**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





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


For the fiscal year ended
                **December
                    31, 2007**





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





For
                the transition period from


Commission
                file number
            **333-138430**





**CYBERDEFENDER
                CORPORATION**(Name
                of registrant in its charter)




California
            
            65-1205833(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification
                No.)617
                West 7thStreet, Suite 401, 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: None





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. o 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. o 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 o





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. x







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


o
      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. There was no public market for the registrant’s common stock on June
      29, 2007.





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 28, 2008 the number of
      shares of the registrant’s classes of common stock outstanding was
      14,565,688.





List
      hereunder the following documents if incorporated by reference and the Part
      of
      the Form 10-K (eg., Part I, Part II, etc.) into which the document is
      incorporated: (1) Any annual report to security holders; (2) Any proxy or
      information statement; and (3) Any prospectus filed pursuant to Rule 424(b)
      or
      (c) under the Securities Act of 1933. The listed documents should be clearly
      described for identification purposes.










CONTENTS




*Page*Forward-Looking
                Statements
            
            iPart
                1Item
                1
            
            Business
            
            1Item
                1A
            
            Risk
                Factors
            
            9Item
                2
            
            Properties
            
            18Item
                3
            
            Legal
                Proceedings
            
            18Item
                4
            
            Submission
                of Matters to a Vote of Security Holders
            
            19Part
                IIItem
                5
            
            Market
                for Registrant’s Common Equity, Related Stockholder Matters
                and
            
            20Issuer
                Purchases of Equity SecuritiesItem
                6
            
            Selected
                Financial Data
            
            22Item
                7
            
            Management’s
                Discussion and Analysis of Financial Condition and Results
            
            22Of
                OperationsItem
                7A
            
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            30Item
                8
            
            Financial
                Statements and Supplementary Data
            
            30Item
                9
            
            Changes
                In and Disagreements With Accountants on Accounting and
            
            30Financial
                DisclosureItem
                9A
            
            Controls
                and Procedures
            
            30Item
                9B
            
            Other
                Information
            
            32Part
                IIIItem
                10
            
            Directors,
                Executive Officers and Corporate Governance
            
            33Item
                11
            
            Executive
                Compensation
            
            36Item
                12
            
            Security
                Ownership of Certain Beneficial Owners and Management and
            
            39Related
                Stockholder MattersItem
                13
            
            Certain
                Relationships and Related Transactions and Director
                Independence
            
            41Item
                14
            
            Principal
                Accountant Fees and Services
            
            45


Part
                IVItem
                15
            
            Exhibits,
                Financial Statement Schedules
            
            46Signatures
                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 Operation”. 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;





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





·
            whether
                our plan to provide our product for free and to generate revenues
                through
                advertising is successful;





·
            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**





We
      were
      incorporated as Network Dynamics in California on August 29, 2003, and changed
      our name to CyberDefender Corporation on October 21, 2005. We are a provider
      of
      secure content management (commonly referred to as “SCM”) software. Our mission
      is to bring to market advanced solutions to combat and prevent online
      information theft, unwanted advertisements, spam, Internet viruses, spyware
      and
      related security threats. Individuals who 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 product is available for downloading from our
      website, which makes it available to anyone in the world, we do not have a
      significant customer base outside of the United States.




Our
      business was originally built around the sale of a single product, our
      CyberDefender anti-spyware. During the period from our founding through 2004,
      our primary focus was on marketing and selling this product. In 2005, we
      acquired certain assets from Unionway International, LLC, an entity controlled
      by Mr. Bing Liu, one of our directors and a consultant. Among these assets
      was
      software that formed the basis for our Collaborative Internet Security
      Network.




On
      November 20, 2006 we stopped engaging in new sales of our product, CyberDefender
      Anti-Spyware 2006 (although we still continue to support the product and will
      continue upgrading it), and we began providing a suite of Internet security
      products called CyberDefender Early Detection Center, which is also provided
      as
      CyberDefender FREE 2.0. We decided to change our focus from being a marketing
      software publisher - that is, creating and marketing individual software
      products - to providing SCM software for two reasons.




First,
      we
      began to see that large security software companies, such as McAfee, Symantec
      and Trend Micro, were offering security suites as opposed to single, stand-alone
      products. A “silo” approach to threats, where separate specialized programs each
      protect against a different threat, is not only cumbersome and expensive, but
      it
      assumes that attackers will conform to these categories. In fact, many of the
      most dangerous attacks today are hybrid attacks, which combine two or more
      types
      of threats. An effective SCM software system should be able to protect against
      all of these threats, and we determined that consumers would come to expect
      a
      single product that would provide comprehensive protection against Internet
      threats, rather than having to license several products.




Secondly,
      we believed that the business model we had been using, where we offered free
      software for a limited trial period, could be improved since oftentimes the
      subscriber would not renew a subscription after the trial period expired. Rather
      than depend solely on revenues from the renewal of software licenses, we
      determined that we could also earn advertising revenues by partnering with
      other
      businesses that would use our software for advertising. The ads are aggregated
      from ad networks.  Ad
      networks provide advertising for a website and share advertiser revenue each
      time the website visitors click on the ads. During the month that the ads are
      displayed on a subscriber’s computer, revenues will be earned from the ad
      networks each time an ad is shown (per impression), when an ad is clicked (per
      click) or when the subscriber takes action after clicking on the ad and visiting
      the advertiser’s website. We offer CyberDefender FREE 2.0 as a free download in
      an ad-supported version and CyberDefender Early Detection Center, without ads,
      in exchange for the payment of a licensing fee. There is no trial period and
      no
      monthly or annual fee to pay for using CyberDefender FREE 2.0. Instead, we
      receive payment from the advertisers, typically at the end of each month.
      Subscribers who choose CyberDefender Early Detection Center pay for the license
      fees via credit card. The annual subscription rate for this version of the
      security suite ranges from $11.99 to $39.99, depending on the marketing and
      distribution channels that we use.




1




Once
      our
      CyberDefender Early Detection Center or CyberDefender FREE 2.0 suite of security
      products is downloaded, the subscriber becomes a part of our Collaborative
      Internet Security Network, which we sometimes refer to as CISN or
“earlyNetwork”TM. We believe that the CISN provides a unique approach to updating
      personal computer security. We have developed the CISN 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. Our CISN 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 CISN. 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. This approach
      is different and, we believe, significantly faster than traditional Internet
      security companies that provide manual, broadcast-updated threat management
      systems. (See Figure 1 below.)




**Figure
      1**


**Collaborative
                  Security Network Architecture**
              **Traditional
                  Client Server Architecture**




Our
      CISN
      is an adaptive network of machines that defends automatically against a wide
      spectrum of software attacks and provides users with proprietary automated
      processes that rapidly identify and quarantine both known and emerging threats. Our
      customers obtain access to the CISN by downloading and installing our security
      suite (CyberDefender Early Detection Center or CyberDefender FREE 2.0) or the
      CyberDefender Security Toolbar, discussed below. As
      additional users are added to well-managed peer networks, the networks work
      better. The same is true of our collaborative security network. 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.
      Users of our software who cannot connect with other users will always be able
      to
      fall back on the Alert Server.




