directors, and GRM appointed Mr. Luc Vanhal in his place.  Mr.
Vanhal resigned this position as of February 28, 2010 and on March 22, 2010,
GRM  reappointed Bennet Van De Bunt as a director.


33





Item
14. Principal Accounting Fees and Services





The
information required by this item is incorporated by reference to our Proxy
Statement for our 2010 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended December 31,
2009.


34


PART
IV





Item
15. Exhibits, Financial Statement Schedules





3.1
              
              Articles
      of incorporation of the registrant, as amended (1)3.2
              
              Bylaws
      of the registrant, as amended (1)3.2.1
              
              Amendment
      No. 1 to Bylaws3.2.2
              
              Amendment
      No. 2 to Bylaws10.1
              
              2005
      Stock Incentive Plan (1)10.2
              
              Amended
      and Restated 2006 Equity Incentive Plan (1)10.3
              
              Securities
      purchase agreement between registrant and each purchaser identified on the
      signature pages thereof dated as of September 12, 2006
  (1)10.4
              
              Employment
      agreement between the registrant and Gary Guseinov dated August 31, 2006
      (1)**10.5
              
              Employment
      agreement between the registrant and Igor Barash dated September 1, 2003
      (1)**10.6
              
              Employment
      offer between the registrant and Igor Barash dated November 23,
      2005(14)**10.7
              
              Employment
      agreement between the registrant and Igor Barash dated July 1,
      2008(14)**10.
      8
              
              Agreement
      for Internet Advertising Agent Services date May 16, 2008 between the
      registrant and WebMetro (2)10.
      9
              
              Consulting
      Agreement with Frontier Capital Partners LLC dated July 15, 2008
      (3)10.10
              
              Form
      of Indemnification Agreement entered into between the registrant and Gary
      Guseinov, Bing Liu, Igor Barash, John LaValle and Michael Barrett
      (1)**10.11
              
              Form
      of Securities Purchase Agreement for the sale of Units (August 2008)
      (4)10.12
              
              Form
      of Warrant to Purchase Common Stock (August 2008) (4)10.13
              
              Common
      Stock Purchase Warrant issued to Newview Finance L.L.C. dated November 10,
      2008 (5)10.14
              
              Settlement
      Agreement between the registrant and Patrick Hinojosa
  (6)10.15
              
              Form
      of 7.41% Senior Secured Note (7)10.16
              
              Form
      of Registration Rights Agreement executed in conjunction with the sale of
      7.41% Senior Secured Notes (7)10.17
              
              Form
      of Amended and Restated Security Agreement executed in conjunction with
      the sale of 7.41% Senior Secured Notes (7)10.18
              
              Form
      of Securities Purchase Agreement executed in conjunction with the sale of
      7.41% Senior Secured Notes (7)10.19
              
              Form
      of Common Stock Purchase Warrant issued in conjunction with the sale of
      7.41% Senior Secured Notes (7)10.20
              
              Lease
      Agreement dated October 19, 2007 between the registrant and 617 7th
      Street Associates, LLC (8)10.21
              
              Form
      of Securities Purchase Agreement (November 25, 2008/December 5, 2008)
      (9)10.22
              
              Form
      of 10% Convertible Promissory Note (November 25, 2008/December 5, 2008)
      (9)10.23
              
              Form
      of Common Stock Purchase Warrant (November 25, 2008/December 5, 2008)
      (9)10.24
              
              Form
      of Registration Rights Agreement (November 25, 2008/December 5, 2008)
      (9)10.25
              
              Form
      of Subordination Agreement (November 25, 2008/December 5, 2008)
      (9)10.26
              
              Consent
      and Waiver Agreement dated November 21, 2008 between the registrant and
      the holders of the 10% Secured Convertible Debentures dated September 12,
      2006 (November 25, 2008/December 5, 2008) (9)10.27
              
              Amended
      and Restated Consent and Waiver dated August 19, 2008 between the
      registrant and the holders of the 10% Secured Convertible Debentures dated
      September 12, 2006 (10)10.28
              
              Consent
      and Waiver dated September 22, 2008 between the registrant and the holders
      of the 10% Secured Convertible Debentures dated September 12, 2006
      (10)10.29
              
              Warrant
      to Purchase Common Stock issued to Guthy-Renker Match LLC
    (7)10.30
              
              Employment
      Agreement between the registrant and Kevin Harris (7)
**10.31
              
              Amendment
      to Lease Agreement dated January 30, 2009 between the registrant and 617
      7th
      Street Associates, LLC (7)10.32
              
              Media
      and Marketing Services Agreement with GR Match, LLC (7)10.33
              
              Securities
      Purchase Agreement dated June 3, 2009 between the registrant and GR Match,
      LLC(9)10.34
              
              First
      Amendment to Medial and Marketing Services Agreement dated June 4, 2009
      between the registrant and GR Match,
LLC(9)


35





10.35
              
              Indemnification
      Agreement dated July 21, 2009 between the registrant and Bennet Van De
      Bunt(10)10.36
              
              First
      Amendment dated October 26, 2009 to Securities Purchase Agreement between
      the registrant and GR Match, LLC(11)10.37
              
              Second
      Amendment dated October 26, 2009 to Media and Marketing Services Agreement
      between the registrant and GR Match, LLC(11)10.38
              
              Indemnification
      Agreement dated January 1, 2010 between the registrant and Luc
      Vanhal(12)10.39
              
              Consulting
      Agreement dated April 1, 2009 between the registrant and SCP Holdings
      LLC(13)10.40
              
              Consent
      and Waiver Agreement dated April 23, 2009(13)10.41
              
              Securities
      Purchase Agreement dated June 10, 2009 between the registrant and Shimski
      LP(13)10.42
              
              Amended
      and Restated Warrant to Purchase Common Stock issued to GR Match LLC on
      May 6, 2009(13)10.43
              
              Warrant
      to Purchase Common Stock issued to GR Match LLC on May 6,
      2009(13)10.44
              
              Warrant
      to Purchase Common Stock issued to GR Match LLC on May 6,
      2009(13)10.45
              
              Amendment
      to Lease Agreement dated September 30, 2009 between the registrant and 617
      7th
      Street Associates, LLC (14)23.1
              
              Consent
      of Grant Thornton LLP*31.1
              
              Certification
      Pursuant to Rule 13a-14(a) and 15d-14(a) (4)*31.2
              
              Certification
      Pursuant to Rule 13a-14(a) and 15d-14(a) (4)*32
              
              Certification
      Pursuant to Section 1350 of Title 18 of the United States
      Code*


*Filed
herewith.


**
Denotes an agreement with management.


(1)
Incorporated by reference from the registrant’s Registration Statement on Form
SB-2, file no. 333-138430, filed with the Securities and Exchange Commission on
November 3, 2006.


(2)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on June 5, 2008.


(3)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on July 22, 2008.


(4)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on September 3,
2008.


(5)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on November 18,
2008.


(6)
Incorporated by reference from the registrant’s Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on August 14,
2008.  This document is the subject of a confidential treatment
request therefore portions of it have been redacted. A full copy of the document
has been filed separately with the Securities and Exchange
Commission.


(7)
Incorporated by reference from the registrant’s Annual Report on Form 10-K filed
with the Securities and Exchange Commission on April 15,
2008.


(8) Incorporated by
reference from the registrant’s Current Report on Form 8-K filed with the
Securities and Exchange Commission on November 19, 2007.


(9)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on December 5,
2008.


(10)
Incorporated by reference from the registrant’s Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on November 14,
2008.


(11)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on November 6, 2009.


(12)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on January 20, 2010.


(13)
Incorporated by reference from the registrant’s Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on August 14,
2009.


(14)
Incorporated by reference from the registrant’s Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 31,
2010.


36





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.





Date:  December
      20, 2010
                
                CYBERDEFENDER
      CORPORATIONBy:
                /s/ Gary GuseinovGary
      GuseinovChief
      Executive OfficerBy:
                /s/ Kevin HarrisKevin
      HarrisChief
      Financial Officer








CYBERDEFENDER
CORPORATION


Table
of Contents




PageReport
      of Independent Registered Public Accounting Firm
                  F-2Balance
      Sheets – December 31, 2009 (restated) and 2008
                  F-3Statements
      of Operations - For the Years Ended December 31, 2009 (restated) and
      2008
                  F-4Statements
      of Stockholders’ Deficit - For the Years Ended December 31, 2009
      (restated) and 2008
                  F-5Statements
      of Cash Flows - For the Years Ended December 31, 2009 (restated) and
      2008
                  F-6Notes
      to Financial Statements
                  F-8


F-1


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  Board of
Directors and Stockholders
 CyberDefender
Corporation
 
 We have
audited the accompanying balance sheets of CyberDefender Corporation (the
“Company”) as of December 31, 2009 and 2008, and the related statements of
operations, stockholders’ deficit, and cash flows for the years then ended.These financial
statements are the responsibility of the Company’s management.Our responsibility is
to express an opinion on these financial statements based on our
audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting.Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.Accordingly, we express
no such opinion.An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.We believe that our
audits provide a reasonable basis for our opinion.
 
 In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of CyberDefender Corporation as of
December 31, 2009 and 2008, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
 
 As
discussed in Note 2 to the financial statements, the Company restated its
financial statements as of and for the year ended December 31,
2009.
  
 /s/ GRANT
THORNTON LLP
  Los
Angeles, CA
 December
20, 2010


F-2


CYBERDEFENDER
CORPORATION


BALANCE
SHEETS





December
      31,
                      
                      
                      December
      31,2009
                      
                      
                      2008(Restated)ASSETSCURRENT
      ASSETS:Cash
                      
                      $
                      3,357,510
                      
                      
                      $
                      779,071Restricted
      cash
                      
                      
                      1,565,841
                      
                      
                      
                      15,000Accounts
      receivable
                      
                      
                      489,464
                      
                      
                      
                      204,635Deferred
      financing costs, current
                      
                      
                      191,566
                      
                      
                      
                      324,200Prepaid
      expenses
                      
                      
                      302,291
                      
                      
                      
                      674,478Deferred
      charges, current
                      
                      
                      3,316,535
                      
                      
                      
                      811,542Total
      Current Assets
                      
                      
                      9,223,207
                      
                      
                      
                      2,808,926PROPERTY
      AND EQUIPMENT, net
                      
                      
                      242,927
                      
                      
                      
                      94,883DEFERRED
      FINANCING COSTS, net of current portion
                      
                      
                      47,892
                      
                      
                      
                      -DEFERRED
      CHARGES, net of current portion
                      
                      
                      609,904
                      
                      
                      
                      239,983OTHER
      ASSETS
                      
                      
                      67,605
                      
                      
                      
                      26,196Total
      Assets
                      
                      $
                      10,191,535
                      
                      
                      $
                      3,169,988LIABILITIES AND STOCKHOLDERS’
      DEFICITCURRENT
      LIABILITIES:Accounts
      payable
                      
                      $
                      4,893,186
                      
                      
                      $
                      3,798,645Accrued
      expenses
                      
                      
                      862,023
                      
                      
                      
                      384,974Deferred
      revenue, current
                      
                      
                      9,662,030
                      
                      
                      
                      4,025,026Convertible
      notes payable, net of discount
                      
                      
                      -
                      
                      
                      
                      2,421,529Capital
      lease obligations, current
                      
                      
                      9,410
                      
                      
                      
                      27,291Total
      Current Liabilities
                      
                      
                      15,426,649
                      
                      
                      
                      10,657,465DEFERRED
      RENT
                      
                      
                      65,938
                      
                      
                      
                      -DEFERRED
      REVENUE, less current portion
                      
                      
                      1,117,116
                      
                      
                      
                      527,927CONVERTIBLE
      NOTES PAYABLE, net of discount
                      
                      
                      1,593,000
                      
                      
                      
                      -CAPITAL
      LEASE OBLIGATIONS, less current portion
                      
                      
                      9,708
                      
                      
                      
                      16,776Total
      Liabilities
                      
                      
                      18,212,411
                      
                      
                      
                      11,202,168COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS’
      DEFICIT:Common
      stock, no par value; 50,000,000 shares authorized; 25,673,967 and
      17,350,798 shares issued and outstanding at December 31, 2009 and December
      31, 2008, respectively
                      
                      
                      25,674
                      
                      
                      
                      17,351Additional
      paid-in capital
                      
                      
                      36,884,000
                      
                      
                      
                      17,763,193Accumulated
      deficit
                      
                      
                      (44,930,550
                      )
                      
                      
                      (25,812,724
                      )Total
      Stockholders’ Deficit
                      
                      
                      (8,020,876
                      )
                      
                      
                      (8,032,180
                      )Total
      Liabilities and Stockholders’ Deficit
                      
                      $
                      10,191,535
                      
                      
                      $
                      3,169,988





See
accompanying notes to financial statements





F-3




CYBERDEFENDER
CORPORATION


STATEMENTS
OF OPERATIONS


FOR
THE YEARS ENDED DECEMBER 31,





2009
                
                
                2008(Restated)REVENUES:Net
      sales
                
                $
                18,841,893
                
                
                $
                4,887,759COST
      OF SALES
                
                
                4,182,462
                
                
                
                767,115GROSS
      PROFIT
                
                
                14,659,431
                
                
                
                4,120,644OPERATING
      EXPENSES:Media
      and marketing services
                
                
                21,308,667
                
                
                
                7,487,053Product
      development
                
                
                1,851,931
                
                
                
                530,010Selling,
      general and administrative
                
                
                6,566,661
                
                
                
                3,346,655Investor
      relations and other related consulting
                
                
                2,473,345
                
                
                
                1,265,616Depreciation
      and amortization
                
                
                37,117
                
                
                
                39,408Total
      Operating Expenses
                
                
                32,237,721
                
                
                
                12,668,742LOSS
      FROM OPERATIONS
                
                
                (17,578,290
                )
                
                
                (8,548,098
                )OTHER
      INCOME/(EXPENSE):Change
      in fair value of derivative liabilities
                
                
                109,058
                
                
                
                -Loss
      on registration rights agreement
                
                
                -
                
                
                
                (216,540
                )Interest
      expense, net
                
                
                (2,371,724
                )
                
                
                (2,486,334
                )Total
      Other Expenses, net
                
                
                (2,262,666
                )
                
                
                (2,702,874
                )LOSS
      BEFORE INCOME TAX EXPENSE
                
                
                (19,840,956
                )
                
                
                (11,250,972
                )INCOME
      TAX EXPENSE
                
                
                800
                
                
                
                800NET
      LOSS
                
                $
                (19,841,756
                )
                
                $
                (11,251,772
                )Basic
      and fully diluted net loss per share
                
                $
                (0.91
                )
                
                $
                (0.72
                )Weighted
      Average Shares Outstanding:Basic
      and fully diluted
                
                
                21,890,656
                
                
                
                15,562,790





See
accompanying notes to financial statements


F-4




CYBERDEFENDER
CORPORATION
 STATEMENT
OF STOCKHOLDERS’ DEFICIT
 FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008
   AdditionalCommon
      Stock
              
              
              Paid-in
              
              
              AccumulatedShares
              
              
              Amount
              
              
              Capital
              
              
              Deficit
              
              
              Total(Restated)
              
              
              (Restated)
              
              
              (Restated)Balance
      at December 31, 2007
              
              
              13,994,597
              
              
              $
              13,995
              
              
              $
              11,879,782
              
              
              $
              (14,560,952
              )
              
              $
              (2,667,175
              )Sale
      of shares with warrants attached, net of cash issuance costs of
      $112,757
              
              
              1,155,500
              
              
              
              1,155
              
              
              
              1,041,588
              
              
              
              ---
              
              
              
              1,042,743Issuance
      of shares and warrantsfor
      services
              
              
              300,000
              
              
              
              300
              
              
              
              2,266,483
              
              
              
              ---
              
              
              
              2,266,783Issuance
      of shares for penalties and interest
              
              
              271,091
              
              
              
              271
              
              
              
              252,810
              
              
              
              ---
              
              
              
              253,081Value
      of warrants issued in association with debt
              
              
              ---
              
              
              
              ---
              
              
              
              83,590
              
              
              
              ---
              
              
              
              83,590Conversion
      of OID notes and accrued interest
              
              
              744,749
              
              
              
              745
              
              
              
              744,004
              
              
              
              ---
              
              
              
              744,749Conversion
      of convertible notes and accrued interest
              
              
              796,876
              
              
              
              797
              
              
              
              796,079
              
              
              
              ---
              
              
              
              796,876Value
      of warrants and  beneficial conversion feature of convertible
      notes payable
              
              
              ---
              
              
              
              ---
              
              
              
              445,467
              
              
              
              ---
              
              
              
              445,467Cashless
      warrant exercise
              
              
              37,985
              
              
              
              38
              
              
              
              (38
              )
              
              
              ---
              
              
              
              ---Exercise
      of stock options
              
              
              50,000
              
              
              
              50
              
              
              
              485
              
              
              
              ---
              
              
              
              535Compensation
      expense on vested options
              
              
              ---
              
              
              
              ---
              
              
              
              252,943
              
              
              
              ---
              
              
              
              252,943Net
      loss
              
              
              ---
              
              
              
              ---
              
              
              
              ---
              
              
              
              (11,251,772
              )
              
              
              (11,251,772
              )Balance
      at December 31, 2008
              
              
              17,350,798
              
              
              
              17,351
              
              
              
              17,763,193
              
              
              
              (25,812,724
              )
              
              
              (8,032,180
              )Sale
      of shares
              
              
              1,975,360
              
              
              
              1,975
              
              
              
              3,604,905
              
              
              
              ---
              
              
              
              3,606,880Value
      of warrants and  beneficial conversion feature of convertible
      notes payable
              
              
              ---
              
              
              
              ---
              
              
              
              1,074,367
              
              
              
              ---
              
              
              
              1,074,367Issuance
      of warrants for media and marketing services
              
              
              ---
              
              
              
              ---
              
              
              
              5,343,509
              
              
              
              ---
              
              
              
              5,343,509Issuance
      of shares and warrantsfor
      services
              
              
              94,628
              
              
              
              95
              
              
              
              1,670,536
              
              
              
              ---
              
              
              
              1,670,631Issuance
      of shares and warrants for penalties and interest
              
              
              34,922
              
              
              
              35
              
              
              
              32,517
              
              
              
              ---
              
              
              
              32,552Conversion
      of convertible notes and accrued interest
              
              
              3,651,973
              
              
              
              3,652
              
              
              
              3,939,102
              
              
              
              ---
              
              
              
              3,942,754Exercise
      of stock  warrants
              
              
              2,265,607
              
              
              
              2,265
              
              
              