The
      nature of current SCMs, which assume a single point of threat capture, a
      cumbersome threat analysis system and an intermittent 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 CISN. Other SCMs send updates
      in a
      scheduled batch. 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 SCM software vendors announced their
      discoveries of the same virus. We believe we are the first to provide threat
      updates in this manner.




Using
      the
      CISN infrastructure instead of relying on expensive bandwidth for mass updates
      means that our updates are relayed securely throughout the CISN using each
      local
      user’s bandwidth. There is no need to wait for a scheduled update - updates are
      simply sent to the entire network in approximately one hour as opposed to 12
      hours for a conventional network. The network responds quickly to new threats
      because it enlists all the machines in the CISN to act as listening posts for
      new threats. Our solution works well with existing security software and can
      operate as an additional layer of security on a desktop.




2


***Industry
      Background***




**Secure
      Content Management (SCM) Market**




The
      SCM
      market includes content security solutions designed to secure, monitor, filter
      and block threats from messaging and Internet traffic. According to information
      provided on the Internet by IDC, a global provider of marketing data, the
      worldwide SCM market was estimated to be $5.5 billion in 2005, representing
      a
      23.3% growth rate over 2004. In comparison, the SCM market was $4.5 billion
      in
      2004 and achieved 27.6% growth over 2003. The SCM market is forecast to increase
      to $10.5 billion in 2009, representing a five-year compound annual growth rate
      of 18.7%.




SCM
      protects against inbound threats such as spam, fraudulent emails, viruses,
      worms, trojans, spyware and offensive material. SCM solutions are also designed
      to protect against outbound threats such as confidential data, customer records,
      intellectual property and offensive content leaving an
      organization.




Three
      specific product areas comprise SCM:




**Antivirus
      software** identifies and/or eliminates harmful software and macros by scanning hard
      drives, email attachments, disks, Web pages and other types of electronic
      traffic, for example, instant messaging and short message service (SMS), for
      any
      known or potential viruses, malicious code, trojans or spyware.




**Web
      filtering** software
      is used to screen and exclude from access or availability Web pages that are
      deemed objectionable or not business related. Web filtering is used by entities
      to enforce corporate Internet use policies as well as by schools, universities
      and home computer owners for parental controls.




**Messaging
      security** software
      is used to monitor, filter and/or block messages from different messaging
      applications, for example, e-mail, IM, SMS and P2P, containing spam,
      confidential information and objectionable content. Messaging security is also
      used by certain industries to enforce compliance with privacy
      regulations.




**SCM
      Growth Drivers**




Viruses,
      worms and spyware are serious threats facing businesses and consumers today
      because these programs 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 through:




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




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




(iii)  increased
      use of mobile devices to access key data;




(iv)  opening
      networks to a flood of external traffic;




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




3




(vi)  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;




(vii)  lack
      of
      industry standards in the computer software industry to define spyware, adware,
      viruses, phishing or other malicious code; and




(viii)  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 SCM market developed and continues to
      expand in order to respond to the ever-evolving threats presented by malicious
      programs.




**Current
      Product Limitations**




Many
      SCM
      software vendors have attempted to solve Internet security problems with a
      variety of software applications. 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 Catch all Viruses 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.




**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 because 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.




Every
      consumer or business using any networked device needs to have some form of
      Internet security. We plan to provide consumers and business users with a
      platform of products and services designed to protect against all types of
      security attacks.




**Our
      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:




·
            The
                expense related to this process; the network cannot be updated in
                real-time, and instead is updated in batches 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.




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




4




We
      have
      addressed these shortcomings by developing the CISN to detect, analyze and
      quarantine new security threats. The
      CISN
      is not a conventional peer-to-peer network because the Alert Server is a
      required checkpoint for all client activities, thus assuring the integrity
      of
      the network. The CISN is a controlled publishing network that leverages the
      power of distributed bandwidth. Each client has a controlled role in relaying
      the threat updates to as many as 20 clients, thus allowing continuous release
      of
      threat updates.




Unusual
      behavior is detected by a personal computer equipped with our CyberDefender
      Internet security software. The potential threat may be anything from spam
      to a
      virus. The program puts the potential threat on standby, and reports it to
      our
      Early Alert Center’s Alert ServerTM. The Alert Server compares the threat to
      existing threat definitions. If the Alert Server does not recognize the threat,
      the threat is sent to our AppHunterTM 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, our 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 CISN. We
      continually make changes to our technology to make sure that we address as
      many
      security concerns as possible.




We
      believe that our CISN may be the only network today that distributes information
      securely between the individual personal computer users who have installed
      our
      software, which we have sometimes referred to as “peers” in this
      discussion.




Using
      our
      peer-to-peer technology, our CyberDefender Alert Server notifies users of our
      software who, in turn, notify up to 20 other users 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. Because the
      cost of updating using the CISN is very small, Alert Server can send out updates
      as fast as threats are confirmed, resulting in better 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. We believe that this process
      occurs roughly ten times faster than the updating of any other competitive
      system.




**Products**




*CyberDefender
      Early Detection Center and CyberDefender FREE 2.0*




Our
      CyberDefender Early Detection Center/CyberDefender FREE 2.0 - a complete
      Internet security suite - includes protection against viruses, spyware, phishing
      and spam, along with helpful security utilities. This product was launched
      in
      November 2006. CyberDefender Early Detection Center/CyberDefender FREE 2.0
      currently performs all of the following functions for users:




·
            automatically
                analyzes running executable files and assigns threat
                levels;




·
            automatically
                analyzes e-mail attachment files from Outlook and assigns threat
                levels;




5




·
            automatically
                blocks high-threat files and associated
                files;




·
            provides
                an online advisory with detailed information on infected
                files;




·
            undertakes
                a security audit that generates a daily report of security analysis
                and
                results;




·
            the
                event viewer records application running-history and other critical
                activities;




·
            automatically
                blocks infected e-mails;




·
            blocks
                against known spyware, virus, spam-based and phishing
                attacks;




·
            incorporates
                a Safe Search Toolbar that helps users search through a major search
                provider such as Google (generating “AdWords” revenue) and helps prevent
                users from accessing scam sites;




·
            supports
                Microsoft Windows 98, 2000, NT, ME, XP and
                Vista;




·
            updates
                itself as needed when a user goes
                online.




All
      or
      some of the features of this application will likely change from time to time
      to
      address new threats or business opportunities.




We
      currently provide two versions of this product. One version includes advertising
      and is provided to subscribers without charge. The other version, which does
      not
      have advertising, is available for licensing at an annual rate of $11.99 to
      $39.99, depending on the marketing and distribution channels that we
      use. **




*CyberDefender
      Security Toolbar and the safeSEARCH Toolbar*




We
      believe that our security toolbar is one of the first anti-phishing and
      anti-hijacking toolbars in the market. As with CyberDefender Early Detection
      Center/CyberDefender FREE 2.0, persons who download our security toolbar become
      a part of the CISN. The toolbar may be downloaded free from our website. With
      the launch of the Early Detection Center, a simplified version of the Toolbar,
      called the safeSEARCH Toolbar, is provided with all copies of CyberDefender
      Early Detection Center/CybeDefender FREE 2.0. In addition safeSEARCH V2 allows
      users to rate sites that they visit. This allows other CyberDefender users
      to
      avoid less reputable sites and visit only the sites that are trusted. Our full
      toolbar will continue to be available on a private label or OEM
      basis.




*CyberDefenderULTIMATETM
      and CyberDefenderCOMPLETETM*




On
      September 27, 2007 we announced the launch of CyberDefenderULTIMATETM and
      CyberDefenderCOMPLETETM. These are enhanced versions of our security software.
      For an annual fee, CyberDefenderULTIMATETM provides year round support for any
      software or hardware connected to a subscriber’s computer while
      CyberDefenderCOMPLETETM provides year-round unlimited anti-malware support for a
      subscriber’s computer. These new security suites also include 2 gigabytes of
      online backup. These products are sold for $59.95 to $199.95 per
      year.




*Potential
      Future Products*




We
      have
      products in various stages of development, including the safeSEARCH toolbar
      V3
      which is a social network designed to protect Internet users against identity
      theft and to allow users to rate websites. We cannot assure you that we will
      be
      successful in developing and marketing any of these products or that any of
      these products, if marketed, will produce significant revenues for
      us.




6




**Technical
      Support**




We
      have
      support staff that is available to help with software installations or other
      problems or questions via our website. Users of our software log onto our
      website and register their support issue. We maintain software support
      facilities at our Los Angeles office. For billing concerns we maintain both
      a
      website and live customer support also located in Los Angeles, California.




As
      noted
      above, on September 27, 2007 we announced the launch of enhanced versions of
      our
      security software, CyberDefenderULTIMATETM and CyberDefenderCOMPLETETM. For an
      annual fee, CyberDefenderULTIMATETM provides year round support for any software
      or hardware connected to a subscriber’s computer while CyberDefenderCOMPLETETM
provides year-round unlimited anti-malware support for a subscriber’s
      computer.




**Growth
      Strategy**




We
      plan
      to increase revenue by adding advertising revenues to our licensing revenues.
      By
      creating a large network of users of CyberDefender Early Detection
      Center/CyberDefender FREE 2.0, we expect to generate advertising revenue,
      referral income from sponsoring partners, and revenue from upgrades to a product
      for which payment will be required. We also plan to create private label
      solutions on a fee and/or revenue sharing basis and to market private labeled
      products and services into the free and paid user base. Our plan to capture
      continued growth in the consumer market will be based on acquiring large numbers
      of users of CyberDefender FREE 2.0. We intend to do this by establishing
      relationships with websites that have access to significant user bases and
      to
      pay them a fee for the customers we obtain through them. We are also planning
      to
      continue to develop and introduce additional software products to address the
      needs of the SCM market.




As
      many
      businesses do, we sometimes rely on independent contractors and vendors or
      service providers to obtain services or products that we need. Aside from
      Michael Barrett, our Chief Financial Officer, and Bing Liu, who provides the
      services of Chief Software Architect, these contractors and vendors include
      individuals or companies who assist us with marketing and software development,
      billing, and advertising. We have no long term agreements with any of these
      individuals, including Messrs. Barrett and Liu. With the exception of Messrs.
      Barrett and Liu, none of these independent contractors, vendors or service
      providers bring knowledge or skills to us that cannot be easily
      replaced.




**Revenue
      Model**




We
      currently earn revenues from direct sales of our CyberDefender Early Detection
      Center and advertising revenues from downloads of CyberDefender FREE 2.0. We
      license CyberDefender Early Detection Center software for $11.99 to $99.99
      for
      one year of service. This price includes a level of technical support, software
      updates and definition updates. After one year of service, consumers have the
      option to renew the service. Users are notified when a subscription is due
      to
      expire and what the cost will be to continue the subscription.




On
      September 27, 2007 we announced the launch of CyberDefenderULTIMATETM and
      CyberDefenderCOMPLETETM. These are enhanced versions of our security software.
      For an annual fee, CyberDefenderULTIMATETM provides year round support for any
      software or hardware connected to a subscriber’s computer while
      CyberDefenderCOMPLETETM provides year-round unlimited anti-malware support for a
      subscriber’s computer. These new security suites also include two gigabytes of
      online backup. These products are sold for $59.95 to $199.95 per
      year.




Since
      November 2006 we have begun generating revenue from advertising by showing
      users
      of our CyberDefender FREE 2.0 software small banners inside the CyberDefender
      user interface, showing text links to third party products and/or getting paid
      by search engine companies whenever individuals use our SafeSearch Toolbar.
      Our
      goal is to maximize our advertising revenue by increasing the number of
      CyberDefender FREE 2.0 subscribers. As the number of these subscribers
      increases, the amount paid to us per user will increase.




7




We
      expect
      revenues from product licensing, including the licensing of our premium support
      services through CyberDefenderCOMPLETE and CyberDefenderULTIMATE, to increase
      during the 2008 fiscal year. In addition we anticipate that our advertising
      revenue will grow as a result of the distribution of our safeSEARCH security
      toolbar.




On
      occasion, we also offer to our software users, both paying and non-paying,
      other
      subscription services such as identity theft protection and consumer credit
      management. There are several providers of these types of additional services
      and we have in the past, and will continue in the future, to affiliate with
      these providers.




**Retail
      Sales**




At
      this
      time our software is licensed or otherwise distributed only through the
      Internet.




**Customers**




Our
      primary customers are consumers who use home computers that use the Microsoft
      Windows operating system. 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
      and Sales**




We
      market
      our products to computer users through the use of Internet marketing and our
      e-commerce website. We make our products available to customers through channels
      that include retailers, distributors, direct marketers, Internet-based
      resellers, original equipment manufacturers (OEMs), and Internet service
      providers. Current and future marketing opportunities include online
      advertising, search engine optimization, advertising in trade and technical
      publications, public relations, targeted customer marketing, direct e-mailings
      to existing end-users, co-marketing with distributors and resellers, marketing
      through the use of a CyberDefender web browser security toolbar and
      participation in trade and computer shows and user group
      conferences.




**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 and Kaspersky Labs.
      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 SCM industry.




**Intellectual
      Property**




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




8




On
      September 22, 2005 we filed two applications with the US Patent and Trademark
      Office for final patents. The application titles and numbers are “Threat
      Protection Network” - Application No. US2006/0075504 and “System for
      Distributing Information Using a Secure Peer to Peer Network” - Application No.
      US2006/0075083.




On
      September 21, 2005 we submitted an application to the US Patent and Trademark
      Office for the registration of our name, CyberDefender, on the principal
      register. The mark was published for opposition on December 26, 2006. We also
      own a registered mark consisting of the @ symbol inside a star.




We
      may
      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 or to protect trade secrets or trademarks rights.




**Employees**




We
      currently employ 15 full time employees and 3 independent contractors. Our
      employees are segmented by the following functions: executive management,
      research and development, information technology, marketing and sales, customer
      service and call center, and finance and administration.




**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 (e.g.,
      the Federal CAN-Spam Act of 2003), spyware (e.g., H.R. 29, the “Spy Act”), and
      taxation. Other laws and regulations 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.