              2,244,873
              
              
              
              ---
              
              
              
              2,247,138Exercise
      of stock options
              
              
              300,679
              
              
              
              301
              
              
              
              279,677
              
              
              
              ---
              
              
              
              279,978Compensation
      expense on vested options
              
              
              ---
              
              
              
              ---
              
              
              
              308,776
              
              
              
              ---
              
              
              
              308,776Issuance
      of warrants in connection with warrant tender offer
              
              
              ---
              
              
              
              ---
              
              
              
              548,728
              
              
              
              ---
              
              
              
              548,728Reclassification
      of derivatives to liabilities
              
              
              ---
              
              
              
              ---
              
              
              
              (7,065,940
              )
              
              
              723,930
              
              
              
              (6,342,010
              )Reclassification
      of derivatives to equity
              
              
              ---
              
              
              
              ---
              
              
              
              7,139,757
              
              
              
              ---
              
              
              
              7,139,757Net
      loss
              
              
              ---
              
              
              
              ---
              
              
              
              ---
              
              
              
              (19,841,756
              )
              
              
              (19,841,756
              )Balance
      at December 31, 2009
              
              
              25,673,967
              
              
              $
              25,674
              
              
              $
              36,884,000
              
              
              $
              (44,930,550
              )
              
              $
              (8,020,876
              )
 
 See
accompanying notes to financial statements


F-5




CYBERDEFENDER
CORPORATION


STATEMENTS
OF CASH FLOWS


FOR
THE YEARS ENDED DECEMBER 31,




2009
                  
                  
                  2008(Restated)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                  
                  $
                  (19,841,756
                  )
                  
                  $
                  (11,251,772
                  )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Loss
      on registration rights agreement
                  
                  
                  -
                  
                  
                  
                  216,540Amortization
      of debt discount
                  
                  
                  1,169,026
                  
                  
                  
                  1,322,379Depreciation
      and amortization
                  
                  
                  37,117
                  
                  
                  
                  39,408Compensation
      expense from vested stock options
                  
                  
                  308,776
                  
                  
                  
                  252,943Amortization
      of deferred financing costs
                  
                  
                  423,589
                  
                  
                  
                  702,061Warrants
      issued for media and marketing services
                  
                  
                  5,343,509
                  
                  
                  
                  380,598Shares
      issued for penalties and interest
                  
                  
                  32,552
                  
                  
                  
                  253,081Shares
      and warrants issued for services
                  
                  
                  3,044,242
                  
                  
                  
                  1,886,185Warrants
      issued in connection with warrant tender offer
                  
                  
                  548,728
                  
                  
                  
                  -Change
      in fair value of derivative liabilities
                  
                  
                  (109,058
                  )
                  
                  
                  -Changes
      in operating assets and liabilities:Restricted
      cash
                  
                  
                  (1,550,841
                  )
                  
                  
                  (15,000
                  )Accounts
      receivable
                  
                  
                  (284,829
                  )
                  
                  
                  (185,582
                  )Prepaid
      and other assets
                  
                  
                  (198,710
                  )
                  
                  
                  (652,593
                  )Deferred
      charges
                  
                  
                  (2,874,914
                  )
                  
                  
                  (1,010,965
                  )Other
      assets
                  
                  
                  (41,409
                  )
                  
                  
                  (99
                  )Accounts
      payable and accrued expenses
                  
                  
                  1,741,619
                  
                  
                  
                  3,059,002Deferred
      revenue
                  
                  
                  6,226,193
                  
                  
                  
                  3,923,511Cash
      Flows Used In Operating Activities
                  
                  
                  (6,026,167
                  )
                  
                  
                  (1,080,303
                  )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                  
                  
                  (185,161
                  )
                  
                  
                  (2,286
                  )Cash
      Flows Used In Investing Activities
                  
                  
                  (185,161
                  )
                  
                  
                  (2,286
                  )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from notes payable and convertible notes payable, net of
      commissions
                  
                  
                  2,680,720
                  
                  
                  
                  954,300Principal
      payments on notes payable
                  
                  
                  -
                  
                  
                  
                  (349,000
                  )Principal
      payments on capital lease obligations
                  
                  
                  (24,949
                  )
                  
                  
                  (23,913
                  )Proceeds
      from exercise of stock options
                  
                  
                  279,978
                  
                  
                  
                  535Proceeds
      from exercise of stock warrants
                  
                  
                  2,247,138
                  
                  
                  
                  -Proceeds
      from sale of stock, net of issuance costs
                  
                  
                  3,606,880
                  
                  
                  
                  1,042,743Cash
      Flows Provided by Financing Activities
                  
                  
                  8,789,767
                  
                  
                  
                  1,624,665NET
      INCREASE IN CASH
                  
                  
                  2,578,439
                  
                  
                  
                  542,076CASH,
      beginning of year
                  
                  
                  779,071
                  
                  
                  
                  236,995CASH,
      end of year
                  
                  $
                  3,357,510
                  
                  
                  $
                  779,071


See
accompanying notes to financial statements


F-6




CYBERDEFENDER
CORPORATION


STATEMENTS
OF CASH FLOWS


FOR
THE YEARS ENDED DECEMBER 31,




2009
                  
                  
                  2008(Restated)Supplemental
      disclosures of cash flow information:Income
      taxes paid
                  
                  $
                  800
                  
                  
                  $
                  39Cash
      paid for interest
                  
                  $
                  102,338
                  
                  
                  $
                  36,203Supplemental
      schedule of non-cash financing activities:Property
      and equipment acquired through capital lease obligation
                  
                  $
                  -
                  
                  
                  $
                  2,362Discount
      on notes payable
                  
                  $
                  923,801
                  
                  
                  $
                  83,590Warrants
      issued in connection with sale of stock
                  
                  $
                  -
                  
                  
                  $
                  903,239Conversion
      of notes payable and accrued interest to common stock and
      warrants
                  
                  $
                  3,942,754
                  
                  
                  $
                  1,541,625Warrants
      issued in connection with debt conversion
                  
                  $
                  -
                  
                  
                  $
                  445,467Convertible
      notes payable issued as payment for accrued interest and
      penalties
                  
                  $
                  -
                  
                  
                  $
                  440,784Warrants
      issued for placement fees with convertible debt
                  
                  $
                  150,566
                  
                  
                  $
                  -Cumulative
      effect of accounting change to additional paid-in capital for derivative
      liabilities
                  
                  $
                  7,065,940
                  
                  
                  $
                  -Cumulative
      effect of accounting change to retained earnings for derivative
      liabilities
                  
                  $
                  723,930
                  
                  
                  $
                  -Reclassification
      of derivatives to equity
                  
                  $
                  7,139,757
                  
                  
                  $
                  -Value
      of warrants and embedded conversion features recorded to derivative
      liabilities
                  
                  $
                  906,805
                  
                  
                  $
                  -





See
accompanying notes to financial statements


F-7


CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES





Organization and
Business


The
Company, based in Los Angeles, California, is a provider of security software
and services to the consumer and small business market. The Company develops,
markets and licenses security software and related services. The Company’s goal
is to bring to market advanced solutions to protect computer users against
identity theft, Internet viruses, spyware, and related computer threats. The
Company markets its products directly to consumers.





The
Company sells a suite of products and services that includes anti-malware
software, a registry cleaner, technical support and identity protection
services.  The Company markets its products through multiple channels
including internet, radio, television and retail.




During
May 2010, the Company entered into an Agreement and Plan of Merger with a wholly
owned Delaware subsidiary, pursuant to which the Company merged with and into
the Delaware subsidiary, with the Delaware subsidiary being the surviving
corporation, on the basis of one share of common stock of the Delaware
subsidiary to be exchanged for each outstanding share of common stock of the
Company, all as more particularly set forth in the Agreement and Plan of Merger.
The main purpose of the merger was to change the Company’s state of
incorporation from California to Delaware. Additionally, at the time of the
merger the Company increased the number of authorized shares of common stock to
100 million, changed the common stock from no par value to $0.001 par value and
authorized 10 million shares of preferred stock. As a result the Company
retroactively restated its financial statements as if the change in par value
was effective for all periods presented.


Liquidity


The
Company has experienced operating losses since inception.  Management
has implemented plans to continue to build its revenue base, expand sales and
marketing and improve operations, however, through September 2010, the Company
continued to operate at negative cash flow.  For the years ended
December 31, 2009 and 2008, the Company has incurred a net loss of $19.8 million
and $11.3 million with negative cash flows from operations of $6.0 million and
$1.1 million, respectively.  As December 31, 2009 and 2008, the
Company had stockholders’ deficit of $8.0 million and $8.0 million,
respectively.  To date, the Company’s operations have been primarily
financed through debt and equity proceeds from private placement
offerings.  Management believes that it has sufficient working capital
from recent financings to fund operations through at least March 31,
2011.  As discussed in Note 11, the Company entered into a revolving
credit facility with GRM effective as of December 3, 2010.  The credit
facility permits the Company to borrow up to $5 million, and the initial
principal amount includes $4,287,660 of outstanding trade payables owed by the
Company to GRM on December 3, 2010 pursuant to the Media Services
Agreement.  All outstanding principal and accrued but unpaid interest
is due and payable in full at the earlier of either March 31, 2011 or the
closing of the Company’s sale and issuance of any debt or equity securities of
the Company in an aggregate amount exceeding $10 million. The Company intends to
obtain additional financing to satisfy the obligation.  However, there
can be no assurances that the Company will obtain additional financing on terms
acceptable to the Company, or at all. In the event the Company is unable to
obtain additional financing, the Company expects it would be able to renegotiate
the terms of the credit facility, however, there can be no assurance
that this would occur.  Failure to obtain additional funding or an
amendment to the credit facility may require the Company to significantly
curtail its operations which could have a material
adverse impact on our results of operations and financial
position.





Reclassification


To
conform to the current year's presentation, as a result of management's
continuing analysis of its financial reporting, the Company consolidated its
2008 Accrued expenses – registration rights agreement account with Accrued
expenses on the balance sheet. Additionally, the Company reclassified $15,000
from Prepaid expenses to Restricted cash. The Company also reclassified $380,598
from selling, general and administrative expense to media and marketing services
expense. These reclassifications had no effect on the previously reported net
loss for 2008.





Use of
Estimates


The
preparation of financial statements in conformity with U.S. Generally Accepted
Accounting Principles (“GAAP”) requires management 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 financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates made by management are, among others,
collectibility of accounts receivable, recoverability of prepaid expenses,
deferred charges and property and equipment, value of shares and
options/warrants granted, valuation of deferred tax assets and recognition of
revenue. Actual results could differ from those estimates and
assumptions.





Property and
Equipment


Property
and equipment are recorded at cost. Expenditures for major additions and
improvements are capitalized and minor replacements, maintenance, and repairs
are charged to expense as incurred. When equipment is retired or otherwise
disposed of, the cost and accumulated depreciation are removed from the accounts
and any resulting gain or loss is included in the results of operations for the
respective period. Depreciation is provided over the estimated useful lives of
the related assets ranging from three to ten years, using the straight-line
method. Amortization of leasehold improvements is provided over the shorter
of the estimated useful lives of the improvements or the term of the
lease.





Equipment under Capital
Lease


The
Company leases certain of its furniture and other equipment under agreements
accounted for as capital leases. The assets and liabilities under capital lease
are recorded at the lesser of the present value of aggregate future minimum
lease payments, including estimated bargain purchase options, or the fair value
of the assets under lease. Assets under capital lease are depreciated using the
straight-line method over their estimated useful lives.





F-8




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)





Revenue
Recognition


The
Company sells a combination of products, services and packages that include
both.





The
Company recognizes revenue from the sale of software licenses under the guidance
of the Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 985, “Software.”





Specifically,
the Company recognizes revenues from its products when all of the following
conditions for revenue recognition are met:





i.
            persuasive
      evidence of an arrangement exists,


ii.
            the
      product or service has been
delivered,


iii.
            the
      fee is fixed or determinable, and


iv.
            collection
      of the resulting receivable is reasonably
  assured.





As part
of the sales price of its software licenses, the Company provides renewable
product support and content updates, which are separate components of product
licenses and sales. Term licenses allow customers to use the Company’s products
and receive product support coverage and content updates for a specified period,
generally twelve months. The Company invoices for product support, content
updates and term licenses at the beginning of the term. These revenues contain
multiple element arrangements where “vendor specific objective evidence”
(“VSOE”) may not exist for one or more of the elements. Certain of the Company’s
software licenses are in substance a subscription and the entire fee is deferred
and is recognized ratably over the term of the arrangement.





Revenue
is recognized immediately for the sale of products that do not require product
updates and services that are performed when purchased.  Additionally,
the Company recognizes the portion of the sale of bundled products and one of
its services at the time of purchase when all of the elements necessary for
revenue recognition have occurred.





The
Company also uses third parties to sell its software and therefore evaluates the
criteria of FASB ASC Topic 605, “Revenue Recognition,” in
determining whether it is appropriate to record the gross amount of revenue and
related costs or the net amount earned as commissions. The Company is the
primary obligor, is subject to inventory risk, has latitude in establishing
prices and selecting suppliers, establishes product specifications, and has the
risk of loss. Accordingly, the Company's revenue is recorded on a gross
basis.





The
Company also offers MyIdentityDefender Toolbar free to the subscriber and still
supports CyberDefender FREE 2.0 although it is no longer offered to new
subscribers.. Revenues are earned from advertising networks which pay the
Company to display advertisements inside the software or through the toolbar
search. The Company recognizes revenue from the advertising networks monthly
based on a rate determined either by the quantity of the ads displayed or the
performance of the ads based on the amount of times the ads are clicked by the
user. Furthermore, advertising revenue is recognized provided that no
significant Company obligations remain at the end of a period and collection of
the resulting receivable is probable. The Company’s obligations do not include
guarantees of a minimum number of impressions.





Deferred
Charges


The
Company uses a third party to provide technical support services associated with
the CyberDefenderULTIMATE product.  The costs associated with this
service are deferred and amortized against the recognition of the related sales
revenue.





Advertising
Costs


The
Company expenses advertising costs as they are incurred. As described in detail
in Note 5 below, the Company issued warrants for media and marketing
services.  The non-cash value of those warrants is included in media
and marketing services on the accompanying statements of
operations.  For the years ended December 31, 2009 and 2008, the
Company recorded non-cash expense of $5.9 million and $0.4 million,
respectively.





Reserves for
Refunds


The
Company’s policy with respect to refunds is to offer refunds within the first 30
days after the date of purchase. The Company may voluntarily issue refunds to
customers after 30 days of purchase, however the majority are issued within 30
days of the original sale and are charged against the associated sale or
deferred revenues (as applicable). Refunds were $3.0 million and $0.4 million
for the years ended December 31, 2009 and 2008, respectively. As of December 31,
2009 and 2008, the Company had $0 accrued for customer refunds, based on
historical timing of refunds.




F-9




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)





Concentrations of
Risk


As of
December 31, 2009, all of our cash was maintained at a major financial
institution in the United States. At times, deposits held with the financial
institution may exceed the amount of insurance provided on such deposits by the
Federal Deposit Insurance Corporation (“FDIC”) which provides deposit coverage
with limits up to $250,000 per owner through December 31, 2013. As of December
31, 2009, the Company had a balance of approximately $3,366,000 in excess of the
FDIC limit.





Advertising
purchased from four vendors accounted for 92% of the Company’s total advertising
expense for the year ended December 31, 2008.





Income
Taxes


The
Company has adopted the liability method of accounting for income taxes pursuant
to FASB ASC Topic 740, “Income
Taxes.” Deferred income taxes are recorded to reflect tax consequences on
future years for the differences between the tax basis of assets and liabilities
and their financial reporting amounts at each year-end. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statements carrying amounts of existing assets
and liabilities and their respective tax basis. Deferred tax assets, including
tax loss and credit carryforwards, and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.





Deferred
income tax expense represents the change during the period in the deferred tax
assets and deferred tax liabilities. The components of the deferred tax assets
and liabilities are individually classified as current and non-current based on
their characteristics. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized.





FASB ASC
Topic 740 prescribes recognition thresholds that must be met before a tax
position is recognized in the financial statements and provides guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. An entity may only recognize or continue to
recognize tax positions that meet a “more likely than not”
threshold.





The
Company does not have any unrecognized tax benefits as of December 31, 2009
that, if recognized, would affect the Company’s effective income tax
rate.





The
Company’s policy is to recognize interest and penalties related to income tax
issues as components of income tax expense. The Company did not recognize or
have any accrual for interest and penalties relating to income taxes as of
December 31, 2009.





Software Development
Costs


The
Company accounts for software development costs in accordance with FASB ASC
Topic 985, “Software.”
Such costs are expensed prior to achievement of technological feasibility and
thereafter are capitalized. There have been very limited software development
costs incurred between the time the software and its related enhancements have
reached technological feasibility and its general release to customers. As a
result, all software development costs have been charged to product development
expense.





Derivative
Instruments


Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and
Hedging,” that
applies to any freestanding financial instruments or embedded features that have
the characteristics of a derivative and to any freestanding financial
instruments that are potentially settled in an entity’s own common stock. As a
result, as of January 1, 2009, 7,134,036 of the Company’s issued and outstanding
common stock purchase warrants previously treated as equity pursuant to the
derivative treatment exemption were no longer afforded equity treatment. In
addition, amounts related to the embedded conversion feature of convertible
notes issued previous to January 1, 2009 and treated as equity pursuant to the
derivative treatment exemption were also no longer afforded equity treatment. As
such, effective January 1, 2009, the Company reclassified the fair value of
these common stock purchase warrants and the fair value of the embedded
conversion features, which both have exercise price reset features, from equity
to liability status as if these warrants and embedded conversion features were
treated as a derivative liability since the earliest date of issue in
September 2006. On January 1, 2009, the Company reclassified from
additional paid-in capital, as a cumulative effect adjustment,
$7,065,940 to beginning additional paid-in capital, $723,930 to opening
retained earnings and $6,342,010 to a long-term derivative liability to
recognize the fair value of such warrants and embedded conversion features on
such date.




F-10




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)





During
the year ended December 31, 2009, the Company issued 1,192,000 common stock
purchase warrants that contained features that required the Company to record
their fair value as a derivative liability.  In addition, the value
related to the embedded conversion feature of convertible notes issued during
the year ended December 31, 2009 was also recorded as a derivative liability.
The fair value of these common stock purchase warrants and the embedded
conversion feature on their respective value date for the year ended December
31, 2009 was $906,805.  We recognized income of $109,058 from the
change in fair value of the outstanding warrants and embedded conversion feature
for the year ended December 31, 2009.





The
Company obtained waivers from the warrant and note holders, pursuant to which
the warrant and note holders forever waived, as of and after April 1, 2009, any
and all conversion or exercise price adjustments that would otherwise occur, or
would have otherwise occurred on or after April 1, 2009, as a result of the
price reset provisions included in the warrants and notes. As a result of
obtaining the waivers, the warrants and notes are now afforded equity treatment
resulting in the elimination of the derivative liabilities of $7,139,757 and a
corresponding increase in additional paid-in capital.





Fair Value
Measurements


In
September 2006, the FASB issued guidance now codified as ASC Topic 820,
“Fair Value Measurements and
Disclosures,”which defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements. The
pronouncement is effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. In February 2008, the FASB
released additional guidance now codified under FASB ASC Topic 820, which
provides for delayed application of certain guidance related to non-financial
assets and non-financial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually), until fiscal years beginning after November 15, 2008, and
interim periods within those years. On January 1, 2008, the Company adopted
the provisions of ASC Topic 820, except as it applies to those nonfinancial
assets and nonfinancial liabilities for which the effective date has been
delayed by one year, which the Company adopted on January 1, 2009. The
implementation of this pronouncement did not have a material impact on the
Company’s financial position, results of operations or cash flows.





The fair
value hierarchy distinguishes between assumptions based on market data
(observable inputs) and an entity’s own assumptions (unobservable inputs). The
hierarchy consists of three levels:





•
            Level
      one — Quoted market prices in active markets for identical assets or
      liabilities;





•
            Level
      two — Inputs other than level one inputs that are either directly or
      indirectly observable; and





•
            Level
      three — Unobservable inputs developed using estimates and assumptions,
      which are developed by the reporting entity and reflect those assumptions
      that a market participant would
use.




Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates its hierarchy disclosures each
quarter. The Company has no assets or liabilities that are measured at fair
value on a recurring basis. There were no assets or liabilities measured at fair
value on a non-recurring basis during the year ended December 31,
2009.





For
certain of the Company’s financial instruments, including cash, restricted cash,
accounts receivable, accounts payable, other accrued liabilities and notes
payable, the carrying amounts approximate fair value due to their short
maturities.




F-11




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)





Loss Per
Share


In
accordance with FASB ASC Topic 260, “Earnings Per Share,” the
basic loss per common share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares outstanding.
 Diluted loss per common share is computed similar to basic loss per common
share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued and if the additional common shares were dilutive.
As of December 31, 2009 and 2008, there were 16,139,945 and 14,807,513 shares of
potentially dilutive securities outstanding, respectively. As the Company
reported a net loss, none of the potentially dilutive securities were
included in the calculation of diluted earnings per share since their effect
would be anti-dilutive for that reporting period.





Stock Based
Compensation


The
Company applies FASB ASC Topic 718, “Compensation – Stock Compensation,”which requires companies to measure and recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value. For non-employee stock based compensation, the Company
recognizes an expense in accordance with FASB ASC Topic 505, “Equity,” and values the
equity securities based on the fair value of the security on the date of grant.
For stock-based awards the value is based on the market value of the stock on
the date of grant or the value of services, whichever is more readily available.
Stock option awards are valued using the Black-Scholes option-pricing
model.





The
Company accounts for equity instruments issued to consultants and vendors in
exchange for goods and services in accordance with the provisions of FASB ASC
Topic 505, “Equity.”
The measurement date for the fair value of the equity instruments issued is
determined at the earlier of (i) the date at which a commitment for performance
by the consultant or vendor is reached or (ii) the date at which the consultant
or vendor’s performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized over the term
of the consulting agreement. An asset acquired in exchange for the issuance of
fully vested, non-forfeitable equity instruments should not be presented or
classified for accounting purposes as an offset to equity on the grantor’s
balance sheet once the equity instrument is granted. Accordingly, the Company
records the fair value of the fully vested, non-forfeitable common stock issued
for future consulting services as prepaid expense in its balance
sheet.





Segment
Disclosures


The
Company operates in one segment and its chief operating decision maker is its
chief executive officer.





Subsequent
events


The
Company has evaluated subsequent events through the filing date of this Form
10-K/A, and determined that no subsequent events have occurred that would
require recognition in the consolidated financial statements or disclosure in
the notes thereto other than as discussed in the accompanying notes (see Note
10).





Recently Issued Accounting
Pronouncements


The
Company has adopted all accounting pronouncements effective before December 31,
2009 which are applicable to the Company.





In
September 2009, the FASB issued an update to its accounting guidance
regarding multiple-deliverable revenue arrangements. The guidance addresses how
to measure and allocate consideration to one or more units of accounting.
Specifically, the guidance requires that consideration be allocated among
multiple deliverables based on relative selling prices. The guidance establishes
a selling price hierarchy of (1) vendor-specific objective evidence, (2)
third-party evidence and (3) estimated selling price. This guidance is effective
for annual periods beginning on or after June 15, 2010 but may be early adopted
as of the beginning of an annual period. The Company expects to adopt this
guidance on January 1, 2010 and does not expect this guidance to have a material
impact on its financial statements.





In
October 2009, the FASB issued an update to its accounting guidance
regarding software revenue recognition. The guidance changes the accounting
model for revenue arrangements that include both tangible products and software
elements. Under this guidance, tangible products containing software components
and non-software components that function together to deliver the tangible
product’s essential functionality are excluded from the software revenue
guidance in FASB ASC Topic 985, “Software.” In addition,
hardware components of a tangible product containing software components are
always excluded from the software revenue guidance. This guidance is effective
prospectively for revenue arrangements entered into or materially modified in
fiscal years beginning on or after June 15, 2010 but may be early adopted. The
Company expects to adopt this guidance on January 1, 2010 and does not expect
this guidance to have a material impact on its financial
statements.





In
January 2010, the FASB issued an update to its accounting guidance regarding
fair value measurement and disclosure. The guidance affects the disclosures made
about recurring and non-recurring fair value measurements. This guidance is
effective for annual reporting periods beginning after December 15, 2009, except
for the disclosures about purchases, sales, issuances and settlements in the
roll forward of activity in Level 3 fair value measurements. Those disclosures
are effective for fiscal years beginning after December 15,
2010.  Early adoption is permitted. The Company is currently
evaluating the impact that this guidance will have on its financial
statements.





In
February 2010, the FASB issued amended guidance on subsequent events. Under
this amended guidance, SEC filers are no longer required to disclose the date
through which subsequent events have been evaluated in originally issued and
revised financial statements. This guidance was effective immediately and will
be adopted in the quarter ended September 30, 2010.




F-12




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
2 – RESTATEMENT OF FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31,
2009





On
November 19, 2010, the Company’s Audit Committee concluded that the Company’s
financial statements for the year ended December 31, 2009 and the quarters ended
March 31, 2009, June 30, 2009 and September 30, 2009, and the quarters ended
March 31 and June 30,2010 should be restated in order to make the following
adjustments:  (i) the Black Scholes value of the warrants issued by
the Company in March 2009 pursuant to the Media and Marketing Services Agreement
should have been classified as an operating expense rather than interest expense
and that the Black Scholes value of the warrants should be measured as of each
monthly vesting date rather than the grant date starting from March 2009 through
September 2010; (ii) certain warrants issued to consultants must be revalued as
of their respective vesting dates rather than the grant date, using the Black
Scholes method; and (iii) all of the Company’s advertising expenses starting in
the fourth quarter of 2009 should have been expensed as incurred rather than
capitalized and amortized against revenues for a period of 12 months under ASC
340-20  (collectively, the “Adjustments”).





The
following tables set forth the effects of the restatement on certain line items
within our balance sheet at December 31, 2009:




December 31, 2009Restated
                            
                            
                            Adjustments
                            
                            
                            As FiledDeferred
      charges, current
                            
                            $
                            3,316,535
                            
                            
                            $
                            (2,312,753
                            )
                            
                            $
                            5,629,288
                            (1)Total
      Current Assets
                            
                            $
                            9,223,207
                            
                            
                            $
                            (2,312,753
                            )
                            
                            $
                            11,535,960Additional
      paid-in capital
                            
                            $
                            36,884,000
                            
                            
                            $
                            3,825,872
                            
                            
                            $
                            33,058,128
                            (2)(4)Accumulated
      deficit
                            
                            $
                            (44,930,550
                            )
                            
                            $
                            (6,138,625
                            )
                            
                            $
                            (38,791,925
                            )    (3)Total
      Stockholders’ Deficit
                            
                            $
                            (8,020,876
                            )
                            
                            $
                            (2,312,753
                            )
                            
                            $
                            (5,708,123
                            )




Reference


(1)
Expensing of direct-response advertising costs as incurred rather than
capitalizing and amortizing per ASC 340-20.


(2)
Increase in the value of the warrants as revalued at vesting dates using black
scholes method.


(3) The
Adjustments as described above.


Per Note
2 above, there was a reclassification from common stock to additional paid-in
capital as a result of the merger.


The
following tables set forth the effects of the restatement on certain line items
within our statement of operations for the year ended December 31,
2009:




For the Year EndedDecember 31, 2009Restated
                          
                          
                          Adjustments
                          
                          
                          As FiledMedia
      and marketing services
                          
                          $
                          21,308,667
                          
                          
                          $
                          8,227,158
                          
                          
                          $
                          13,081,509
                          (1)Investor
      relations and other related consulting
                          
                          $
                          2,473,345
                          
                          
                          $
                          (730,443
                          )
                          
                          $
                          3,203,788
                          (2)Total
      Operating Expenses
                          
                          $
                          32,237,721
                          
                          
                          $
                          7,496,715
                          
                          
                          $
                          24,741,006LOSS
      FROM OPERATIONS
                          
                          $
                          (17,578,290
                          )
                          
                          $
                          (7,496,715
                          )
                          
                          $
                          (10,081,575
                          )Interest
      expense
                          
                          $
                          2,371,724
                          
                          
                          $
                          (1,358,090
                          )
                          
                          $
                          3,729,814
                          (2)NET
      LOSS
                          
                          $
                          (19,841,756
                          )
                          
                          $
                          (6,138,625
                          )
                          
                          $
                          (13,703,131
                          )EPS
                          
                          $
                          (0.91
                          )
                          
                          $
                          (0.28
                          )
                          
                          $
                          (0.63
                          )





Reference


(1) $2.3
million relates to expensing of direct-response advertising costs as incurred
rather than capitalizing and amortizing per ASC 340-20 and balance relates to
reclassification of warrants from interest expense and revaluation of
warrants.


(2)
Reclassification of warrants from interest expenseand revaluation of
warrants.





NOTE
3 – RESTRICTED CASH





Under a
credit card processing agreement with a financial institution, the Company is
required to maintain a security reserve deposit as collateral.  The
amount of the deposit is at the discretion of the financial institution and as
of December 31, 2009 and 2008 was $10,000 and $15,000, respectively. Under a
separate credit card processing agreement with a different financial
institution, the Company is also required to maintain a security reserve deposit
as collateral. The amount of the deposit is currently based on 10% of the
six-month rolling sales volume and was approximately $1.3 million and $0 as of
December 31, 2009 and 2008, respectively. The security reserve deposit is funded
by the institution withholding a portion of daily cash receipts from Visa and
MasterCard transactions.





On
September 30, 2009, the Company entered into a second amendment to its lease as
more fully described in Note 9 below. As part of the amendment the Company is
required to issue a $250,000 letter of credit as a security deposit. The letter
of credit is collateralized by cash held in an account at the Company’s bank.
The account is interest bearing and the Company receives the interest that is
earned.




F-13




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
4 – PROPERTY AND EQUIPMENT





Property
and equipment consists of the following:


December 31,
                    
                    
                    December 31,2009
                    
                    
                    2008Furniture
      and fixtures
                    
                    $
                    121,370
                    
                    
                    $
                    121,370Leasehold
      improvements
                    
                    
                    169,661
                    
                    
                    
                    —Office
      equipment
                    
                    
                    97,227
                    
                    
                    
                    88,294Software
                    
                    
                    17,333
                    
                    
                    
                    10,766405,591
                    
                    
                    
                    220,430Less
      accumulated depreciation and amortization
                    
                    
                    (162,664
                    )
                    
                    
                    (125,547
                    )Property
      and equipment, net
                    
                    $
                    242,927
                    
                    
                    $
                    94,883





NOTE
5 - INCOME TAXES





The
Company is subject to taxation in the United States and the State of
California.  The Company is subject to examination for tax years 2005
forward by the United States and the tax years 2004 forward by
California.  The Company may be, due to unused net operating losses,
subject to examination for earlier years.





Deferred
income taxes reflect the tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting and income
tax purposes.  A valuation allowance is established when uncertainty
exists as to whether all or a portion of the net deferred tax assets will be
realized.





Components
of the net deferred tax asset as of December 31, 2009 and 2008 are approximately
as follows:





December 31,2009
                      
                      
                      2008Deferred
      tax assetsNet
      operating loss carryforwards
                      
                      $
                      9,595,000
                      
                      
                      $
                      5,703,000Stock
      compensation expense
                      
                      
                      453,000
                      
                      
                      
                      336,000Accrued
      liabilities
                      
                      
                      48,000
                      
                      
                      
                      41,000Contingent
      liabilities
                      
                      
                      11,000
                      
                      
                      
                      20,000Accounts
      payable
                      
                      
                      19,000
                      
                      
                      
                      19,000AMT
      credit carryforwards
                      
                      
                      6,000
                      
                      
                      
                      6,000Warrants
      issued for services
                      
                      
                      3,154,000
                      
                      
                      
                      347,000Deferred
      revenue
                      
                      
                      420,000
                      
                      
                      
                      199,000Total
      gross deferred tax assets
                      
                      
                      13,706,000
                      
                      
                      
                      6,671,000Deferred
      tax liabilitiesDepreciation/amortization
                      
                      
                      (23,000
                      )
                      
                      
                      21,000Total
      gross deferred tax liabilities
                      
                      
                      (23,000
                      )
                      
                      
                      21,000Net
      deferred tax asset
                      
                      
                      13,683,000
                      
                      
                      
                      6,692,000Less
      valuation allowance
                      
                      
                      (13,683,000
                      )
                      
                      
                      (6,692,000
                      )Net
      deferred tax assets
                      
                      $
                      -
                      
                      
                      $
                      -





F-14




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
5 - INCOME TAXES (continued)





The
Company’s effective income tax rate differs from the statutory federal income
tax rate as follows for the years ended December 31, 2009 and 2008:





December 31,2009
                                  
                                  
                                  2008Federal
      tax benefit rate
                                  
                                  
                                  -34.0
                                  %
                                  
                                  
                                  -34.0
                                  %State
      tax benefit, net of federal benefit
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -1.8
                                  %Loan
      discount accretion
                                  
                                  
                                  2.9
                                  %
                                  
                                  
                                  3.9
                                  %Investment
      banking fees
                                  
                                  
                                  -
                                  
                                  
                                  
                                  5.6
                                  %Other
                                  
                                  
                                  -2.5
                                  %
                                  
                                  
                                  6.1
                                  %Valuation
      allowance
                                  
                                  
                                  33.6
                                  %
                                  
                                  
                                  20.2
                                  %Effective
      income tax rate
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -





The
change in the valuation allowance for the years ended December 31, 2009 and 2008
was approximately $6,991,000 and $2,582,000, respectively.





At
December 31, 2009, the Company had federal and state net operating loss
carryforwards of $25,943,000 and $15,169,000 available, respectively, to reduce
future taxable income and which will expire at various dates beginning in 2015
through 2025.





Pursuant
to Internal Revenue Code Sections 382 and 383, the use of the Company’s net
operating loss and credit carryforwards may be limited if a cumulative change in
ownership of more than 50% occurs within a three-year period.  The
annual limitation may result in the expiration of net operating losses and
credits before utilization.





The
Company has not completed a study to assess whether an ownership change has
occurred or whether there have been multiple ownership changes since the
Company's formation due to the complexity and cost associated with such a study,
and the fact that there may be additional such ownership changes in the future.
If the Company has experienced an ownership change at any time since its
formation, utilization of the NOL carryforwards would be subject to an annual
limitation under Section 382 of the Code, which is determined by first
multiplying the value of the Company's stock at the time of the ownership change
by the applicable long-term, tax-exempt rate, and then could be subject to
additional adjustments, as required. Any limitation may result in expiration of
a portion of the NOL carryforwards before utilization. Further, until a study is
completed and any limitation known, no amounts are being considered as an
uncertain tax position or disclosed as an unrecognized tax benefit. Due to the
existence of the valuation allowance, future changes in the Company's
unrecognized tax benefits will not impact its effective tax rate. Any
carryforwards that will expire prior to utilization as a result of such
limitations will be removed from deferred tax assets with a corresponding
reduction of the valuation allowance.





NOTE
6 – STOCKHOLDERS’ DEFICIT





Common
Stock


On
October 18, 2007, the Company began an offering of units. Each unit consisted of
25,000 shares of common stock and a warrant to purchase 18,750 shares of common
stock at an exercise price of $1.25 per share. The purchase price was $25,000
per unit. The warrants have a term of five years. Pursuant to the warrant
agreements, from and after the warrant issue date, in the event the Company
sells common stock for less than the exercise price or issues securities
convertible into or exercisable for common stock at a conversion price or
exercise price less than the exercise price (a “Dilutive Issuance”), then the
exercise price shall be multiplied by a fraction, the numerator of which is the
number of shares of common stock sold and issued at the closing of such Dilutive
Issuance plus the number of shares which the aggregate offering price of the
total number of shares of common stock sold and issued at the closing of such
Dilutive Issuance would purchase at the exercise price, and the denominator of
which is the number of shares of common stock issued and outstanding on the date
of such Dilutive Issuance plus the number of additional shares of common stock
sold and issued at the closing of such Dilutive Issuance. As of April 1, 2009,
the holders of the warrants have waived their rights to any adjustments to the
exercise price as a result of a Dilutive Issuance (see Note 1).





F-15




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE 6 – STOCKHOLDERS’ DEFICIT
(continued)





During
February and March 2008, the Company raised $175,000 through this offering and
issued 175,000 shares of common stock and warrants to purchase 131,250 shares of
common stock.  The warrants issued in connection with the units were
valued at $118,058 using the Black-Scholes option pricing
model.  Issuance costs consisted of a 7% cash fee and an additional
warrant to purchase 8,750 shares of common stock with an exercise price of $1.00
per share valued at $7,895 using the Black-Scholes option pricing
model.  In May 2008, the Company updated the agreement prospectively
with the placement agent to increase both the cash and warrant placement fees
from 7% to 9% as well as to provide to the placement agent a 2.5% cash expense
allowance. From June through August 2008, the Company issued 980,500 shares and
raised $867,743, net of placement fees, through this offering. The 735,375
warrants issued in connection with the units were valued at $740,369 using the
Black-Scholes option pricing model. Issuance costs included additional warrants
at $1.00 per share to purchase 9% of the number of shares of common stock sold
in the offering, valued at $83,573.