**Item
      1A. Risk Factors**




*You
      should carefully consider the risks described below before making an investment
      decision. Our business could be harmed by any of these risks. The trading price
      of our common stock could decline due to any of these risks, and you may lose
      all or part of your investment. In assessing these risks, you should also refer
      to the other information contained in this report, including our financial
      statements and related notes.*




**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:




9




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




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




·
            successfully
                protect personal computer or corporate 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.




***We
      incurred net losses for four of our last five fiscal years. If we continue
      to
      incur losses for a significant amount of time, the value of your investment
      could be adversely affected and you could even lose your entire investment.***




We
      incurred a net loss of $140,909 and $3,247,969 for the fiscal years ended
      December 31, 2003 and 2004, respectively, and we had net income of $642,896
      for
      the fiscal year ended December 31, 2005. We incurred a net loss of $5,507,600
      and $5,866,123 for the fiscal years ended December 31, 2006 and 2007,
      respectively. As we move from being a marketing focused software publisher
      to a
      developer of a suite of Internet security products, we are likely to continue
      to
      incur losses. We cannot predict when, or if, we will be profitable in the
      future. Even if we achieve profitability, we may not be able to sustain
      it.




***As
      of March 28, 2008 we had approximately $236,000 in cash. We believe that we
      can
      continue to operate through*** ***July*** ***2008 with this cash, the proceeds from offerings we undertake and the revenues
      we generate from our suite of Internet security products. In order to meet
      our
      financial obligations for a period of 12 months, we will need an additional
      $1,100,000. If we are not able to raise additional funds
      by***  ***July***  ***2008,
      our business could be adversely affected.***




We
      have
      no committed sources of additional capital. We have been funding our operations
      and capital expenditures from limited cash flow from operations, our cash on
      hand and the proceeds from the offerings of our debt and equity securities.
      As
      of March 28, 2008 we had approximately $236,000 in cash. We believe that this
      cash combined with the revenues we generate from our products and the proceeds
      from offerings we undertake will fund our operations through July 2008. However,
      we will need additional funds to continue our operations beyond that date,
      pursue business opportunities (such as expansion or the development of new
      products or services), react to unforeseen difficulties or respond to
      competitive pressures. As a result of employee attrition, a reduction in
      executive salaries and a reduction in the number of independent contractors
      we
      need to employ due to the completion of the development and launch of our
      CyberDefender Early Detection Center/CyberDefender FREE 2.0 product, we have
      significantly decreased the rate at which we use cash. We estimate that we
      will
      need approximately $1,100,000 in addition to the cash flow from our operations
      and the cash we currently have on hand to continue our business for the next
      12
      months. We cannot assure you that any financing arrangements will be available
      in amounts or on terms acceptable to us, if at all. If additional financing
      is
      not available or is not available on acceptable terms, we may be unable to
      continue our operations, in which case our securities would become worthless.
      If
      we choose to raise additional funds through the issuance of equity securities,
      our existing equity security holders may experience significant dilution of
      their ownership interests, and holders of the additional equity securities
      may
      have rights senior to those of the holders of our common stock. If we obtain
      additional financing by issuing debt securities, the terms of these securities
      could restrict or prevent us from paying dividends and could limit our
      flexibility in making business decisions.




10




***We
      market our product through search engines (for example, Google, Yahoo! and
      MSN),
      e-mail and banner advertising and affiliate marketing. If we fail to market
      our
      product effectively, our sales could decline and our results of operations
      would
      be adversely affected.***




We
      market
      our product and related services over the Internet, primarily through space
      purchased from Internet-based marketers and search engines. Currently we drive
      traffic to our website by spending approximately 82% of our advertising budget
      on pay-per-click advertising on Google, Yahoo! and MSN. While the amount that
      we
      spend on this advertising varies on a daily basis, in general approximately
      65%
      of our advertising budget is spent on pay-per-click advertising through Yahoo!,
      15% through Google and 2% through MSN. If Internet advertising fails to perform
      as we anticipate, our sales could decline and the cost of the advertising,
      per
      click, would increase. This could have a material, adverse effect on our results
      of operations.




***If
      we cannot find businesses willing to advertise inside our ad-supported software,
      we may not achieve our revenue targets and our business and results of
      operations will be adversely affected.***




Our
      ad-supported CyberDefenderFREE 2.0 software includes small banners imbedded
      inside the user interface. These small banners are displayed on the top right
      corner of the software and rotate randomly throughout the day and as users
      interact with the software. These banners link to the websites of the businesses
      providing the advertising. Since there are thousands of potential businesses
      that advertise, we have decided to work with advertising networks, which are
      companies that represent many advertisers at the same time and are able to
      provide us with new advertisers on a consistent basis. Examples of such
      advertising networks include ValueClick Inc., Advertising.com, and Traffic
      Market Place/TMP, but there are many others. We are selling this advertising
      space based on what is commonly known in the industry as Cost Per Thousand
      (CPM), where the advertiser pays us a set fee for each one thousand ad
      impressions, or Cost Per Click (CPC), where the advertiser pays us a set fee
      for
      each click delivered to its site, or Cost Per Action (CPA), where the advertiser
      pays us a set fee for each action that takes place after the user clicks on
      the
      ad and visits the advertiser’s web site. If we fail to generate a significant
      base of CyberDefenderFREE 2.0 users, we may not generate enough daily
      advertising impressions to be attractive to advertising networks. This would
      have a material adverse effect on our business and 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 product. Our competitors include
      software companies that offer products that directly compete with our product
      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 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 product, 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. Our goal in creating CyberDefender FREE 2.0 was
      to
      differentiate our software from that of our competitors and to make it more
      attractive to consumers by offering it for free. If this marketing strategy
      is
      unsuccessful, our business and results of operations will be adversely
      affected.




11




***If
      we are unable to develop new and enhanced Internet security products, such
      as
      products that protect devices like mobile telephones or PDAs, 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. For example, in November 2006 we
      introduced our security suite of products, CyberDefender Early Detection
      Center/CyberDefender FREE 2.0, in response to new products released by companies
      such as Symantec. We must also 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.




***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 Vista, a new 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 obtaining directors' and
      officers' liability insurance.***




We
      may be
      unable to obtain or 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 Gary Guseinov, 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
      Information Officer and Secretary, and Bing Liu, a director and formerly our
      Chief Software Architect. We believe that the skills of Mr. Guseinov would
      be
      particularly difficult to replace. We do not have long-term employment
      agreements with any of the members of our management team, except Gary Guseinov.
      We have entered into an employment agreement with Mr. Barash, but it is
“at-will” and does not preclude him from leaving us. We have an independent
      contractor agreement with Mr. Liu that will end in July 2008. While we believe
      that this agreement will be renewed, we have no guarantee that Mr. Liu will
      continue to provide services to us.




12




In
      January 2008 Ivan Ivankovich, our Chief Financial Officer, resigned. On February
      8, 2008 we announced that Michael Barrett joined us as Chief Financial
      Officer.




As
      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 implementation of our business plan 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. Although we have
      in
      the past and intend in the foreseeable future to issue stock options or other
      equity-based compensation, such incentives may not be sufficient to attract
      and
      retain key personnel.




***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.




***Our
      business is the development and distribution of software.*** ***If
      we do not protect our proprietary information and prevent third parties from
      making 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 overlaps, 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:




13




·
            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, for royalty or licensing
                arrangements.