On
February 12, 2008, the Company entered into a consulting agreement with New
Castle Consulting.Pursuant to
this agreement, New Castle provided investor relations services to the Company
for a period of six months in exchange for payment of $4,500, which was made in
conjunction with the execution of the agreement, a monthly fee of $4,500, the
payment of which began in March 2008, the issuance of 100,000 shares of
restricted common stock valued at $100,000 and an indemnity.  As the
shares were unforfeitable and fully vested upon issuance and there was no
guarantee of future benefit to be provided, the value of the shares was expensed
upon issuance to investor relations and other related consulting
expense.





On
February 14, 2008, the Company entered into a consulting agreement with Kulman
IR. Pursuant to this agreement, Kulman was to provide investor relations
services to the Company for a period of 12 months in exchange for a monthly fee
of $3,500, the issuance of 100,000 shares of restricted common stock valued at
$100,000, the payment of pre-approved expenses incurred by Kulman in discharging
its obligations under the agreement and cross-indemnities. Regarding the stock
that was issued, 50,000 shares vested immediately, 25,000 shares vested on
August 7, 2008 and the remaining 25,000 shares were to vest on October 7, 2008.
During August 2008, the Company terminated the agreement and cancelled the
25,000 unvested shares. As there was no guarantee of future benefit to be
provided, the value of the shares was expensed upon issuance to investor
relations and other related consulting expense.





On July
15, 2008, the Company entered into a consulting agreement with Frontier Capital
Partners L.L.C. (“Frontier”) pursuant to which Frontier agreed to provide
investor relations and other business advisory services. The agreement term was
three months, but the agreement could be terminated by either party upon five
days written notice. The agreement also includes provisions allowing immediate
termination in the event of dissolution, bankruptcy or insolvency and for cause.
The Company agreed to issue to Frontier 125,000 shares of its restricted common
stock as compensation for these services. 75,000 of these shares, valued at
$81,000, were issued immediately (upon execution of the agreement) and were
deemed to be a non-refundable retainer. The remaining 50,000 shares, valued at
$63,000, were issued 46 days after execution of the agreement. The value of the
shares was expensed to investor relations and other related consulting
expense.





On August
14, 2008, a holder of warrants to purchase 98,121 shares of common stock of the
Company at a price of $1.01 per share exercised the warrants under Section 3(c)
of the warrant document which allows for cashless exercise of the warrants. As a
result, the Company issued 37,985 shares of its common stock.





During
2009, nine investors exercised warrants to purchase 393,989 shares of common
stock exercisable at $1.00 to $1.01 per share.  The warrants were
exercised pursuant to the cashless provision contained in the warrants and as
such, the Company issued 234,447 shares to the investor.





During
2009, eight investors exercised warrants to purchase 192,208 shares of common
stock exercisable at $1.00 to $1.25 per share.  The Company received
proceeds of $238,958.





In
February 2009, the Company issued 94,628 shares of restricted common stock
valued at $1.10 per share to a vendor as settlement for past services
rendered.





On June
4, 2009, the Company closed the sale and issuance of 1,142,860 shares of common
stock to a subsidiary of Guthy-Renker, GR Match, LLC (“GRM”) for an aggregate
purchase price of $2,000,005, of which $400,000 (the “Commercial Funds”) must be
used for the creation and production by GRM of television commercials
advertising the Company’s products and services, and the balance of which the
Company will use for general working capital. At December 31, 2009, the balance
of the Commercial Funds of $161,153 was recorded in prepaid expenses on the
accompanying balance sheet. Pursuant to the terms of the Securities Purchase
Agreement documenting the transaction, GRM has demand and piggyback registration
rights with respect to the shares. Also, in the event the Company sells or
issues shares of its common stock or common stock equivalents at a price per
share below $1.75 during the ninety days following the closing of the
transaction, except for certain exempt issuances, GRM will receive additional
shares of common stock in order to effectively re-price the shares at such lower
price. No additional shares were issued below $1.75 during the ninety-day
period.




F-16





CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (continued)




On June
10, 2009, the Company closed the sale and issuance of 632,500 shares of common
stock to Shimski L.P. for an aggregate purchase price of $1,106,875. Pursuant to
the terms of the Securities Purchase Agreement, Shimski L.P. has demand and
piggyback registration rights with respect to the shares. Also, in the
event the Company sells or issues shares of its common stock or common stock
equivalents at a price per share below $1.75 during the ninety days following
the closing of the transaction, except for certain exempt issuances, Shimski
L.P. will receive additional shares of common stock in order to effectively
re-price the shares at such lower price. No additional shares were issued below
$1.75 during the ninety-day period.





On July
21, 2009, the Company closed the sale and issuance of 200,000 shares of common
stock to twenty-eight accredited investors for an aggregate purchase price of
$500,000, the proceeds of which the Company will use for general working
capital. There were no issuance costs related to this sale.





On August
17, 2009, the Company issued 1,838,952 shares of common stock for warrants that
were exercised in connection with a tender offer as more fully described in
“stock warrants” below.





See
“stock options” below for additional shares issued related to the exercise of
stock options.





See Note
6 for a discussion of additional shares of common stock issued during the year
ended December 31, 2009 related to the convertible notes payable.





Stock
warrants


On
November 11, 2008, the Company entered into a consulting agreement with Newview
Consulting L.L.C. (“Newview”) Pursuant to this agreement, Newview agreed to
provide investor relations services in exchange for a warrant to purchase
2,250,000 shares of common stock at a price of $1.25 per share. 900,000 warrants
vested immediately and 270,000 warrants were to vest on the 1st of each month
beginning December 1, 2008 and ending April 1, 2009. At January 1, 2009, the
Company amended the vesting schedule in the Newview warrant to vest the
remaining 1,080,000 warrants on the first of each month from January 1, 2009 to
June 1, 2009 at the rate of 180,000 warrants per month.  1,080,000 and
1,170,000 warrants vested during the years ended December 31, 2009 and 2008,
respectively. The warrants were valued at $1,932,289, using the Black Scholes
pricing model, and $1,010,673 and $921,616 was expensed to investor relations
and other consulting expense for the years ended December 31, 2009 and 2008,
respectively.





On
January 17, 2009, the Company entered into a two-month consulting agreement with
Michael Barrett for consulting services relating to financial management and
reporting.  As part of the agreement, Mr. Barrett was granted a
warrant to purchase 2,500 shares of common stock with a term of five years at an
exercise price of $1.25 per share, for each month of the term of the
agreement.  The fair value of these warrants was $3,753, using a Black
Scholes pricing model, and was expensed to investor relations and other
consulting expense.





On
October 30, 2008, the Company executed a letter of intent with GRM to create,
market and distribute direct response advertisements to sell the Company’s
products.  GRM is responsible for creating, financing, producing,
testing and evaluating a radio commercial to market the Company’s products in
exchange for $50,000 and a fully vested, non-forfeitable warrant to purchase
1,000,000 shares of common stock at a price of $1.25 per share with an estimated
fair value of $951,495 using the Black-Scholes pricing model.  The
fair value of the warrant was recorded to prepaid expenses at the time of
issuance and has been expensed over the five-month term of service. The Company
expensed $570,897 and $380,598 to media and marketing services expense for the
years ended December 31, 2009 and 2008, respectively. The warrant included an
anti-dilutive provision that reduced the exercise price of the warrant if the
Company at any time while this warrant is outstanding sells and issues any
common stock at a price per share less than the then exercise price. During
August 2009, the Company received a waiver whereby GRM permanently waived, as of
and after April 1, 2009, any and all exercise price adjustments that would
otherwise occur, or would have occurred on or after April 1, 2009, as a result
of this provision.





On March
24, 2009, the Company entered into a Media and Marketing Services Agreement with
GRM.  Pursuant to the agreement, GRM will provide direct response
media campaigns, including radio and television direct response commercials, to
promote the Company’s products and services and will purchase media time on the
Company’s behalf.  During the term of the agreement, which is to
continue until August 31, 2010, subject to certain rights of termination, GRM
will be the exclusive provider of all media purchasing and direct response
production services.  On June 23, 2009, because the agreement had not
been terminated, the Company appointed a representative of GRM to the Company’s
board of directors.  A GRM representative will continue to serve
throughout the term of the agreement and for so long as GRM owns shares of the
Company’s common stock or the right to purchase shares of the Company’s common
stock which constitute at least 5% of the Company’s issued and outstanding
common stock.




F-17




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (Continued)





As
compensation for GRM’s services, the Company agreed to amend the warrant
described above so that the terms were consistent with the warrants described
below.  None of the amended terms resulted in an accounting change to
the warrant.  In conjunction with the execution of the Media and
Marketing Services Agreement and for creating, financing, producing, testing and
evaluating a television commercial to market the Company’s products, the Company
issued to GRM a second five-year warrant for the purchase of 1,000,000 shares of
the Company’s common stock at a price of $1.25 per share valued at $712,303
using the Black-Scholes pricing model.  The fair value of the warrant
was recorded to prepaid expenses at the time of issuance and was expensed over
the five-month expected term of service to media and marketing services
expense.  This warrant may be exercised only for
cash.  Finally, the Company agreed to issue to GRM a five-year warrant
(“Media Services Warrant”) for the purchase of 8,000,000 shares of the Company’s
common stock at an exercise price of $1.25 per share.  The Media
Services Warrant may be exercised only with cash and is subject to vesting as
follows: for each $2 of media placement costs advanced by GRM on the Company’s
behalf, the right to purchase one share of the Company’s common stock will
vest.  As of December 31, 2009, the right to purchase 1,837,332 of the
8,000,000 Media Services Warrant shares has vested and was valued at $4,631,206
using the Black-Scholes pricing model.  The fair value of these vested
shares has been expensed to media and marketing services expense. The remaining
6,162,668 shares from the Media Services Warrant are not guaranteed to vest as
they are contingent on GRM advancing media placement costs, therefore, these
unvested warrants have not been included or accounted for as outstanding
dilutive securities at December 31, 2009. These warrants included an
anti-dilutive provision that reduced the exercise price of the warrants if the
Company at any time while the warrants are outstanding sells and issues any
common stock at a price per share less than the then exercise price. During
August 2009, the Company received a waiver whereby GRM permanently waived, as of
and after April 1, 2009, any and all exercise price adjustments that would
otherwise occur, or would have occurred on or after April 1, 2009, as a result
of this provision.





If GRM
terminates the agreement due to a breach by the Company in the Company’s
performance or as a result of the Company’s discontinuance, dissolution,
liquidation, winding up or insolvency, or if the Company terminates the
agreement for any reason, any unexpired and unvested rights of GRM to purchase
shares of the Company’s common stock pursuant to the agreement will immediately
vest. If the Company breaches its payment obligations under the agreement and
fails to cure the breach within 15 days after receiving notice from GRM, then
the number of warrant shares which would otherwise vest during the month of the
delinquent payment will automatically double.





In
November 2009, the Company amended the Media and Marketing Services Agreement
with GRM. Pursuant to this amendment, if any of the warrants that have been
issued to GRM are outstanding and the Company sells and issues common stock at a
price per share less than the exercise price set forth in the applicable
warrant, as adjusted thereunder (such issuances collectively, a “Lower Priced
Issuance”), without the prior written consent of GRM, then 37.5%of any unexpired and
unvested rights of GRM to purchase shares of the Company’s common stock pursuant
to the Media Services Warrant shall immediately and automatically vest in full
without any notice or action of GRM. As of December 31, 2009, no common stock
has been issued at a price less than the exercise price of the GRM
warrants.





On April
1, 2009, the Company entered into an agreement with a consultant for management
consulting and business advisory services on an as needed basis.  The
consultant was granted a warrant to purchase 850,000 shares of the Company’s
common stock for a period of five years at an exercise price of
$1.25.  These warrants vest as follows: 300,000 immediately and 50,000
per month on the 1st day of
each month commencing May 1, 2009 and ending March 1, 2010. As of December 31,
2009, the right to purchase 700,000 of the 850,000 warrant shares has vested and
was valued at $1,162,294 using the Black-Scholes pricing model.  The
fair value of the vested warrants has been expensed to investor relations and
other consulting expense.





On April
5, 2009, the Company entered into an agreement with a consultant for marketing
related services.  The agreement had a term of three
months.  The agreement provided compensation of $13,000 for month one,
$14,000 for month two and $15,000 for month three.  In addition, the
consultant was granted a warrant to purchase 15,000 shares of the Company’s
common stock for a period of five years at an exercise price of
$1.25.  This warrant was to vest 5,000 shares per month over the term
of the agreement. On May 15, 2009, the original agreement was terminated, along
with the right to purchase 8,387 shares of common stock that would have vested
over the remaining term of the agreement, and the Company entered into a second
agreement with the consultant.  The second agreement had a term of
three months and provided for compensation of $17,500 for month one, of which
50% was deferred for 30 days, and $8,750 per month thereafter. In addition, the
consultant was granted a warrant to purchase 15,000 shares of the Company’s
common stock for a period of five years at an exercise price of
$1.25.  The warrant was to vest 5,000 shares per month over the term
of the second agreement. The second agreement also provided for a bonus of up to
50,000 additional warrant shares at an exercise price of $1.83 for achieving
certain goals. On June 15, 2009, the second agreement was terminated, along with
the right to purchase 10,000 shares of common stock that would have vested in
July and August 2009, and the Company entered into a third agreement with the
consultant.  The third agreement had a term of two months. The third
agreement provided compensation of $12,500 per month. In addition, the
consultant was granted a warrant to purchase 10,000 shares of the Company’s
common stock for a period of five years at an exercise price of
$1.25.  This warrant vests 5,000 shares per month over the term of the
agreement. Additionally, the consultant was granted a warrant to purchase 5,000
shares of the Company’s common stock for a period of five years at an exercise
price of $1.83 for deferring 50% of the compensation due for May 2009 until July
30, 2009 and a warrant to purchase 5,000 shares of the Company’s common stock
for a period of five years at an exercise price of $1.83 as part of the bonus
that was earned under the second agreement. The third agreement also provided
for a bonus of up to 45,000 additional warrant shares at an exercise price of
$1.83 for achieving certain goals. These goals were achieved and the Company
issued the bonus warrant to the consultant on August 15, 2009. The fair value of
the 76,613 warrant shares that were granted and vested totaled $127,803 and was
expensed to investor relations and other consulting expense.





On April
24, 2009, the Company entered into an agreement with Michael Barrett for
consulting services relating to financial management and
reporting.  As part of the agreement, Mr. Barrett was granted a
warrant to purchase 2,500 shares of common stock at an exercise price of $1.80
per share. The fair value of the warrant was $3,453, using a Black Scholes
pricing model, and was expensed to investor relations and other consulting
expense.




F-18




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (Continued)





In May
2009, the Company began an offering to the holders of its warrants issued with
“cashless exercise” provisions and/or “down-round” provisions (collectively the
“Released Provisions”).  Pursuant to the offering, the warrant holders
were given the opportunity to increase by 10% the number of shares of common
stock covered by their warrants in exchange for extinguishing the Released
Provisions from their warrants.  In order for the warrant holders to
take advantage of the offer, they were required to exercise a portion of their
warrant(s) and purchase for cash no less than 30% of the shares of common stock
covered by their warrant(s), after giving effect to the increase.  On
June 29, 2009, the Company filed a Schedule TO with the SEC covering this
offering.  Per the Schedule TO, the offering was to expire on July 28,
2009.  The Schedule TO was subsequently amended and the offering was
extended until August 17, 2009. The Company received $2,008,180 in proceeds, net
of offering costs of $72,835, and issued 1,838,952 shares of common stock to
warrant holders that participated in this offer.  Additionally, the
Company issued warrants to purchase 269,681 shares of the Company’s common stock
which represented the 10% increase in the shares of common stock covered by the
warrants. The additional warrants were valued at $548,728, using the Black
Scholes pricing model, and were expensed to interest expense.





On May
15, 2009, the Company entered into an agreement with a consultant for marketing
related services.  The agreement had a term of three months and
provided compensation of $17,500 for month one, of which 50% will be deferred
for 30 days, and $8,750 per month thereafter. In addition, the consultant was
granted a warrant to purchase 15,000 shares of the Company’s common stock for a
period of five years at an exercise price of $1.83.  The warrant was
to vest 5,000 shares per month over the term of the agreement. The agreement
also provided for a bonus of up to 50,000 additional warrant shares at an
exercise price of $1.83 for achieving certain goals. On June 15, 2009, the
agreement was terminated, along with the right to purchase 10,000 shares of
common stock that would have vested in June and July 2009, and the Company
entered into a second agreement with the consultant.  The second
agreement had a term of two months and provided for compensation of $12,500 per
month. In addition, the consultant was granted a warrant to purchase 10,000
shares of the Company’s common stock for a period of five years at an exercise
price of $1.83.  This warrant vests 5,000 shares per month over the
term of the agreement. Additionally, the consultant was granted a warrant to
purchase 5,000 shares of the Company’s common stock for a period of five years
at an exercise price of $1.83 for deferring 50% of the compensation due for May
2009 until July 30, 2009 and a warrant to purchase 5,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.83 as part of
the bonus that was earned under the first agreement. The second agreement also
provided for a bonus of up to 45,000 additional warrant shares at an exercise
price of $1.83 for achieving certain goals. These goals were achieved and the
Company issued the bonus warrant to the consultant on August 15, 2009. The fair
value of the 70,000 warrant shares that were granted and vested of $115,684 was
expensed to investor relations and other consulting expense.





On August
1, 2009, the Company entered into an agreement with a consultant for business
development services related to the signing of the Wiley licensing
contract.  The consultant was granted a warrant to purchase 55,000
shares of the Company’s common stock for a period of three years at an exercise
price of $2.18.  The warrant was to vest 15,000 shares at the signing
of the Wiley contract, 15,000 shares at the Wiley launch and 25,000 shares at
the earlier of the first anniversary date of the agreement or when sales of the
Wiley branded products exceed 100,000 units. The fair value of the 15,000 vested
warrant shares was $25,933 and was expensed to investor relations and other
consulting expense.





On May 1,
2009, the Company entered into an agreement with a consultant to provide
investor relations services.  The agreement was amended in August 2009
to include the issuance of a warrant to purchase 5,000 shares of the Company’s
common stock for a period of three years at an exercise price of $2.25 for each
month the contract remained in effect. The contract was terminated after three
months.  The fair value of the 15,000 warrant shares that were granted
and vested of $23,751 was expensed to investor relations and other consulting
expense.





See Note
6 for additional warrants issued related to the convertible notes
payable.




F-19




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (Continued)




The
following represents a summary of the warrants outstanding at December 31,
2009 and 2008 and changes during the years then ended:





Year EndedDecember 31, 2009
                                        
                                        
                                        December 31, 2008Weighted
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        WeightedNumber
                                        
                                        
                                        Average
                                        
                                        
                                        Aggregate
                                        
                                        
                                        Number
                                        
                                        
                                        Average
                                        
                                        
                                        Aggregateof
                                        
                                        
                                        Exercise
                                        
                                        
                                        Intrinsic
                                        
                                        
                                        of
                                        
                                        
                                        Exercise
                                        
                                        
                                        IntrinsicWarrants
                                        
                                        
                                        Price
                                        
                                        
                                        Value
                                        
                                        
                                        Warrants
                                        
                                        
                                        Prices
                                        
                                        
                                        ValueOutstanding
      and exercisable, beginning of year
                                        
                                        
                                        11,029,890
                                        
                                        
                                        $
                                        1.14
                                        
                                        
                                        
                                        
                                        
                                        
                                        5,741,306
                                        
                                        
                                        $
                                        1.05Issued
                                        
                                        
                                        4,421,916
                                        
                                        
                                        $
                                        1.29
                                        
                                        
                                        
                                        
                                        
                                        
                                        5,386,705
                                        
                                        
                                        $
                                        1.24Exercised
                                        
                                        
                                        (2,425,149
                                        )
                                        
                                        $
                                        1.12
                                        
                                        
                                        
                                        
                                        
                                        
                                        (98,121
                                        )
                                        
                                        
                                        1.01Outstanding,
      end of year
                                        
                                        
                                        13,026,657
                                        
                                        
                                        $
                                        1.20
                                        
                                        
                                        $
                                        45,517,994
                                        
                                        
                                        
                                        11,029,890
                                        
                                        
                                        $
                                        1.14
                                        
                                        
                                        $
                                        1,379,311Exercisable,
      end of year
                                        
                                        
                                        12,836,657
                                        
                                        
                                        $
                                        1.19
                                        
                                        
                                        $
                                        45,000,494
                                        
                                        
                                        
                                        9,949,890
                                        
                                        
                                        $
                                        1.13
                                        
                                        
                                        $
                                        1,357,711




The
following table summarizes information about warrants outstanding at
December 31, 2009:


WeightedAverageNumber of
                              
                              
                              RemainingWarrant
                              
                              
                              ContractualExercise Price
                              
                              Shares
                              
                              
                              Life (Years)$ 1.00
                              
                              
                              2,778,090
                              
                              
                              
                              1.85$ 1.01
                              
                              
                              700,306
                              
                              
                              
                              5.91$ 1.20
                              
                              
                              324,875
                              
                              
                              
                              3.00$ 1.25
                              
                              
                              8,948,396
                              
                              
                              
                              3.44$ 1.80
                              
                              
                              2,500
                              
                              
                              
                              4.31$ 1.83
                              
                              
                              125,000
                              
                              
                              
                              4.38$ 2.05
                              
                              
                              77,490
                              
                              
                              
                              4.73$ 2.18
                              
                              
                              55,000
                              
                              
                              
                              2.72$ 2.25
                              
                              
                              15,000
                              
                              
                              
                              4.6413,026,657




The
weighted average grant date fair value of warrants granted during the years
ended December 31, 2009 and 2008 was $0.91 and $0.92 per share, respectively. As
of December 31, 2009, 150,000 shares of common stock covered by a warrant, with
an estimated remaining value of $139,113, will vest over the next three months.
The weighted average remaining life of the vested warrants is 3.24
years.





F-20




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (Continued)





The
Company’s common stock purchase warrants do not trade in an active securities
market, therefore, we estimate the fair value of these warrants using the
Black-Scholes option pricing model using the following assumptions for the years
ended December 31, 2009 and 2008:




2009
                            
                            
                            2008Annual
      dividend yield
                            
                            
                            0.0
                            %
                            
                            
                            0.0
                            %Average
      expected life (years)
                            
                            
                            2.07-5.10
                            
                            
                            
                            3.00-5.00Risk-free
      interest rate
                            
                            
                            1.46-3.72
                            %
                            
                            
                            3.81-4.52
                            %Expected
      volatility
                            
                            
                            85-103
                            %
                            
                            
                            99-148
                            %





Expected
volatility is based primarily on historical volatility. Historical volatility
was computed using weekly pricing observations for the prior year. The Company
believes this method produces an estimate that is representative of the
Company’s expectations of future volatility over the expected term of these
warrants. The Company currently has no reason to believe future volatility over
the expected remaining life of these warrants is likely to differ materially
from historical volatility. The expected life is based on the remaining term of
the warrants. The risk-free interest rate is based on 5-year to 10-year U.S.
Treasury securities.





Stock
options


In
January 2005, the Company adopted the CyberDefender Corporation 2005 Stock
Option Plan (sometimes called the CyberDefender Corporation 2005 Equity
Incentive Plan and referred to herein as the “2005 Plan”), which provides for
the granting of Incentive Stock Options or Nonstatutory Stock Options, the
issuance of stock appreciation rights, stock purchase rights and awards of
stock. Under the terms of the 2005 Plan, the exercise price of options granted
may be equal to, greater than or less than the fair market value on the date of
grant, the options have a maximum term of ten years and generally vest over
a period of
service or attainment of specified performance objectives. The maximum aggregate
amount of options that may be granted from the 2005 Plan is 931,734
shares.





On
October 30, 2006, the Company adopted the Amended and Restated 2006 Equity
Incentive Plan (“2006 Plan”) that provides for the granting of Incentive Stock
Options or Nonstatutory Stock Options, the issuance of stock appreciation
rights, stock purchase rights and awards of stock. Under the terms of the 2006
Plan, the exercise price of options granted may be equal to, greater than
or less than the fair market value on the date of grant, the options may have a
maximum term of ten years and generally vest over a period of service or
attainment of specified performance objectives. The maximum aggregate amount of
stock based awards that may be granted from the 2006 Plan is 2,875,000
shares.





During
2008, the Company granted to Michael Barrett, the Company’s former Chief
Financial Officer, options to purchase 62,500 shares of common stock at prices
from $1.00 to $1.30 per share.





On April
16, 2008, the Company granted to three consultants options to purchase 130,700
shares of common stock at prices ranging from $1.00 to $1.25 per
share.





On August
1, 2008, the Company granted to Bing Liu, a consultant and former member of the
Company’s Board of Directors, an option to purchase 12,500 shares of common
stock at a price of $1.00 per share.





During
2008, the Company granted to employees options to purchase 262,500 shares of
common stock at prices ranging from $1.01 to $1.44 per share.





On
October 1, 2008, the Company granted to Kevin Harris, a consultant, an option to
purchase 35,000 shares of common at a price of $1.00 per
share.  15,000 of the shares were cancelled as Mr. Harris joined the
Company in January 2009 as described below.





In
January 2009, the Company granted to Kevin Harris, the Company’s Chief Financial
Officer, an option to purchase 200,000 shares of common stock at an exercise
price of $1.00 per share, vesting as follows: 25,000 of the option shares vested
on the date of grant; 25,000 of the option shares vested three months after the
grant date; and the balance of 150,000 option shares vests in equal monthly
increments over the term of his employment agreement.  In addition,
per the terms of the employment agreement, the Company granted options to
purchase a total of 100,000 shares of common stock at an exercise price of $1.00
per share, vesting equally over 24 months, as bonus compensation with 25,000
options being issued at March 31, 2009, June 30, 2009, September 30, 2009, and
December 31, 2009, respectively.





On
January 1, 2009, the Company entered into a three-month consulting agreement
with Unionway International, LLC, an entity controlled by Mr. Bing Liu, for
consulting services.  As part of the agreement, Mr. Liu was granted a
10-year option to purchase 18,000 shares of common stock at an exercise price of
$1.00 per share vesting in equal monthly increments over the term of the
agreement as compensation for 2008 achievements.  In addition, Mr. Liu
has been granted a 10-year option to purchase 5,000 shares of common stock at an
exercise price of $1.00 per share vesting 2,500 shares on January 1, 2009, 1,250
shares on February 1, 2009 and 1,250 shares on March 1, 2009.




F-21




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (Continued)





On
January 17, 2009, the Company entered into a two-month consulting agreement with
Michael Barrett for consulting services relating to financial management and
reporting.  As part of the agreement, Mr. Barrett was granted an
option to purchase 2,500 shares of common stock at an exercise price of $1.25
per share, per month for the term of the agreement.





On April
1, 2009, the Company entered into a three-month consulting agreement with
Unionway International, LLC, an entity controlled by Mr. Bing Liu, for
consulting services.  As part of the agreement, Mr. Liu was granted a
10-year option to purchase 15,000 shares of common stock at an exercise price of
$1.25 per share vesting over the term of the agreement.





On
October 1, 2009, the Company granted to Igor Barash, Chief Product Officer, per
his employment agreement dated July 1, 2008 an option to purchase 150,000 shares
of common stock at a price of $1.00 per share vesting over four years from the
date of the employment agreement.  In addition, the Company granted to
Mr. Barash an option to purchase 47,000 shares of common stock at a price of
$1.00 per share per his prior employment offer dated November 23,
2005.





During
2009, the Company granted to employees options to purchase a total of 417,126
shares of common stock under the 2006 Plan and the 2005 Plan at a prices ranging
from of $1.00 to $4.60 per share.





A summary
of stock option activity for the 2005 Plan and 2006 Plan is as
follows:





Year EndedDecember 31, 2009
                                            
                                            
                                            December 31, 2008Weighted
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            WeightedWeighted
                                            
                                            
                                            
                                            
                                            
                                            Average
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            Weighted
                                            
                                            
                                            AverageNumber
                                            
                                            
                                            Average
                                            
                                            
                                            Remaining
                                            
                                            
                                            Aggregate
                                            
                                            
                                            Number
                                            
                                            
                                            Average
                                            
                                            
                                            Remaining
                                            
                                            
                                            AggregateOf
                                            
                                            
                                            Exercise
                                            
                                            
                                            Contractual
                                            
                                            
                                            Intrinsic
                                            
                                            
                                            of
                                            
                                            
                                            Exercise
                                            
                                            
                                            Contractual
                                            
                                            
                                            IntrinsicOptions
                                            
                                            
                                            Price
                                            
                                            
                                            Term
                                            
                                            
                                            Value
                                            
                                            
                                            Options
                                            
                                            
                                            Prices
                                            
                                            
                                            Term
                                            
                                            
                                            ValueOutstanding,
      beginning of year
                                            
                                            
                                            1,444,084
                                            
                                            
                                            $
                                            0.83
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            1,316,384
                                            
                                            
                                            $
                                            0.75Granted
                                            
                                            
                                            957,126
                                            
                                            
                                            $
                                            1.44
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            503,200
                                            
                                            
                                            $
                                            1.09Exercised
                                            
                                            
                                            (300,679
                                            )
                                            
                                            $
                                            0.93
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (50,000
                                            )
                                            
                                            
                                            0.01Cancelled/forfeited
                                            
                                            
                                            (244,238
                                            )
                                            
                                            $
                                            1.10
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (325,500
                                            )
                                            
                                            $
                                            1.05Outstanding,
      end of year
                                            
                                            
                                            1,856,293
                                            
                                            
                                            $
                                            1.09
                                            
                                            
                                            
                                            7.57
                                            
                                            
                                            $
                                            6,699,108
                                            
                                            
                                            
                                            1,444,084
                                            
                                            
                                            $
                                            0.83
                                            
                                            
                                            
                                            7.66
                                            
                                            
                                            $
                                            649,905Vested
      and expected to vest in the future at December 31, 2009
                                            
                                            
                                            1,677,043
                                            
                                            
                                            $
                                            1.01
                                            
                                            
                                            
                                            7.40
                                            
                                            
                                            $
                                            6,183,077
                                            
                                            
                                            
                                            1,355,037
                                            
                                            
                                            $
                                            0.81
                                            
                                            
                                            
                                            7.55
                                            
                                            
                                            $
                                            635,011Exercisable,
      end of year
                                            
                                            
                                            1,160,210
                                            
                                            
                                            $
                                            0.81
                                            
                                            
                                            
                                            6.71
                                            
                                            
                                            $
                                            4,510,095
                                            
                                            
                                            
                                            1,080,662
                                            
                                            
                                            $
                                            0.73
                                            
                                            
                                            
                                            7.25
                                            
                                            
                                            $
                                            582,098





The
weighted-average grant date fair value of options granted during the years ended
December 31, 2009 and 2008 was $1.29 and $0.96 per share,
respectively.




As of
December 31, 2009 and 2008, 696,083 and 363,242 of the options granted are not
vested with an estimated remaining value of $735,771 and $251,001, respectively.
At December 31, 2009 and 2008, the remaining value of non vested options granted
is expected to be recognized over the weighted average vesting period of 2.53
and 2.95 years, respectively.




The
Company recorded compensation expense associated with the issuance and
vesting of stock options of $308,776 and $252,943 in selling, general and
administrative expense for the years ended December 31, 2009 and 2008,
respectively.





During
the years ended December 31, 2009 and 2008, 300,679 and 50,000 of employee stock
options were exercised for total proceeds to the Company of $279,978 and $535,
respectively.  The aggregate intrinsic value of the exercised options
was $689,630 and $62,965 for the years ended December 31, 2009 and 2008,
respectively.




F-22




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
6 – STOCKHOLDERS’ DEFICIT (Continued)





The
Company’s common stock options do not trade in an active securities market,
therefore, we estimate the fair value of these warrants using the Black-Scholes
option pricing model using the following average assumptions for the years ended
December 31, 2009 and 2008:





2009
                      
                      
                      2008Annual
      dividend yield
                      
                      
                      0.0
                      %
                      
                      
                      0.0
                      %Average
      expected life (years)
                      
                      
                      5.46
                      
                      
                      
                      4.93Risk-free
      interest rate
                      
                      
                      2.25
                      %
                      
                      
                      2.96
                      %Expected
      volatility
                      
                      
                      69.89
                      %
                      
                      
                      143.65
                      %





Expected
volatility is based primarily on historical volatility. The Company believes
this method produces an estimate that is representative of the Company’s
expectations of future volatility over the expected term of these options. The
Company currently has no reason to believe future volatility over the expected
remaining life of these options is likely to differ materially from historical
volatility. The expected life is based on the remaining term of the options. The
risk-free interest rate is based on 5-year to 10-year U.S. Treasury
securities.





NOTE
7 –NOTES PAYABLE





Convertible
Notes


On
September 12, 2006, the Company entered into a Securities Purchase Agreement
with 13 accredited investors pursuant to which it sold 10% secured convertible
debentures (the “2006 Debentures”) in the aggregate principal amount of
$3,243,378 and common stock purchase warrants to purchase an aggregate of
3,243,378 shares of the Company’s common stock at $1.00 per share. The 2006
Debentures are convertible at $1.00 (the “Base Conversion Price”) into shares
of common stock. The 2006 Debentures mature on September 12, 2009 and bear
interest at the rate of 10% per year, payable quarterly. If, during the time
that the 2006 Debentures were outstanding, the Company sells or grants any
option to purchase (other than options issued pursuant to a plan approved by our
board of directors), or sells or grants any right to reprice its securities, or
otherwise disposes of or issues any common stock or common stock equivalents
entitling any person to acquire shares of the Company’s common stock at a price
per share that is lower than the conversion price of the debentures or that is
higher than the Base Conversion Price but lower than the daily volume weighted
average price of the common stock, then the conversion price of the 2006
Debentures will be reduced. During August 2009, the Company received a waiver
whereby the holders of the 2006 Debentures permanently waived, as of and after
April 1, 2009, any and all conversion or exercise price adjustments that would
otherwise occur, or would have occurred on or after April 1, 2009, as a result
of this provision.





Under the
terms of the Registration Rights Agreement executed in conjunction with the
offering, the Company is obligated to register for resale at least 130% of the
shares of its common stock issuable upon the conversion of the 2006 Debentures
and the exercise of the common stock purchase warrants. However, the agreement
also prohibits the Company from registering shares of common stock on a
registration statement that total more than one-half of the issued and
outstanding shares of common stock, reduced by 10,000 shares.





If a
registration statement was not filed within 30 days of the sale of the 2006
Debentures, or was not effective 120 days from the date of the sale of the 2006
Debentures, which was January 10, 2007, or if the Company did not respond to an
SEC request for information during the registration period within 10 days of
notice, the Company was required to pay to each holder of its 2006 Debentures an
amount in cash, as partial liquidated damages and not as a penalty, equal to
1.5% of the aggregate subscription amount paid by each holder. The Company, (1)
was not liable for liquidated damages with respect to any warrants or warrant
shares, (2) was not liable for liquidated damages in excess of 1.5% of the
aggregate subscription amount of the holders in any 30-day period, and (3) the
maximum aggregate liquidated damages payable to a holder was 18% of the
aggregate subscription amount paid by such holder up to a maximum aggregate
liquidated damages of 18% of the total amount of the 2006 Debentures, or
$583,808. If the Company failed to pay any partial liquidated damages in full
within seven days after the date payable, the Company would pay interest at a
rate of 18% per annum to the holder, accruing daily from the date such partial
liquidated damages were due until such amounts, plus all such interest, were
paid in full. The partial liquidated damages applied on a daily pro-rata basis
for any portion of a month.





Pursuant
to Amendment No. 1 to the Registration Rights Agreement, the holders of the
Company’s 2006 Debentures agreed to extend the filing date of the registration
statement to October 31, 2006, and pursuant to Amendment No. 2 to the
Registration Rights Agreement, the holders of the Company’s 2006 Debentures
agreed to extend the filing date of the registration statement to November 3,
2006. The Company did not meet the 10 day response period for responding to an
SEC request for additional information nor did the Company meet the target
registration statement effectiveness date of January 10, 2007. The holders did
not agree to waive the liquidated damages that accrued due to the Company’s
failure to meet the 10 day period for responding to an SEC request for
additional information nor did the holders agree to waive the liquidated damages
that accrued due to the Company’s failure to have the registration statement
declared effective by January 10, 2007.