**Risks
      Related to Ownership of Our Securities**




***The
      holders of our 10% Secured Convertible Debentures and 7.41% Senior Secured
      Notes
      have a security interest in all of our assets. If we were to fail to pay these
      obligations as required, or any other event of default set forth in the debt
      securities were to occur, these investors could foreclose on their security
      interest and your securities could become worthless.***




In
      September 2006 we placed $3,243,378 in aggregate principal amount of our 10%
      Secured Convertible Debentures of which $2,783,378 are outstanding after
      conversion of $460,000 into common stock and since April 2007 we placed $864,000
      in aggregate principal amount of our 7.41% Senior Secured Notes. The payment
      of
      these obligations is secured with all of our assets. If we were to default
      in
      our repayment obligation, or any other event of default set forth in the debt
      securities were to occur, the investors who purchased these securities could
      foreclose the security interest, take our assets and sell or otherwise dispose
      of them. If that were to happen, we may not be able to continue our business
      and
      your securities would become worthless.




***Holders
      of our 10% Secured Convertible Debentures have anti-dilution rights that are
      triggered by a disposition of our common stock at a price per share that is
      lower than the conversion price of the debt securities. These rights are not
      available to the holders of our common stock. If future issuances of our common
      stock trigger the anti-dilution rights, your investment in our common stock
      would be diluted to the extent such convertible debentures are
      converted.***




Holders
      of our 10% Secured Convertible Debentures may convert the outstanding principal
      amount and accrued interest of the debentures to common stock at a conversion
      price of $1.00 per share. If all the holders of our debentures converted the
      debentures to common stock, we would be required to issue an additional
      2,783,378 shares. If, during the time that the debentures are outstanding,
      we
      sell or grant any option to purchase (other than options issued pursuant to
      a
      plan approved by our board of directors), or sell or grant any right to reprice
      our 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 the debentures
      (which, for purposes of this discussion will be designated as the “Base
      Conversion Price”) 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 debentures will be reduced.




In
      the
      first instance, the conversion price will be reduced to the Base Conversion
      Price. In the second instance, 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 daily volume weighted average
      price.




For
      example, if we sold common stock to an investor at $0.50 per share while the
      convertible debentures remain outstanding, then the holder of a convertible
      debenture for $100,000 could convert it into 200,000 shares of common stock
      rather than into 100,000 shares. Alternatively, if the daily volume weighted
      average price of the common stock was $2.00, but we sold 100,000 shares of
      common stock at $1.50 per share, then the conversion price would be reduced
      from
      $1.00 to $0.996 (assuming 14,565,688 shares of common stock outstanding on
      the
      date of sale). The convertible debenture holders also have anti-dilution rights
      in the event that we undertake a rights offering or make a pro rata distribution
      of, among other things, our assets to the holders of our common
      stock.




14




A
      reduction in the conversion price resulting from any of the foregoing would
      allow the debenture holders to receive more shares of common stock than they
      would otherwise be entitled to receive. In that case, your investment would
      be
      diluted to a greater extent than it would be if no adjustment to the conversion
      price were required.




***Holders
      of warrants issued in conjunction with our 10% Secured Convertible Debentures,
      our 7.41% Senior Secured Notes and units we began offering in October 2007
      also
      have anti-dilution rights that are triggered by a disposition of our common
      stock at a price per share that is lower than the exercise price of the
      warrants. These rights are not available to the holders of our common stock.
      If
      future issuances of our common stock trigger the anti-dilution rights, your
      investment in our common stock would be diluted to the extent that the warrants
      are exercised.***




In
      conjunction with the offering of our 10% Secured Convertible Debentures, our
      7.41% Senior Secured Notes and the units we began offering in October 2007,
      we
      issued warrants that have anti-dilution rights. Pursuant to the warrant
      agreements, if we issue 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. For example, if the warrant allows the investor
      to purchase 1,000 shares of our common stock at an exercise price is $1.25,
      and
      we subsequently sold shares of common stock for $1.00, the warrant exercise
      price would be reduced to $1.00 and the number of shares of common stock that
      could be purchased would be increased to 1,250 from 1,000. Furthermore, if,
      during the time that the warrants are outstanding, we sell or grant any option
      to purchase, or sell or grant any right to reprice our 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 higher
      than the exercise price but lower than the daily volume weighted average price
      (“VWAP”) of the common stock, or if we issue rights, options or warrants to all
      holders of our common stock but not to the warrant holders entitling them to
      subscribe for or purchase shares of of our common stock at a price per share
      less than the VWAP, then the exercise price of the warrants will be reduced
      by a
      fraction, the denominator of which will be the number of shares of common stock
      outstanding on the date of such issuance plus the number of additional shares
      of
      common stock offered for subscription or purchase, and of which the numerator
      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 VWAP. For example,
      if
      the daily VWAP of the common stock was $2.00, but we sold 100,000 shares of
      common stock at $1.50 per share, then the exercise price would be reduced from
      $1.25 to $1.2475 (assuming 14,565,688 shares of common stock outstanding on
      the
      date of sale).




The
      warrant holders also have anti-dilution rights in the event that we undertake
      a
      pro rata distribution of, among other things, our assets to the holders of
      our
      common stock. In such a case the warrant exercise price will be adjusted by
      multiplying the exercise price in effect immediately prior to the record date
      fixed for determination of shareholders entitled to receive such distribution
      by
      a fraction of which the denominator will be the VWAP determined as of the record
      date, and of which the numerator will be the VWAP on the record date less the
      then per share fair market value at the record date of the portion of the assets
      so distributed applicable to one outstanding share of our common stock, as
      determined by our board of directors in good faith.




15


***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 a market develops, you may be unable to sell
      at
      or near ask prices or at all if you need to sell your shares to raise money
      or
      otherwise desire to liquidate your shares.***




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
      now
      accepted for quotation on the OTC Bulletin Board, there may be periods of
      several days or more when trading activity in our shares is minimal or non
      existent, 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, you
      may
      be unable to sell your shares if you need to liquidate your
      investment.




***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 your
      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.




16


***Our
      executive officers and directors, along with their friends and family, own
      or
      control approximately*** **55.6** ***%
      of our outstanding common stock, which may limit the ability of our
      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
      55.6% of the 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. Gary Guseinov, our Chief Executive Officer and
      President, owns 45.8% of our 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. If you acquire shares of common stock, you
      may
      have no effective voice in our management.





***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.





***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, if such
      a
      market develops, 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.




17


***The
      OTC Bulletin Board is an electronic quotation system, not an issuer listing
      service, market or exchange. Therefore, buying and selling stock on the OTC
      Bulletin Board is not as efficient as buying and selling stock through an
      exchange. As a result, it may be difficult for you to sell your common stock
      or
      you may not be able to sell your common stock for an optimum trading
      price.***





The
      OTC
      Bulletin Board is a regulated electronic quotation service that displays
      real-time quotes, last sale prices and volume limitations in over-the-counter
      securities.





Because
      trades and quotations on the OTC Bulletin Board involve a manual process, the
      market information for such securities cannot be guaranteed. In addition, quote
      information, or even firm quotes, may not be available. The manual execution
      process may delay order processing and intervening price fluctuations may result
      in the failure of a limit order to execute or the execution of a market order
      at
      a significantly different price. Execution of trades, execution reporting and
      the delivery of legal trade confirmations may be delayed significantly.
      Consequently, one may not be able to sell shares of our common stock at the
      optimum trading prices.