The
Company believed, at the time the 2006 Debentures were issued, that it was
probable that it would be in violation of certain filing provisions within the
Registration Rights Agreement and recorded $111,897 as a discount to the 2006
Debentures. On March 23, 2007 the Company entered into a Consent and Waiver
agreement as more fully described below that determined the actual liquidated
damages to be $169,917 calculated through March 23, 2007 and covering the period
through April 30, 2007.




F-23





CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
7 –NOTES PAYABLE (Continued)




The
Company was also required to make an interest payment to the 2006 Debenture
holders on April 1, 2007. The Consent and Waiver allowed the Company to make the
April 1 interest payment and pay the liquidated damages in one of two ways to be
chosen by each holder. For payment of the 2006 Debenture holder’s pro rata
portion of the April 1 interest payment, the 2006 Debenture holder could choose
to increase the principal amount of his 2006 Debenture by his pro-rata share of
the accrued interest amount or accept shares of the Company’s common stock
valued at $0.85 per share for this purpose. For payment of the 2006 Debenture
holders pro rata portion of the liquidated damages, each 2006 Debenture holder
had the same choice, that is, either to increase his 2006 Debenture by the pro
rata liquidated damages amount or accept shares of the Company’s common stock
valued at $0.85 per share for this purpose. If all the 2006 Debenture holders
were to choose to accept shares of the Company’s common stock in payment of the
April 1 interest payment and the liquidated damages, the Company would be
required to issue up to a total of 566,336 shares of the Company’s common stock.
The Consent and Waiver allowed the Company to issue these shares without
triggering the anti-dilution rights included in the original offering documents.
The Company issued 195,594 shares during 2007 as partial payment for these
liquidated damages valued at $166,259. At December 31, 2009 and 2008, $3,658 of
these damages remained in accrued expenses. The Company issued 190,090 shares in
November and December 2007 as a partial payment in the amount of $161,580 for
the April 1 interest. The Company issued 15,669 shares in January and February
2008 as a partial payment in the amount of $13,319 for the April 1
interest.





The
Company did not meet the April 30, 2007 date for its registration statement to
be declared effective by the SEC. The registration statement became effective on
July 19, 2007. As a result, the Company incurred additional liquidated damages
for the period May 1 through July 19, 2007 of $132,726. On September 21, 2007
the Company received from the holders of the 2006 Debentures a second Consent
and Waiver. The holders of the 2006 Debentures agreed to accept shares of the
Company’s common stock at $0.85 per share instead of cash as payment
for the interest due on July 1, 2007 and October 1, 2007 and for damages
incurred under the Registration Rights Agreement. The Company issued 135,063
shares in February 2008 as partial payment for these liquidated damages valued
at $106,513. The Company issued 931 shares in April 2009 as partial payment for
these liquidated damages valued at $791. At December 31, 2009 and 2008, $25,422
and $26,213 of these damages remained in accrued expenses, respectively. The
Company issued 94,952 shares in February 2008 as a partial payment in the amount
of $110,147 for the July 1 and October 1, 2007 interest payments.





The
Company did not meet the August 18, 2007 date to file a second registration
statement. As a result, the Company incurred additional liquidated damages for
the period August 18 through December 19, 2007 of $194,603.  The
Company received from the holders of the 2006 Debentures a third Consent and
Waiver, dated February 13, 2008 and amended on August 19, 2008. The third
Consent and Waiver waived the requirement included in the 2006 Debentures and
the Registration Rights Agreement that the Company file a second registration
statement, waived the liquidated damages that accrued from and after December
19, 2007 and waived the payment of any interest that would have accrued on the
liquidated damages. The holders of the 2006 Debentures agreed to accept either
additional debentures or shares of the Company’s common stock at $0.85 per
share instead of cash as payment for the interest due on January 1, 2008
and as payment of the liquidated damages accrued prior to December 19, 2007
under the Registration Rights Agreement. In September 2008, the Company issued
$64,422 in additional unsecured convertible 10% debentures (“2006 Unsecured
Debentures”) as payment of liquidated damages, which included $4,422 of penalty
interest, and $26,868 in 2006 Unsecured Debentures as payment for quarterly
interest due on January 1, 2008, which included $1,868 of penalty interest. The
2006 Unsecured Debentures had a term of 18 months and are convertible at $0.85
per share.  During October and December 2008, the Company issued
$349,494 in 2006 Unsecured Debentures as payment of liquidated damages,
quarterly interest, and penalty interest.  The Company issued 3,750
shares in December 2008 as partial payment for these liquidated damages valued
at $3,750. The Company issued 5,567 shares in April 2009 as final payment for
$4,732 in liquidated damages. At December 31, 2009 and 2008, $0 and $4,732
remained in accrued expenses, respectively.





According
to the terms of the 2006 Debentures, the Company is to make interest payments
quarterly on January 1, April 1, July 1 and October 1 until September 2009, when
the principal amount and all accrued but unpaid interest will be due. On
September 22, 2008 the Company received from the holders of the 2006 Debentures
a fourth Consent and Waiver of defaults of the 2006 Debentures. The holders of
the 2006 Debentures agreed to accept either additional debentures or shares of
the Company’s common stock at $0.85 per share instead of cash as
payment for the interest due on April 1, July 1, and October 1, 2008, totaling
$205,207.  In August 2008, certain holders of the 2006 Debentures
converted $8,694 of accrued interest into 8,694 shares of common stock as more
fully described below. The Company issued 6,250 shares in December 2008 as
partial payment for $6,250 in interest. The Company failed to make the interest
payments that were due on January 1, April 1, and July 1 2009, totaling
$126,614. The Company issued 9,281 shares in April 2009 as partial payment for
$7,886 in interest. In May 2009, the Company paid $56,575 for quarterly
interest, which included $3,810 of penalty interest.  In September
2009, the Company paid $47,614 for quarterly interest. At December 31, 2009 and
2008, $69,982 and $109,946 remained in accrued interest on the 2006 Debentures,
respectively.





The
holders of certain shares and warrants for the purchase of common stock issued
in conjunction with the sale of the Company’s Secured Convertible Promissory
Notes during the period from November 2005 through March 2006, which were
converted on September 12, 2006, also have certain registration rights. These
holders agreed to defer their rights to require registration of their securities
on the registration statement the Company filed; however, they have maintained
the rights to piggyback on future registration statements filed by the
Company.




F-24





CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
7 –NOTES PAYABLE (Continued)





The
Company has accounted for the 2006 Debentures according to FASB ASC Topic 470,
“Debt.” The value of the 2006
Debentures was allocated between the 2006 Debentures, the registration rights
arrangement and the warrants, including the discount, which amounted to $63,689,
$111,897 and $3,067,792, respectively. The discount of $3,179,689 related to the
registration rights arrangement and the warrants, including the discount, is
being amortized over the term of the 2006 Debentures. The Company amortized
$477,282 and $1,071,060 to interest expense for the years ended December 31,
2009 and 2008, respectively, including the acceleration of amortization due to
conversions discussed below.





In
addition, as part of the transaction, the Company paid $217,000, issued
1,000,515 shares of common stock in November 2006 valued at $1,000,515 and
issued 217,000 unit purchase options with each unit consisting of 1 share of
common stock and a warrant to purchase 1 share of common stock for $1.00 per
share in November 2006. The unit purchase options were valued at $374,531 using
the Black-Scholes option pricing model. These costs, totaling $1,592,046, are
being amortized over the term of the 2006 Debentures. The Company recorded
amortization of $238,605 and $535,448 to interest expense, including the
acceleration of amortization due to conversions discussed below, related to the
2006 Debentures during the years ended December 31, 2009 and 2008,
respectively.





During
2008, certain holders of the 2006 Debentures converted $781,408 of principal and
$15,468 of accrued interest, accrued liquidated damages and penalty interest
into 796,876 shares of common stock at $1.00 per share and 86,601 warrants to
purchase shares of the Company’s common stock at $1.25 per share.





During
2009, certain holders of the 2006 Debentures converted $2,001,970 of principal
into 2,001,970 shares of common stock at $1.00 per share.





During
2009, certain holders of the 2006 Unsecured Debentures converted $440,784 of
principal into 518,574 shares of common stock at $0.85 per share.





As of
December 31, 2009, all of the holders of the 2006 Debentures and 2006 Unsecured
Debentures have converted the outstanding principal amount to shares of common
stock and all of the related note discount and debt issuance costs have been
amortized to interest expense.





On
November 21, 2008, the Company entered into a fifth Consent and Waiver agreement
whereby the holders of the 2006 Debentures agreed to allow the Company to sell
up to $1,200,000 in aggregate principal amount of the Company’s 10% Convertible
Promissory Notes (“2008 Convertible Notes”), due eleven months from the date of
issuance and convertible into shares of Common Stock at a conversion price of
$1.25 per share. In consideration of the waiver and the consent provided by the
holders, the Company agreed to accelerate the maturity date of the 2006
Unsecured Debentures to September 12, 2009 and the Company agreed and
acknowledged that the 2006 warrant shares and the shares of common stock
underlying the 2006 Unsecured Debentures issued or issuable to each of the
holders in payment of interest and liquidated damages pursuant to prior consent
and waiver agreements shall carry “piggyback” registration rights.





Per the
Consent and Waiver discussed above, in November and December 2008, the Company
entered into a Securities Purchase Agreement, that also included registration
rights, with certain accredited investors to which it sold 2008 Convertible
Notes in the aggregate principal amount of $845,000, which may be converted at
the price of $1.25 per share (subject to adjustment as discussed below) into an
aggregate of 676,000 shares of common stock.  In conjunction with the
sale of the 2008 Convertible Notes, the Company issued common stock purchase
warrants to purchase an aggregate of 338,000 shares of common stock at $1.25 per
share and paid its placement agent a total of $50,700 in commissions and issued
to its placement agent a five-year warrant to purchase an additional 50,700
shares of the Company’s common stock, at an exercise price of $1.25 per share,
valued at $47,498 using the Black-Scholes option pricing
model.   In January 2009, the Company completed the sale and
issuance of the Company’s 2008 Convertible Notes. Accordingly, the Company
received additional gross proceeds of $355,000, which may be converted at the
price of $1.25 per share (subject to adjustment as discussed below) into an
aggregate of 284,000 shares of common stock.  In conjunction with the
sale of the 2008 Convertible Notes, the Company issued common stock purchase
warrants to purchase an aggregate of 142,000 shares of common stock at $1.25 per
share and paid its placement agent a total of $21,300 in commissions and issued
to its placement agent a five-year warrant to purchase an additional 21,300
shares of the Company’s common stock, at an exercise price of $1.25 per share,
valued at $18,197 using the Black-Scholes option pricing model.





If,
during the time that the 2008 Convertible Notes are outstanding, the Company
sells or grants any option to purchase (other than options issued to its
employees, officers, directors or consultants), or sells or grants any right to
re-price its securities, or otherwise dispose of or issue any common stock or
common stock equivalents entitling any person to acquire shares of our common
stock at a price per share that is lower than the conversion price of these
notes, then the conversion price of the 2008 Convertible Notes will be reduced
according to the following weighted average formula:  the conversion
price will be multiplied by a fraction the denominator of which will be the
number of shares of common stock outstanding on the date of the issuance plus
the number of additional shares of common stock offered for purchase and the
numerator of which will be the number of shares of common stock outstanding on
the date of such issuance plus the number of shares which the aggregate offering
price of the total number of shares so offered would purchase at the conversion
price.  A reduction in the conversion price resulting from the
foregoing would allow holders of the Company’s 2008 Convertible Notes to receive
more than 960,000 shares of its common stock upon conversion of the outstanding
principal amount.  In that case, an investment in the Company’s common
stock would be diluted to a greater extent than it would be if no adjustment to
the conversion price were required to be made. During August 2009, the Company
received a waiver from the holders of the 2008 Convertible Notes pursuant to
which they forever waived, as of and after April 1, 2009, any and all conversion
or exercise price adjustments that would otherwise occur, or would have
otherwise occurred on or after April 1, 2009, as a result of this
provision.




F-25




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
7 –NOTES PAYABLE (Continued)





Under the
terms of the Registration Rights Agreement executed in conjunction with the
offering, the Company was obligated to file a registration statement with the
SEC covering the resale of the shares issuable upon conversion of the 2008
Convertible Notes and the exercise of the common stock purchase
warrants  The Company was required to file the registration statement
no later than 60 days following the final closing date of the sale and issuance
of the 2008 Convertible Notes and warrants, and must use its best efforts to
cause the registration statement to become effective no later than 120 days
thereafter. If the Company was delinquent in the filing deadline or the
effectiveness deadline of the registration statement, it would have been
obligated to pay the holders of the 2008 Convertible Notes liquidated damages
equal to 1% of the outstanding principal amount of the 2008 Convertible Notes
for every 30-day period of delinquency, up to a maximum of 10%. The Company
would have been required to pay any such liquidated damages in cash or its
common stock valued at the average volume weighted average price (“VWAP”) for
the five trading days preceding the applicable due date, provided such average
VWAP exceeds $1.00 per share. On May 1, 2009, the Company received a Consent and
Waiver from the holders of the 2008 Convertible Notes waiving all liquidated
damages under the Registration Rights Agreement.





The
warrants are redeemable at a price of $0.01 per share in the event (i) the
average VWAP of the Company’s common stock for 10 consecutive trading days
equals or exceeds 2.5 times the then current exercise price, (ii) the average
daily trading volume of the common stock during such 10-trading day period is at
least 50,000 shares and (iii) there is an effective registration statement
covering the resale of the shares issuable upon exercise of the
warrants.





The total
value of the 2008 Convertible Notes was allocated between the 2008 Convertible
Notes and the warrants, including the discount, which amounted to $595,646 and
$604,354, respectively. The discount of $604,354 ($158,886 was recorded in 2009)
related to the warrants, including the discount, is being amortized over the
term of the 2008 Convertible Notes. The Company amortized $547,829 and $56,525
to interest expense related to the 2008 Convertible Notes for the years ended
December 31, 2009 and 2008, respectively. At December 31, 2009, $109,001 of
interest has been accrued on these notes.





In
addition, as part of the transaction, the Company paid to the placement agent
$72,000 and issued common stock purchase warrants to purchase an aggregate of
72,000 shares of common stock at $1.25 per share. The warrants were valued at
$65,695 using the Black-Scholes option pricing model. These costs, totaling
$137,695 ($39,497 was recorded in 2009), are being amortized over the term of
the 2008 Convertible Notes.  The Company recorded amortization of
$125,092 and $12,603 to interest expense during the years ended December 31,
2009 and 2008, respectively.





On
September 30, 2009, all of the holders of the 2008 Convertible Notes converted
$1,200,000 of principal into 960,000 shares of common stock at $1.25 per share
and all of the related note discount and debt issuance costs have been amortized
to interest expense.





During
May 2009, the Company entered into a ninth Consent and Waiver agreement whereby
the holders of the 2006 Debentures agreed to allow the Company to sell up to
$300,000 in aggregate principal amount of the Company’s 10% Convertible
Promissory Notes (“2009 10% Convertible Notes”), due five months from the date
of issuance and convertible into shares of Common Stock at a conversion price of
$1.75 per share.  Subsequent to the execution of the Consent and
Waiver, in May 2009, the Company entered into a Securities Purchase Agreement
with certain accredited investors to which it sold 2009 10% Convertible Notes in
the aggregate principal amount of $300,000, which may be converted into an
aggregate of 171,429 shares of common stock.  In conjunction with the
sale of the 2009 10% Convertible Notes, the Company paid its placement agent a
total of $12,000 in commissions. The Company recorded amortization of $12,000 to
interest expense during the year ended December 31, 2009.





The total
value of the 2009 10% Convertible Notes was allocated between the 2009 10%
Convertible Notes and the discount, which amounted to $19,715. The discount is
being amortized over the term of the 2009 10% Convertible Notes. The Company
amortized $19,715 to interest expense related to the 2009 10% Convertible Notes
for the year ended December 31, 2009. At December 31, 2009, $12,500 of interest
has been accrued on these notes.





On
September 30 2009, all of the holders of the 2009 10% Convertible Notes
converted $300,000 of principal into 171,429 shares of common stock at $1.75 per
share and all of the related note discount and debt issuance costs have been
amortized to interest expense.




F-26




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
7 –NOTES PAYABLE (Continued)





On
November 4, 2009, the Company closed the sale and issuance of $2.2 million in
aggregate principal amount of its 8% Secured Convertible Promissory Notes (the
“2009 8% Convertible Notes”), convertible into common stock of the Company at a
conversion price of $2.05 per share.  The Company has the right, up to
and including the trading day immediately prior to the payment due date, to
force the holders to convert all or part of the then outstanding principal
amount of the 2009 8% Convertible Notes, plus accrued but unpaid interest, into
shares of the Company’s common stock if the 10-day volume weighted average price
(sometimes referred to as “VWAP”) exceeds 250% of the conversion price. All
outstanding principal and interest of the 2009 8% Convertible Notes is due April
1, 2011.  Out of the total gross proceeds of the offering, the Company
paid its placement agent $154,980 in commissions, equal to 7% of the gross
proceeds of the offering, and issued to its placement agent a three year warrant
to purchase 77,490 shares of common stock, equal to 3.5% of the number of shares
of common stock into which the Notes initially may be converted, at an exercise
price of $2.05 per share. The warrants were valued at $132,369 using the
Black-Scholes option pricing model. These costs, totaling $287,349, are being
amortized over the term of the 2009 8% Convertible Notes. The Company recorded
amortization of $47,892 to interest expense during the year ended December 31,
2009. In conjunction with the sale of the 2009 8% Convertible Notes, the Company
executed a Security Agreement pursuant to which it granted to the note holders a
first lien security interest, subject only to certain Permitted Liens which are
defined in the Security Agreement, in certain collateral to secure payment of
the 2009 8% Convertible Notes.





The total
value of the 2009 8% Convertible Notes was allocated between the 2009 8%
Convertible Notes and the discount, which amounted to $745,200. The discount is
being amortized over the term of the 2009 8% Convertible Notes. The Company
amortized $124,200 to interest expense related to the 2009 8% Convertible Notes
for the year ended December 31, 2009. At December 31, 2009, $32,719 of interest
has been accrued on these notes.