When
      fewer shares of a security are being traded on the OTC Bulletin Board,
      volatility of prices may increase and price movement may outpace the ability
      to
      deliver accurate quote information. Lower trading volumes in a security may
      result in a lower likelihood of an individual’s orders being executed, and
      current prices may differ significantly from the price one was quoted by the
      OTC
      Bulletin Board at the time of the order entry.





Orders
      for OTC Bulletin Board securities may be canceled or edited like orders for
      other securities. All requests to change or cancel an order must be submitted
      to, received and processed by the OTC Bulletin Board. Due to the manual order
      processing involved in handling OTC Bulletin Board trades, order processing
      and
      reporting may be delayed, and an individual may not be able to cancel or edit
      his order. Consequently, one may not able to sell shares of common stock at
      the
      optimum trading prices.





The
      dealer’s spread (the difference between the bid and ask prices) may be large and
      may result in substantial losses to the seller of securities on the OTC Bulletin
      Board if the common stock or other security must be sold immediately. Further,
      purchasers of securities may incur an immediate “paper” loss due to the price
      spread. Moreover, dealers trading on the OTC Bulletin Board may not have a
      bid
      price for securities bought and sold through the OTC Bulletin Board. Due to
      the
      foregoing, demand for securities that are traded through the OTC Bulletin Board
      may be decreased or eliminated.





**Item
                2.**
            **Properties**





Our
      corporate office is located at 617 West 7th Street, Suite 401, Los Angeles,
      California. The monthly rent for the initial 12 month period is $10,669.50,
      and
      will increase by 3% per year thereafter through 2013. 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 4,742 square feet of
      office space, or approximately 2.47% of the building.


We
      expect
      that the premises in which our corporate office is located will be adequate
      for
      our needs for the next 12 months.





**Item
                3.**
            **Legal
                Proceedings**





On
      June
      16, 2006, we were named as a defendant in a civil complaint filed with the
      United States District Court, Central District of California. The action is
      entitled, *Wellbourne
      Limited, a Seychelles corporation vs. 2Checkout.com Inc., a Delaware
      corporation; and CyberDefender Corporation, a California
      Corporation* .
      We
      recorded a liability of $102,000 when the services were rendered.  On
      March
      14, 2007, we entered into a settlement agreement with Wellbourne Limited. The
      terms of the settlement agreement require us to pay Wellbourne Limited the
      sum
      of $55,000. At December 31, 2007 we had paid $50,000 towards the settlement.
      At
      December 31, 2007, we still owed $5,000 plus interest.




18




On
      November 13, 2007 Patrick Hinojosa filed an action in the Los Angeles Superior
      Court, number 8C380620 titled *Patrick
      Hinojosa, plaintiff, vs. CyberDefender, Inc., a California corporation, and
      Does
      1 through 50, inclusive* .
      Mr.
      Hinojosa alleges breach of contract and violations of California Labor Code
      sections 227.3 and 203. Mr. Hinojosa alleges that he has suffered damages in
      excess of $25,000.





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





Not
      applicable. No matters have been submitted to a vote of security holders during
      the fourth quarter of our fiscal year.




19


**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 28, 2008 we have 14,565,688 shares of
      common stock issued and outstanding and we have approximately 120 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





2007
            
            
            Low
                Bid
            
            
            High
                BidFirst
                quarter ended March 31, 2007
            
            $
            (1
            )
            $
            (1
            )Second
                quarter to ended June 30, 2007
            
            
            (1
            )
            
            (1
            )Third
                quarter ended September 30, 2007
            
            
            0.90
            
            
            0.90Fourth
                quarter ended December 31, 2007
            
            
            0.48
            
            
            1.56




(1)
      Our
      common stock did not trade during the first and second quarters of the 2007
      fiscal year. Our common stock began to trade on August 2, 2007.





**Dividends**





During
      the year ended December 31, 2005, our Board of Directors authorized the payment
      of a dividend of $0.05 per share. The total amount of the dividend was $31,400.
      The dividend was paid to all of our shareholders, with the exception of
      shareholders who were also officers and directors. However, 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**





During
      the three months ended December 31, 2007, we sold the following securities,
      which were not registered under the Securities Act of 1933:





On
      October 18, 2007 we began an offering of units. Each unit consisted of 25,000
      shares of our common stock and a five year warrant to purchase 18,750 shares
      of
      our common stock at an exercise price of $1.25 per share. The purchase price
      is
      $25,000 per unit. As of December 31, 2007, we raised $654,500 through this
      offering. We relied on section 4(2) of the Securities Act of 1933 and Regulation
      D promulgated thereunder to issue the securities inasmuch as the securities
      were
      offered and sold without any form of general solicitation or general advertising
      and the offerees made representations that they were accredited
      investors.





Also
      in
      October 2007, we concluded an offering of our 7.41% Senior Secured Notes and
      warrants to purchase common stock. We commenced this offering in April 2007.
      Pursuant to this offering, we sold $864,000 in aggregate principal amount of
      our
      7.41% Secured Notes and five-and-one-half year warrants to purchase an aggregate
      of 400,000 shares of common stock at an exercise price of $1.20 per share,
      for
      an aggregate purchase price of $800,000. Of this amount, during the three months
      ended December 31, 2007, we sold $162,000 in aggregate principal amount of
      our
      7.41% Senior Secured Notes and the aforementioned warrants to purchase an
      aggregate of 75,000 shares of common stock for an aggregate purchase price
      of
      $150,000. We relied on section 4(2) of the Securities Act of 1933 and Regulation
      D promulgated thereunder to issue the securities inasmuch as the securities
      were
      offered and sold without any form of general solicitation or general advertising
      and the offerees made representations that they were accredited
      investors.




20




On
      October 1, 2007 and November 2, 2007 we issued a total of 370,277 shares, having
      an agreed upon price of $0.85 per share, as payment for interest and penalties
      to holders of our debt securities. We relied on section 4(2) of the Securities
      Act of 1933 to issue the securities inasmuch as the securities were offered
      and
      sold without any form of general solicitation or general advertising and the
      offerees made representations that they were accredited investors.





On
      October 25, 2007 we issued 100,000 shares of our common stock to Richardson
      & Patel LLP, our legal counsel, for the payment of legal services.
      Richardson & Patel LLP has agreed to sell the common stock and apply the
      proceeds against the unpaid balance of the fees we owe. As of February 29,
      2008
      we owed Richardson & Patel LLP approximately $93,000. We relied on section
      4(2) of the Securities Act of 1933 to issue the securities inasmuch as the
      securities were offered and sold without any form of general solicitation or
      general advertising and the offeree represented that it was an accredited
      investor.





On
      October 22, 2007 we entered into an agreement with Oceana Partners pursuant
      to
      which we agreed to issue to Oceana Partners warrants to purchase 400,000 shares
      of our common stock in exchange for consulting services. The agreement was
      amended on November 30, 2007. Pursuant to the amendment, we agreed to issue
      37,500 shares to designees of Oceana Partners and to reduce the number of shares
      of common stock covered by the warrants issued to Oceana Partners from 400,000
      shares to 362,500 shares. We relied on section 4(2) of the Securities Act of
      1933 to issue these securities inasmuch as the securities were offered and
      sold
      without any form of general solicitation or general advertising and the offeree
      represented that it was an accredited investor.