Convertible
notes payable consist of the following:


December 31, 2009
                        
                        
                        December 31, 20082006
      Debentures
                        
                        $
                        -
                        
                        
                        $
                        2,442,7542008
      Convertible Notes
                        
                        
                        -
                        
                        
                        
                        845,0002009
      8% Convertible Notes
                        
                        
                        2,214,000
                        
                        
                        
                        -Unamortized
      discount
                        
                        
                        (621,000
                        )
                        
                        
                        (866,225
                        )Convertible
      notes payable, net
                        
                        $
                        1,593,000
                        
                        
                        $
                        2,421,529





7.41% Senior Secured
Original Issue Discount Notes


During
2007, the Company sold $864,000 in face amount of its 7.41% Senior Secured
Original Issue Discount Notes (“7.41% Notes”) and warrants to purchase 400,000
shares of the Company’s common stock for a purchase price of $800,000. The 7.41%
Notes are due one year from issuance with interest at 7.41% payable at maturity.
One warrant to purchase 5 shares of the Company’s common stock was issued for
every $10 of purchase price paid. The warrants may be exercised at a price of
$1.20 per share for a period of 5 years beginning nine months after issuance of
the warrant. Pursuant to the warrant agreements, if the Company issues common
stock or common stock equivalents at a price lower than the warrant exercise
price (the “Base Share Price”), then the warrant exercise price will be reduced
to equal the Base Share Price and the number of warrant shares issuable will be
increased so that the aggregate exercise price, after taking into account the
decrease, will be equal to the aggregate exercise price prior to the adjustment.
During August 2009, the Company received a waiver from the holders of the 7.41%
Notes pursuant to which they forever waived, as of and after April 1, 2009, any
and all conversion or exercise price adjustments that would otherwise occur, or
would have otherwise occurred on or after April 1, 2009, as a result of this
provision. The Company has accounted for the debentures according to FASB ASC
Topic 470, “Debt.” The value of the 7.41%
Notes was allocated between the original issue discount (“OID”), the warrants
and the debentures which amounted to $64,000, $242,352 and $557,648,
respectively. The discount related to the OID and warrants of $306,352 will be
amortized over the one year term of the 7.41% Notes. The warrants issued in
connection with the 7.41% Notes were valued using the Black-Scholes option
pricing model.





The
Company recorded $0 and $158,702 of interest expense related to the amortization
of the discount related to the 7.41% Notes and warrants for the years ended
December 31, 2009 and 2008, respectively.





As part
of the second Consent and Waiver described above, the holders of the Debentures
agreed to allow the Company to sell the $864,000 face amount of 7.41% Notes in
exchange for warrants to purchase 150,000 shares of the Company’s common stock
at an exercise price of $1.00 per share. The warrants were valued at $128,038
using the Black-Scholes option pricing model. These costs were recorded as
deferred financing costs and will be amortized over the term of the 7.41% Notes.
As part of the issuance of the 7.41% Notes certain officers of the Company
transferred to Oceana Partners and Carlin Capital 400,000 shares of common stock
valued at $1.00 per share. The value of $400,000 was recorded as deferred
financing cost and was amortized over the term of the 7.41% Notes. The transfer
of shares from the officers was recorded in additional paid-in
capital.




F-27




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
7 – CONVERTIBLE NOTES PAYABLE (Continued)





The
Company recorded amortization of deferred financing costs of $0 and $154,011 to
interest expense related to the 7.41% Notes during the years ended December 31,
2009 and 2008, respectively.




Pursuant
to the Registration Rights Agreement the Company signed in connection with the
offering of the 7.41% Notes, the Company was required to register 125% of the
number of shares underlying the related warrants. The Company was required to
file a registration statement for this purpose within 180 days following the
date that the units were sold, and the Company would be in default of the
Registration Rights Agreement if it failed to file the registration statement
within 30 days following the expiration of the 180 day period. The Company
obtained a Consent and Waiver from the holders of the 7.41% Notes in relation to
the liquidated damages under the Registration Rights Agreement.  As
more fully described below the Company issued 19,616 shares for payment of
$19,616 of liquidated damages in 2008. In 2009, the Company issued 19,143 shares
for final payment of $19,143 of liquidated damages. As of December 31, 2009 and
2008, the Company has recorded $0 and $19,143 in accrued expenses,
respectively.





During
2008, certain holders of the 7.41% Notes converted their notes in the face
amount of $675,000 plus accrued interest of $50,133 and penalties of $19,616
into 744,749 shares of the Company’s common stock and warrants to purchase
558,557 shares of the Company’s common stock at an exercise price of $1.25 per
share.  As the Company’s negotiated conversion was at a price per
share identical to the units described in Note 5, no gain or loss was recorded
upon the conversion. The Company issued 67,027 warrants to purchase shares of
common stock at $1.00 per share for a term of five years, valued at $81,723 per
the Black Scholes pricing model, to the placement agent for this
conversion.





During
June 2008, the Company repaid $189,000 in principal amount of the 7.41% Notes.
At December 31, 2008 all of the 7.41% Notes were converted or paid in
full.





Note Payable to
Shareholder


In March
2008, Gary Guseinov pledged 750,000 shares of his common stock in CyberDefender
Corporation to Michael and Casey DeBaecke in exchange for a loan of $160,000
made to the Company. The pledge was non-recourse to Mr. Guseinov in the event
the collateral was foreclosed upon due to the Company’s failure to pay the loan.
So long as there was no event of default in connection with the loan, Mr.
Guseinov could continue to vote the shares at any annual or special meeting of
the shareholders. The loan was due to be repaid on the earlier of two months
from signing of the loan document or two days following the Company’s receipt of
over $500,000 in new equity capital following the date of the promissory note
evidencing the loan. Additionally, the Company issued warrants to purchase
40,000 shares of the Company’s stock. The warrants may be exercised at a price
of $1.25 per share for a period of 5 years. The discount related to the warrants
of $36,092 was amortized to interest expense during 2008. The warrants issued in
connection with the note were valued using the Black-Scholes option pricing
model. The loan plus accrued interest was paid in full on July 30, 2008 and the
pledge cancelled.





NOTE
8 - CAPITAL LEASE OBLIGATIONS





The
Company leases certain furniture and other equipment under leases with a bargain
purchase option through November 2012 at implicit rates ranging from 11.1% to
12.4%. The following is a schedule by fiscal years of the future minimum lease
payments under this capital lease together with the present value of the net
minimum lease payments at December 31, 2009:





2010
                          
                          $
                          9,4472011
                          
                          
                          6,7532012
                          
                          
                          6,191Total
      minimum lease payments
                          
                          
                          22,391Less
      amount representing interest
                          
                          
                          (3,273
                          )Present
      value of minimum capitalized payments
                          
                          
                          19,118Less
      current portion
                          
                          
                          (9,410
                          )Long-term
      capital lease obligations
                          
                          $
                          9,708





Property
and equipment included $105,924 and $105,924 and accumulated depreciation
included $67,636 and $49,623 acquired through capital leases as of December 31,
2009 and 2008, respectively. Depreciation expense of $18,013 and $18,621 is
included in the total depreciation expense for the years ended December 31, 2009
and 2008, respectively. Interest expense under the lease was $3,979 and $6,775
for the years ended December 31, 2009 and 2008, respectively.




F-28





CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
9 - RELATED PARTY TRANSACTIONS





Unionway
International, LLC, an entity controlled by Bing Liu, a former officer and
director, provided software development services to the Company. During the
years ended December 31, 2009 and 2008, the Company paid Unionway International,
LLC $49,500 and $92,000, respectively. Mr. Liu is on the Company’s advisory
board as of the date of this filing.





The
Company purchased promotional items with the Company’s name and logo on them
from VK Productions, an entity controlled by Mr. Guseinov’s spouse. During the
year ended December 31, 2009, VK Productions invoiced the Company $36,453 of
which $25,502 remains unpaid as of December 31, 2009.





In March
2008, Gary Guseinov pledged 750,000 shares of his common stock in CyberDefender
Corporation to Michael and Casey DeBaecke in exchange for a loan of $160,000
made to the Company.  The pledge was non-recourse to Mr. Guseinov in
the event the collateral was foreclosed upon due to the Company’s failure to pay
the loan.  So long as there was no event of default in connection with
the loan, Mr. Guseinov could continue to vote the shares at any annual or
special meeting of the stockholders.  The loan plus accrued interest
was paid in full and the pledge was cancelled on July 30, 2008. See Note
6.





NOTE
10 - COMMITMENTS AND CONTINGENCIES





Royalty
Agreement


On July
24, 2009, the Company entered into a licensing agreement with Wiley Publishing,
Inc., owner of the For
Dummies® trademark, for use of the For
Dummies® trademark in connection with the manufacture, development,
operation, sale, distribution and promotion of the Company’s
products.  The term of the agreement is five years with an option for
the Company to renew for an additional five years provided that the Company has
paid to Wiley a minimum royalty of $2,000,000 during the initial term of the
agreement. The Company paid a $100,000 non-refundable royalty advance that is
recorded in Prepaid expenses on the accompanying balance sheet.





Operating
Leases


The
Company's primary offices are in Los Angeles, California.  The Company
entered into a lease on October 19, 2007 which commenced on March 24, 2008 for
approximately 4,742 rentable square feet of office space with a term of
sixty-two months. On October 9, 2009, the Company entered into a second
amendment of its lease with its current landlord to relocate and to occupy
approximately 16,000 square feet in the building to accommodate growth. The
lease calls for a base monthly rent of $35,060 with annual increases of 3% plus
common area expenses with a term of ten years.  The Company’s rent on
its original space was abated beginning July 1, 2009 and the abatement continues
on the new space for a period of fourteen (14) months from the date the Company
began to occupy the new space, which was February 1, 2010, as long as the
Company abides by all the terms and conditions of the lease and if no event of
default occurs. In the event the Company fails to abide by all the terms and
conditions of the lease or an event of default occurs the Company shall
reimburse the landlord for the abated rent along with interest. Rent expense
(including any rent abatements or escalation charges) is recognized on a
straight-line basis from the date the Company takes possession of the property
to the end of the lease term. Aside from the monthly rent, the Company is
required to pay its share of common operating expenses.





The
Company also leases equipment under operating leases that expire at various
dates through 2012.





As of
December 31, 2009, the Company's future minimum lease payments required under
the operating leases with initial or remaining terms in excess of one year are
as follows:





Years
      Ending December 31,2010
                      
                      $
                      24,5032011
                      
                      
                      328,7552012
                      
                      
                      443,7202013
                      
                      
                      455,8202014
                      
                      
                      469,495Thereafter
                      
                      
                      2,727,496Total
                      
                      $
                      4,449,789





Total
rent expense for the years ended December 31, 2009 and 2008 was $155,288 and
$111,026, respectively, which is included in selling, general and administrative
expense.




F-29




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
10 - COMMITMENTS AND CONTINGENCIES (continued)





Employment
Agreements


In
January 2009, the Company entered into an employment agreement with Kevin Harris
pursuant to which Mr. Harris will act as Chief Financial Officer. The agreement
is for two years and unless terminated within that period will renew for
successive one year periods until terminated. Mr. Harris receives compensation
of $190,000 per year plus a car allowance of $750 per month. The Company also
granted Mr. Harris a 10-year option to purchase 200,000 shares of common stock
at an exercise price of $1.00 per share, vesting as follows:  25,000
of the option shares vested upon grant; 25,000 of the option shares vested three
months after the grant date; and the balance of 150,000 option shares vests in
equal monthly increments over the term of his employment agreement. Per the
agreement, in 2009, Mr. Harris earned quarterly performance bonuses equal to 25%
of his base salary plus additional options to purchase a total of 100,000 shares
of common stock, subject to vesting conditions over a two-year period, upon the
achievement of certain goals. At December 31, 2009, $22,500 of Mr. Harris’ bonus
remains unpaid and is included in accrued expenses on the accompanying balance
sheets. In addition to the foregoing, Mr Harris was granted an additional bonus
of $25,000 for the Company’s exceptional increase in sales over the prior fiscal
year and the closing of several financings.





On August
31, 2006, the Company entered into an employment agreement with Gary Guseinov
pursuant to which Mr. Guseinov will act as Chief Executive Officer. The
agreement is for three years and unless terminated within that period will renew
for successive one year periods until terminated. Mr. Guseinov receives
compensation of $225,000 per year and is entitled to participate in any bonus
compensation plan the Company adopts from time to time, so long as any such
bonus does not exceed more than 50% of his base salary for any 12-month
period. Per the agreement, in 2009, Mr. Guseinov earned quarterly
performance bonuses equal to 50% of his base salary. At December 31, 2009,
$61,889 of Mr. Guseinov’s bonus remains unpaid and is included in accrued
expenses on the accompanying balance sheets. In addition to the foregoing, Mr
Guseinov was granted an additional bonus of $25,000 for the Company’s
exceptional increase in sales over the prior fiscal year and the closing of
several financings.





On July
1, 2008, the Company entered into an employment agreement with Igor Barash
pursuant to which Mr. Barash will act as Chief Product Officer. The agreement is
for eighteen months. Mr. Barash receives compensation of $140,000 per year and
is entitled to an increase in salary if certain goals are met and may be due
commissions and bonuses if certain goals are met. The agreement also granted Mr.
Barash an option to purchase 150,000 shares of common stock at a price of $1.00
per share vesting over four years. Per the agreement, in 2009, Mr. Barash’s
salary was increased to $175,000 annually and Mr. Barash was granted a bonus of
$25,000 for the Company’s exceptional increase in sales over the prior fiscal
year and the closing of several financings.





On
November 30, 2006, the Company entered into temporary deferred salary
arrangements with Mr. Guseinov, Mr. Liu and Mr. Barash in which they agreed to
defer 50% of their salaries each pay period. This arrangement with Mr. Liu was
terminated on June 30, 2007.  This arrangement with Mr.
Guseinov and Mr. Barash was terminated on December 16, 2007. The Company
accrued $0 and $36,281 of deferred compensation relating to these arrangements
as of December 31, 2009 and 2008, respectively.





Litigation


In the
ordinary course of business, the Company may face various claims brought by
third parties and the Company may, from time to time, make claims or take legal
actions to assert its rights, including intellectual property rights as well as
claims relating to employment and the safety or efficacy of its products. Any of
these claims could subject the Company to costly litigation and, while the
Company generally believes that it has adequate insurance to cover many
different types of liabilities, the Company’s insurance carriers may deny
coverage or the Company’s policy limits may be inadequate to fully satisfy any
damage awards or settlements. If this were to happen, the payment of any such
awards could have a material adverse effect on the Company’s operations, cash
flows and financial position. Additionally, any such claims, whether or not
successful, could damage the Company’s reputation and business. Management
believes the outcome of currently pending claims and lawsuits will not likely
have a material effect on the Company’s operations or financial
position.




Guarantees and
Indemnities


During
the normal course of business, the Company has made certain indemnities and
guarantees under which it may be required to make payments in relation to
certain transactions. These indemnities include certain agreements with the
Company’s officers, under which the Company may be required to indemnify such
person for liabilities arising out of their employment relationship. The
duration of these indemnities and guarantees varies and, in certain cases, is
indefinite. The majority of these indemnities and guarantees do not provide for
any limitation of the maximum potential future payments the Company could be
obligated to make. The Company hedges some of the risk associated with these
potential obligations by carrying general liability insurance. Historically, the
Company has not been obligated to make significant payments for these
obligations and no liabilities have been recorded for these indemnities and
guarantees in the accompanying statement of financial position.




F-30




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
10 - COMMITMENTS AND CONTINGENCIES (continued)





Beginning
on October 30, 2006 and at various times thereafter, the Company entered into
Indemnification Agreements with its directors and certain of its officers, all
of whom are sometimes collectively referred to in this discussion as the
“indemnified parties” or individually referred to as an “indemnified party”. The
agreements require us to provide indemnification for the indemnified parties for
expenses (including attorneys’ fees, expert fees, other professional fees and
court costs, and fees and expenses incurred in connection with any appeals),
judgments (including punitive and exemplary damages), penalties, fines and
amounts paid in settlement (if such settlement is approved in advance by us,
which approval shall not be unreasonably withheld) actually and reasonably
incurred by the indemnified parties in connection with any threatened, pending
or completed action or proceeding (including actions brought on our behalf, such
as shareholder derivative actions), whether civil, criminal, administrative or
investigative, to which he is or was a party, a witness or other participant (or
is threatened to be made a party, a witness or other participant) by reason of
the fact that he is or was a director, officer, employee or agent of ours or of
any of our subsidiaries. The indemnification covers any action or inaction on
the part of the indemnified party while he was an officer or director or by
reason of the fact that he is or was serving at our request as a director,
officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise.  In the event of any change, after the date
of the Indemnification Agreements, in any applicable law, statute or rule which
expands the right of a California corporation to indemnify a member of its board
of directors or an officer, such changes shall be within the purview of the
indemnified parties’ rights and the Company’s obligations under the
Indemnification Agreements.





The
Indemnification Agreements are effective as of the date they were signed and may
apply to acts or omissions of the indemnified parties which occurred prior to
such date if the indemnified party was an officer, director, employee or other
agent of the Company, or was serving at the Company’s request as a director,
officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise, at the time such act or omission
occurred.  All obligations under the Indemnification Agreements will
continue as long as an indemnified party is subject to any actual or possible
matter which is the subject of the Indemnification Agreement, notwithstanding an
indemnified party’s termination of service as an officer or
director.





NOTE
11 – SUBSEQUENT EVENTS





Subsequent
to December 31, 2009, the Company received $33,925 in proceeds from the exercise
of 28,958 stock options with exercise prices ranging from $1.01 to
$1.44.  The Company also received proceeds of $140,125 from the
exercise of a common stock purchase warrant with exercise prices ranging from
$1.00 to $1.25 for 126,750 shares of common stock.





On March
15, 2010, the Company executed a non-binding term sheet with GRM, for a
strategic investment of $5 million into the Company.  The investment
is to be in the form of a 9% convertible promissory note due 24 months from
issuance, provided that the note shall not be convertible during the first 180
days after its issuance.  If the note is not repaid within the first
180 days, then it would become convertible into common stock at $3.50 per
share.  CyberDefender would have the right to prepay the note without
penalty during the first 180 days.





On April
26, 2010 the Company entered into an Amended and Restated Key Executive
Employment Agreement with each of Gary Guseinov, the Company’s Chief Executive
Officer, Kevin Harris, the Company’s Chief Financial Officer, and Igor Barash,
the Company’s Chief Information Officer.





During
July 2010, the Company and its landlord negotiated a third amendment to the
lease for the Company’s premises. Pursuant to the third amendment, the Company
will occupy an additional 16,000 square feet in the building to accommodate
growth. Once executed, the third amendment will require a base monthly rent upon
occupancy of $35,060 for the additional space, making the total base monthly
rent $70,120, with annual increases of 3%.  The Company expects to
occupy the additional space on November 1, 2010. The third amendment will
provide for six months of rent abatement on the additional space as long as the
Company occupies the space for the full lease term. In the event the Company
fails to abide by all the terms and conditions of the lease or an event of
default occurs the Company shall reimburse the landlord for the abated rent
along with interest. Aside from the monthly rent, the Company is required to pay
its share of common operating expenses.