In
      November and December 2007, we issued 508,406 shares of our common stock in
      connection with the conversion of $460,000 in principal and $48,406 in interest
      accrued on our 10% Secured Convertible Debentures. We relied on section 3(9)
      of
      the Securities Act of 1933 to issue the securities inasmuch as the  security
      was exchanged by us with our existing security holders exclusively and no
      commission or other remuneration was paid or given directly or indirectly for
      the exchange.





**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 830,797 shares of our authorized
      but unissued common stock. As of December 31, 2007 there were two awards
      covering a total of 326,107 shares of our common stock outstanding under this
      plan. The CyberDefender Corporation Amended and Restated 2006 Equity Incentive
      Plan was adopted by our board of directors and approved by our shareholders
      on
      October 30, 2006 and includes 1,165,000 shares of our authorized but unissued
      common stock. As of December 31, 2007 there were twenty-two awards covering
      a
      total of 990,277 shares of our common stock outstanding under this
      plan.





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


21





Plan
                Category
            
            
            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)(a)
            
            
            (b)
            
            
            (c)Shareholder
                Approved(1)
            
            
            1,316,384
            
            $
            0.75
            
            
            689,413Non-ShareholderApproved
            
            
            N/A
            
            
            N/A
            
            
            N/A




(1)
      Includes the CyberDefender Corporation 2005 Equity Incentive Plan and the
      CyberDefender Corporation Amended and Restated 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 secure content management software based in Los Angeles, California.
      We develop and license security software. Our mission is to bring to market
      advanced solutions to combat and prevent online information theft, unwanted
      advertisements, spam, Internet viruses, spyware and related computer
      threats.





We
      have
      developed a Collaborative Internet Security Network (CISN) (also known as
“earlyNetwork”TM) 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 CISN, 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 CISN, and each machine that receives the information
      will,
      in turn, relay it to other machines that are part of the CISN. This protocol
      allows us to rapidly distribute alerts and updates regarding potentially
      damaging viruses, e-mails and other threats to members of the CISN, 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 CISN simply by downloading and installing our software.




22




Historically,
      our revenues were derived from subscriptions to our software. We sold one
      product, our CyberDefender
      Anti-Spyware 2006 ,
      at a
      price of $39.99, which included the initial download and one year of updates.
      The license to use the software was renewed annually, also at $39.99, with
      incentives for early renewals.





We
      do not
      offer a discount on the original purchase of the software license and the
      initial sale of our software license to a subscriber does not contain a right
      to
      a discount to assure renewal of the second year subscription. Our discounts
      are
      not given on the original sale for a future purchase, rather, discounts are
      offered from time to time as a marketing tool to provide an incentive to renew
      to a current base of subscribers who are approaching their renewal period.
      If
      the subscriber renews at a discounted price, which may be 20% to 50% of the
      annual license fee, we will recognize revenue from the sale ratably over the
      period of the license. We record the net revenue received and recognize the
      revenue in accordance with SOP No. 97-2, “Software Revenue Recognition”, as
      amended by SOP No. 98-9, “Modification of SOP 97-2, Software Revenue Recognition
      with respect to Certain Transactions” paragraph 49.





We
      acquired new users with an online direct purchase offer. The offer, to scan
      a
      computer for spyware and then pay for removal of the spyware found, was
      broadcast in emails, banners and search ads.





The
      following table summarizes our revenue during each quarter for both new sales
      of
      our software as well as for renewal sales.





SalesQuarter
                Ended
            
            
            New
            
            
            RenewalMarch
                31, 2006
            
            $
            387,942
            
            $
            842,044June
                30, 2006
            
            
            259,694
            
            
            827,688September
                30, 2006
            
            
            190,335
            
            
            653,534December
                31, 2006
            
            
            103,365
            
            
            637,271Fiscal
                Year 2006 Totals
            
            $
            941,336
            
            $
            2,960,537March
                31, 2007
            
            $
            67,663
            
            $
            598,473June
                30, 2007
            
            $
            60,679
            
            $
            567,764September
                30, 2007
            
            $
            72,982
            
            $
            471,974December
                31, 2007
            
            $
            71,356
            
            $
            309,263Fiscal
                Year 2007 Totals
            
            $
            272,680
            
            $
            1,947,474





In
      November 2006 we launched our new Internet security suite called CyberDefender
      Early Detection Center or CyberDefender FREE 2.0. CyberDefender FREE 2.0 is
      the
      ad-supported version, which is free to the subscriber because advertisers pay
      us
      to display their ads inside the software. CyberDefender Early Detection Center
      is a version of the same software, without ads, which is paid for by the
      subscriber. The annual subscription rate for the version without ads ranges
      from
      $11.99 to $39.99, depending on the marketing or distribution channels that
      we
      use.





Typically,
      a software developer gives away free versions of its software for a limited
      trial period. Very often, though, a user of free software will not purchase
      it
      once the trial period is over. There is no trial period for using our
      CyberDefender FREE 2.0 software with advertising, however. Once a subscriber
      downloads the software, it is his to keep and we receive payment from the
      advertisers. Otherwise, if the subscriber chooses, he may pay for an annual
      subscription to CyberDefender Early Detection Center without advertising. In
      this way, we will generate revenues from either the advertiser or the
      subscriber. This business model allows any computer user to obtain protection
      against Internet threats, regardless of his ability to pay. We made this change
      because we believe that the advertising revenue we may receive, in conjunction
      with the licensing fees we receive, could be substantial. We obtain the ads
      from
      ad networks, which are plentiful. Ad networks provide advertising for a website
      and share advertiser revenue each time the website visitors click on the ads.  During
      the month that the ads are displayed on a subscriber’s computer, revenues will
      be earned from the ad networks each time an ad is shown (per impression) or
      when
      an ad is clicked (per click) or for each action taken by the subscriber after
      he
      clicks on the ad and visits to the advertiser’s website (per
      action).




23




Furthermore,
      we began to see that large security software companies, such as McAfee, Symantec
      and Trend Micro, were offering security suites, as opposed to single,
      stand-alone products. We determined that consumers would come to expect a suite
      of products that would provide comprehensive protection against Internet
      threats, rather than having to license several products. As a result of this
      decision, expenses related to software research and development increased
      significantly during the fiscal year ended December 31, 2006. We expect to
      continue to invest in our technology as we develop additional features and
      functionality in our product.





While
      we
      were developing CyberDefender Early Detection Center/CyberDefender FREE 2.0,
      we
      slowed down our efforts in marketing our CyberDefender Anti-Spyware 2006
      software so that we could devote more of our financial resources to the
      development of our new product. The expense of turning a previously
      marketing-focused publisher into a developer of a suite of Internet security
      products exceeded our revenues. During this period, our new user marketing
      was
      restricted to experimental activities. Therefore, as and when we needed cash,
      we
      sold our securities. To date, we have received $4,275,000 from the sale of
      our
      convertible debt securities, $800,000 from the sale of our OID Notes and
      $654,500 from the sale of our October Units.