During
July 2010, the Company received notice from GRM that pursuant to Section 2(a) of
the GR Note, GRM elected to have the first interest payment due July 1, 2010
added to the aggregate principal amount of the GR note





On
October 22, 2010, the Company and GRM entered into a Third Amendment to the
Media and Marketing Services Agreement (“the Third Amendment”), effective as of
October 15, 2010.  Pursuant to the Third Amendment, (i) GRM has the
right to appoint one observer to the Board of Directors at any time when there
is no GRM director on the board of directors, (ii) the Company shall pay GRM a
monthly creative management fee of $75,000, (iii) the Company shall pay directly
or reimburse GRM for all out-of-pocket costs incurred by GRM in connection with
the creation, development, and/or production of any television or radio direct
response commercials and (iv) the security interest granted to GRM is extended
to include the new monthly creative management fee as well as GRM’s
out-of-pocket production costs.  The Third Amendment also extended the
term of the Media and Marketing Services Agreement until October 31, 2011,
unless earlier terminated in accordance with the provisions of the
Agreement.




F-31





CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
11 – SUBSEQUENT EVENTS (continued)





On
October 22, 2010, the Company and GRM entered into a First Amendment to the
License Agreement (“the First Amendment”), effective as of October 15,
2010.  Pursuant to the First Amendment, the royalties payable in
Schedule D to the License Agreement were amended and GRM was provided the one
time right to cause the eighteen months cutoff date (to which reference is made
in the definition of the International Roll-Out Date)to be delayed for a period
of up to 12 months in the event that GRM elects to delay its marketing of the
products in the International Territory for legitimate business reasons,
including, without limitation, delays in the development of the required
processes, systems or other aspects of GRM’s business.





Effective
as of December 3, 2010, the Company and GRM entered into a Revolving Credit Loan
Agreement (the “Loan Agreement”) pursuant to which GRM has made available to the
Company a secured revolving credit facility in the principal amount not to
exceed $5,000,000 (the “Credit Facility”).  Pursuant to the terms and
conditions of the Loan Agreement, GRM will advance funds to the Company, and the
Company will use the funds solely for the Company’s payments of amounts owing to
GRM pursuant to the Media Services Agreement.





The
initial principal amount of the Credit Facility is $4,288,000, which is the
total amount of invoices owing by the Company to GRM pursuant to the Media
Services Agreement as of December 3, 2010, and will be repaid in accordance with
the terms of the Loan Agreement.   Advances made by GRM under the
Credit Facility will not exceed $500,000 per week during the term of the Credit
Facility and will not exceed a maximum total amount of $5,000,000 unless
otherwise agreed to by GRM.  All outstanding principal and accrued but
unpaid interest under the Credit Facility is due and payable in full on the
earlier of either March 31, 2010 or the closing of the Company’s sale and
issuance of any debt or equity securities of the Company in an aggregate amount
exceeding $10,000,000.  Interest will accrue on the outstanding
principal amount advanced under the Credit Facility at an annual rate of 10%,
and will be calculated on a per diem basis and added to the principal amount
advanced.





Simultaneously
with all repayments of outstanding amounts advanced under the Credit Facility,
including repayment of the Credit Facility on the due date, the Company will pay
GRM a repayment fee in an amount equal to 10% of the total amount being repaid.
Late payments, if any, will incur a fee in an amount equal to 10% of the amount
due.





Pursuant
to a security agreement, the Company granted to GRM a second lien priority
security interest in all of the Company’s assets subject only to liens existing
on the original issue date in favor of GRM under the GR Note. Subject to certain
limited exceptions, any future debt financing by the Company must be approved by
GRM and in all cases must be subordinate to the Credit Facility with respect to
both terms of payment and priority.





In
connection with the Credit Facility, and effective as of December 3, 2010, the
Company and GRM entered into a First Amendment to the GR Note, pursuant to which
the GR Note was amended to provide that the Company does not have the right to
repay the GR Note without the prior written consent of GRM.





In
connection with the Credit Facility, and effective as of December 3, 2010, the
Company and GRM entered into a First Amendment to the Loan and Securities
Purchase Agreement modifying certain loan covenants.





In
connection with the Credit Facility, and effective as of December 3, 2010, the
Company and GRM entered into a Fourth Amendment to the Media Services Agreement
(the “Fourth Amendment”), which amended the Media Services Agreement to reduce
payment terms to fifteen days for GRM invoices as long as there is a balance on
the Credit Facility.  Second, the term of the Services Agreement was
extended to December 31, 2013.




F-32




CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008








NOTE
12 – UNAUDITED QUARTERLY FINANCIAL DATA AND RESTATEMENT OF INTERIM FINANCIAL
STATEMENTS





On
November 19, 2010, the Company’s Audit Committee concluded that the Company’s
financial statements for the year ended December 31, 2009 and the quarters ended
March 31, 2009 and 2010, June 30, 2009 and 2010 and September 30, 2009 should be
restated in order to make the following adjustments: (i) the Black Scholes value
of the warrants issued by the Company in March 2009 pursuant to a Media and
Marketing Services Agreement should have been classified as an operating expense
rather than interest expense and that the Black Scholes value of such warrants
should be measured as of each monthly vesting date rather than the grant date
starting from March 2009 through September 2010; (ii) certain warrants issued to
consultants must be revalued as of their respective vesting dates rather than
the grant date, using the Black Scholes method; and (iii) all of the Company’s
advertising expenses starting in the fourth quarter of 2009 should have been
expensed as incurred rather than capitalized and amortized against revenues for
a period of 12 months under ASC 340-20 (collectively, the
“Adjustments”).





The
following tables summarize the effects of the Adjustments on our previously
issued unaudited condensed financial statements:




Changes
to 2009 Quarterly Balance Sheets (unaudited)
 
 March 31, 2009Restated
                        
                        
                        Adjustments
                        
                        
                        As filedAdditional
      paid-in capital
                        
                        $
                        13,045,167
                        
                        
                        $
                        (104,292
                        )
                        
                        $
                        13,149,459
                        (1)(2)Accumulated
      deficit
                        
                        $
                        (29,801,553
                        )
                        
                        $
                        104,292
                        
                        
                        $
                        (29,905,845
                        ) 
      (1)Total
      stockholders’ deficit
                        
                        $
                        (16,737,158
                        )
                        
                        
                        —
                        
                        
                        $
                        (16,737,158
                        )
  Reference
 (1)
Reclassification and revaluation of warrants.
 Per Note
2 above, there was a reclassification from common stock to additional paid-in
capital as a result of the merger.
 June 30, 2009Restated
                        
                        
                        Adjustments
                        
                        
                        As filedAdditional
      paid-in capital
                        
                        $
                        27,474,931
                        
                        
                        $
                        211,653
                        
                        
                        $
                        27,263,278
                        (1)(2)Accumulated
      deficit
                        
                        $
                        (34,933,065
                        )
                        
                        $
                        (211,653
                        )
                        
                        $
                        (34,721,412
                        )
      (1)Total
      stockholders’ deficit
                        
                        $
                        (7,434,939
                        )
                        
                        
                        —
                        
                        
                        $
                        (7,434,939
                        )
  Reference
 (1)
Reclassification and revaluation of warrants.
   September 30, 2009Restated
                          
                          
                          Adjustments
                          
                          
                          As filedAdditional
      paid-in capital
                          
                          $
                          31,785,679
                          
                          
                          $
                          1,012,319
                          
                          
                          $
                          30,773,360
                          (1)(2)Accumulated
      deficit
                          
                          $
                          (39,289,482
                          )
                          
                          $
                          (1,012,319
                          )
                          
                          $
                          (38,277,163
                          )
      (1)Total
      stockholders’ deficit
                          
                          $
                          (7,478,555
                          )
                          
                          
                          —
                          
                          
                          $
                          (7,478,555
                          )
  Reference
 (1)
Reclassification and revaluation of warrants.
   F-33





CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
12 – UNAUDITED QUARTERLY FINANCIAL DATA AND RESTATEMENT OF INTERIM FINANCIAL
STATEMENTS (continued)





Changes
to 2009 Quarterly Condensed Statement of Operations (unaudited)





For the Three Months EndedMarch 31, 2009Restated
                              
                              
                              Adjustments
                              
                              
                              As FiledMedia
      and marketing services
                              
                              $
                              4,499,734
                              
                              
                              $
                              756,040
                              
                              
                              $
                              3,743,694
                              (1)Investor
      relations and other related consulting
                              
                              $
                              395,285
                              
                              
                              $
                              (824,717
                              )
                              
                              $
                              1,220,002
                              (1)Total
      Operating Expenses
                              
                              $
                              6,456,649
                              
                              
                              $
                              (68,677
                              )
                              
                              $
                              6,525,326LOSS
      FROM OPERATIONS
                              
                              $
                              (3,944,723
                              )
                              
                              $
                              68,677
                              
                              
                              $
                              (4,013,400
                              )Interest
      expense
                              
                              $
                              876,894
                              
                              
                              $
                              (35,615
                              )
                              
                              $
                              912,509
                              (1)NET
      LOSS
                              
                              $
                              (4,712,759
                              )
                              
                              $
                              104,292
                              
                              
                              $
                              (4,817,051
                              )EPS
                              
                              $
                              (0.26
                              )
                              
                              $
                              0.01
                              
                              
                              $
                              (0.27
                              )





Reference


(1)
Reclassification of warrants from interest expense and revaluation of
warrants.





For the Three Months Ended
                          
                          
                          For the Six Months EndedJune 30, 2009
                          
                          
                          June 30, 2009Restated
                          
                          
                          Adjustments
                          
                          
                          As Filed
                          
                          
                          Restated
                          
                          
                          Adjustments
                          
                          
                          As FiledMedia
      and marketing services
                          
                          $
                          4,146,124
                          
                          
                          $
                          737,817
                          
                          
                          $
                          3,408,307
                          (1)
                          
                          $
                          8,645,858
                          
                          
                          $
                          1,493,857
                          
                          
                          $
                          7,152,001
                          (1)Investor
      relations and other related consulting
                          
                          $
                          1,135,418
                          
                          
                          $
                          (210,789
                          )
                          
                          $
                          1,346,207
                          (1)
                          
                          $
                          1,530,703
                          
                          
                          $
                          (1,035,506
                          )
                          
                          $
                          2,566,209
                          (1)Total
      Operating Expenses
                          
                          $
                          7,222,794
                          
                          
                          $
                          527,028
                          
                          
                          $
                          6,695,766
                          
                          
                          $
                          13,679,443
                          
                          
                          $
                          458,351
                          
                          
                          $
                          13,221,092LOSS
      FROM OPERATIONS
                          
                          $
                          (4,289,474
                          )
                          
                          $
                          (527,028
                          )
                          
                          $
                          (3,762,446
                          )
                          
                          $
                          (8,234,197
                          )
                          
                          $
                          (458,351
                          )
                          
                          $
                          (7,775,846
                          )Interest
      expense
                          
                          $
                          841,838
                          
                          
                          $
                          (211,083
                          )
                          
                          $
                          1,052,921
                          (1)
                          
                          $
                          1,718,732
                          
                          
                          $
                          (246,698
                          )
                          
                          $
                          1,965,430
                          (1)NET
      LOSS
                          
                          $
                          (5,131,512
                          )
                          
                          $
                          (315,945
                          )
                          
                          $
                          (4,815,567
                          )
                          
                          $
                          (9,844,271
                          )
                          
                          $
                          (211,653
                          )
                          
                          $
                          (9,632,618
                          )EPS
                          
                          $
                          (0.25
                          )
                          
                          $
                          (0.01
                          )
                          
                          $
                          (0.24
                          )
                          
                          $
                          (0.51
                          )
                          
                          $
                          (0.01
                          )
                          
                          $
                          (0.50
                          )





Reference


(1)
Reclassification of warrants from interest expense and revaluation of
warrants.





For the Three Months Ended
                                  
                                  
                                  For the Nine Months EndedSeptember 30, 2009
                                  
                                  
                                  September 30, 2009Restated
                                  
                                  
                                  Adjustments
                                  
                                  
                                  As Filed
                                  
                                  
                                  Restated
                                  
                                  
                                  Adjustments
                                  
                                  
                                  As FiledMedia
      and marketing services
                                  
                                  $
                                  4,717,729
                                  
                                  
                                  $
                                  1,172,588
                                  
                                  
                                  $
                                  3,545,141
                                  (1)
                                  
                                  $
                                  13,363,588
                                  
                                  
                                  $
                                  2,666,446
                                  
                                  
                                  $
                                  10,697,142
                                  (1)Investor
      relations and other related consulting
                                  
                                  $
                                  2,128,523
                                  
                                  
                                  $
                                  25,916
                                  
                                  
                                  $
                                  2,102,607
                                  (1)
                                  
                                  $
                                  6,477,178
                                  
                                  
                                  $
                                  (1,009,190
                                  )
                                  
                                  $
                                  7,486,368
                                  (1)Total
      Operating Expenses
                                  
                                  $
                                  7,319,993
                                  
                                  
                                  $
                                  1,198,504
                                  
                                  
                                  $
                                  6,121,489
                                  
                                  
                                  $
                                  20,999,837
                                  
                                  
                                  $
                                  1,657,256
                                  
                                  
                                  $
                                  19,342,581LOSS
      FROM OPERATIONS
                                  
                                  $
                                  (3,910,959
                                  )
                                  
                                  $
                                  (1,198,504
                                  )
                                  
                                  $
                                  (2,712,455
                                  )
                                  
                                  $
                                  (12,145,557
                                  )
                                  
                                  $
                                  (1,657,256
                                  )
                                  
                                  $
                                  (10,488,301
                                  )Interest
      expense
                                  
                                  $
                                  445,458
                                  
                                  
                                  $
                                  (397,638
                                  )
                                  
                                  $
                                  843,096
                                  (1)
                                  
                                  $
                                  2,164,189
                                  
                                  
                                  $
                                  (644,337
                                  )
                                  
                                  $
                                  2,808,526
                                  (1)NET
      LOSS
                                  
                                  $
                                  (4,356,417
                                  )
                                  
                                  $
                                  (800,666
                                  )
                                  
                                  $
                                  (3,555,751
                                  )
                                  
                                  $
                                  (14,200,688
                                  )
                                  
                                  $
                                  (1,012,319
                                  )
                                  
                                  $
                                  (13,188,369
                                  )EPS
                                  
                                  $
                                  (0.18
                                  )
                                  
                                  $
                                  (0.03
                                  )
                                  
                                  $
                                  (0.15
                                  )
                                  
                                  $
                                  (0.69
                                  )
                                  
                                  $
                                  (0.05
                                  )
                                  
                                  $
                                  (0.64
                                  )





Reference


(1)
Reclassification of warrants from interest expense and revaluation of
warrants.


F-34


CYBERDEFENDER
CORPORATION


NOTES
TO FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2009 AND 2008





NOTE
12 – UNAUDITED QUARTERLY FINANCIAL DATA AND RESTATEMENT OF INTERIM FINANCIAL
STATEMENTS (continued)





Changes
to 2009 Quarterly Condensed Statement of Cash Flows (unaudited)


For the Three Months EndedMarch 31, 2009Restated
                          
                          
                          Adjustments
                          
                          
                          As FiledNet
      loss
                          
                          $
                          (4,712,759
                          )
                          
                          $
                          104,292
                          
                          
                          $
                          (4,817,051
                          )  
      (1)Adjustments
      to reconcile net loss to net cash used in operating
      activities:Warrants
      issued for interest
                          
                          
                          —
                          
                          
                          $
                          (35,615
                          )
                          
                          $
                          35,615
                          (2)Warrants
      issued for media and marketing services
                          
                          $
                          754,985
                          
                          
                          $
                          754,985
                          
                          
                          
                          —
                          (3)Shares
      and warrants issued for services
                          
                          $
                          499,376
                          
                          
                          $
                          (823,662
                          )
                          
                          $
                          1,323,038
                          (4)
 
 Reference
 (1)
Revaluation of warrants.
 (2)
Reclassification of warrants from interest expense to media and marketing
services expense.
 (3)
Reclassification of warrants from interest expense to media and marketing
services expense and revaluation of warrants.
 (4)
Reclassification of warrants from services to media and marketing services and
revaluation of warrants.
 
 For the Six Months EndedJune 30, 2009Restated
                              
                              
                              Adjustments
                              
                              
                              As FiledNet
      loss
                              
                              $
                              (9,844,271
                              )
                              
                              $
                              (211,653
                              )
                              
                              $
                              (9,632,618
                              )  
      (1)Adjustments
      to reconcile net loss to net cash used in operating
      activities:Warrants
      issued for interest
                              
                              
                              —
                              
                              
                              $
                              (295,722
                              )
                              
                              $
                              295,722
                              (2)Warrants
      issued for media and marketing services
                              
                              $
                              1,065,420
                              
                              
                              $
                              1,065,420
                              
                              
                              
                              —
                              (3)Shares
      and warrants issued for services
                              
                              $
                              1,648,203
                              
                              
                              $
                              (558,045
                              )
                              
                              $
                              2,206,248
                              (4)
 
 Reference
 (1)
Revaluation of warrants.
 (2)
Reclassification of warrants from interest expense to media and marketing
services expense.
 (3)
Reclassification of warrants from interest expense to media and marketing
services expense and revaluation of warrants.
 (4)
Reclassification of warrants from services to media and marketing services and
revaluation of warrants.
 
 For the Nine Months EndedSeptember 30, 2009Restated
                              
                              
                              Adjustments
                              
                              
                              As FiledNet
      loss
                              
                              $
                              (14,200,688
                              )
                              
                              $
                              (1,012,319
                              )
                              
                              $
                              (13,188,369
                              )  
      (1)Adjustments
      to reconcile net loss to net cash used in operating
      activities:Warrants
      issued for media and marketing services
                              
                              $
                              2,095,548
                              
                              
                              $
                              2,095,548
                              
                              
                              
                              —
                              (2)Shares
      and warrants issued for services, interest and penalties
                              
                              $
                              2,631,003
                              
                              
                              $
                              (1,083,229
                              )
                              
                              $
                              3,714,232
                              (3)
 
 Reference
 (1)
Revaluation of warrants.
 (2)
Reclassification of warrants from interest expense to media and marketing
services expense.
 (3)
Reclassification of warrants from interest expense to media and marketing
services expense and revaluation of warrants.
 F-35