We
      are
      continuing to roll-out our CyberDefender Early Detection Center/CyberDefender
      FREE 2.0 product and, to date, revenues we receive from advertising or from
      those who license the product have not been adequate to support our operations.
      We expect that our expenses will continue to exceed our revenues for at least
      the next nine to 12 months. We currently have enough cash to fund our operations
      through July 2008. In order to fund our operations beyond that date, we will
      be
      required to borrow money or to find other sources of financing. We do not have
      any commitments for financing at this time and we cannot guarantee that we
      will
      be able to find financing when we need it. If we are unable to find financing
      when we need it we may be required to curtail, or even to cease, our
      operations.





**Restatement**




In
      July
      2007, as a result of changes made to the valuation allowance as of December
      31,
      2004, management determined that our previously issued financial statements
      as
      of and for the years ended December 31, 2006 and December 31, 2005 would need
      to
      be restated to increase the valuation allowance in the deferred tax asset by
      $966,550. The impact of the adjustment on the financial statements for the
      year
      ended December 31, 2006 has been quantified below:




**Previously**
            
            
            **As**
            
            
            **Increase/****December
                31, 2006**
            
            
            **Reported**
            
            
            **Restated**
            
            
            **(Decrease**)****$
            $
            
            $**Statement
                of Operations**Income
                Tax Expense
            
            
            (966,550
            )
            
            -
            
            
            966,550**Net
                Loss**
            
            
            (6,474,150
            )
            
            (5,507,600
            )
            
            966,550**Loss
                per share, basic and diluted**
            
            
            (0.64
            )
            
            (0.55
            )
            
            0.09




A
      summary
      of the effects of the restatement on reported amounts for the year ended
      December 31, 2006 is presented in Note 14 to our financial statements for the
      fiscal year ended December 31, 2007.




24


**Critical
      Accounting Policies and Estimates**





Our
      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* . We
      recognize revenue from the sale of software licenses under the guidance of SOP
      No.
      97-2, “Software Revenue Recognition,” as amended by SOP No. 98-9, “Modification
      of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”
and SEC Staff Accounting Bulletin (SAB) 104.





Specifically,
      we recognize revenues from our CyberDefender Anti-Spyware 2006
      (“CyberDefender TM ”)
      product when all
      of the following conditions for revenue recognition are met:





·
            persuasive
                evidence of an arrangement exists,





·
            the
                product or service has been
                delivered,





·
            the
                fee is fixed or determinable, and





·
            collection
                of the resulting receivable is reasonably
                assured.





We
      sell
      our CyberDefender TM software
      over the Internet. Customers order the product and simultaneously provide their
      credit card information to us. Upon receipt of authorization from the credit
      card issuer, we license the customer to download the product. As part of the
      sales price, we provide renewable product support and content updates, which are
      separate components of product licenses and sales. Term licenses allow customers
      to use our product and receive product support coverage and content updates
      for
      a specified period, generally twelve months. We invoice 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) does not exist for one or more of the elements. The arrangement is in
      substance a subscription and the entire fee is deferred until the month
      subsequent to the delivery date of the product and is recognized ratably over
      the term of the arrangement according to the guidance in SOP 97-2 paragraph
      49.




We
      use a
      third party to process our product sales. We pay a direct acquisition cost
      to
      the processor for each completed sale. These direct acquisition costs are
      deferred and recognized ratably over the term of the arrangement of the
      associated sale in accordance with FASB Technical Bulletin 90-1, “Accounting for
      Separately Priced Extended Warranty and Product Maintenance Contracts”. The
      third party processor refunds any direct acquisition cost paid to it on any
      credit card chargeback or on any product that is returned. The refunds are
      matched against the associated chargebacks and product returns.




Product
      returns are generally received within 30 days of the original sale and are
      charged against the associated sale upon receipt of the return. A chargeback
      occurs after a customer is automatically charged for a renewal license and
      subsequently, within 30 days of renewal, decides not to continue using the
      license or the credit card processed for renewal is no longer valid. The third
      party processor of renewal sales is usually notified within 30 days by a
      customer that the customer no longer wishes to license our product. The third
      party processor reduces the amounts due to us as a result of any chargeback
      during the preceding 30 day period. As a result, a majority of chargebacks
      occur
      within 30 days of the rebilling event and are recorded prior to closing the
      previous month’s accounting records. As stated in our revenue recognition
      policy, revenue is deferred until the month subsequent to the renewal date
      and
      recognized ratably over the term of the arrangement.




25




In
      November 2006, we launched a new product, CyberDefender FREE 2.0, which is
      free
      to the subscriber. Revenues are earned from advertising networks and search
      engine providers that pay us for displaying the advertiser’s advertisements
      inside the software and from search results generated by our users.
      CyberDefender Early Detection Center is a version of the same software, without
      the advertising, which is paid for by the subscriber. The annual subscription
      rate for the version without ads ranges from $11.99 to $59.99, depending on
      the
      marketing or distribution channels we use.




Customers
      are permitted to return a product that has been paid for within 30 days from
      the
      date of purchase. During the fiscal years ended December 31, 2007 and 2006,
      we
      did not accrue any sum for product returns or chargebacks as such returns and
      chargebacks are identified within the first 30 days of sale and are charged
      against our gross sales in the month that they occur. Our net revenue, including
      returns and chargebacks for each period, are deferred and recognized ratably
      over a 12 month period according to our revenue recognition policy.




*Software
      Development Costs* **.** We
      account for software development costs in accordance with Statement of Financial
      Accounting Standards (“SFAS”) No. 86, “Computer Software to Be Sold, Leased, or
      Otherwise Marketed”. Such costs are expensed prior to achievement of
      technological feasibility and thereafter are capitalized. We have had 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.




*Stock
      Based Compensation and Fair Value of our Shares.* **** We
      adopted SFAS No. 123 (Revised 2004), Share Based Payment (“SFAS
      No. 123R”), under the modified-prospective transition method on
      January 1, 2006. SFAS No. 123R 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. Share-based compensation
      recognized under the modified-prospective transition method of SFAS
      No. 123R includes share-based compensation based on the grant date fair
      value determined in accordance with the original provisions of SFAS
      No. 123, Accounting for Stock-Based Compensation, for all share-based
      payments granted prior to and not yet vested as of January 1, 2006 and
      share-based compensation based on the grant-date fair-value determined in
      accordance with SFAS No. 123R for all share-based payments granted after
      January 1, 2006.




**Contractual
      Obligations**





We
      are
      committed under the following contractual obligations:





**Contractual
                Obligations**
            
            **Payments
                Due By Period**Total
            
            
            Less
                than 1 year
            
            
            1
                to 3 Years
            
            
            3
                to 5 Years
            
            
            Over
                5 YearsLong-term
                debt obligations
            
            $
            3,647,378
            
            $
            864,000
            
            $
            2,783,378Capital
                lease obligations
            
            $
            82,818
            
            $
            31,497
            
            $
            38,377
            
            $
            12,944Operating
                lease obligations
            
            $
            704,488
            
            $
            85,356
            
            $
            265,108
            
            $
            281,252
            
            $
            72,772





**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.




26




**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.





**Results
      of Operations**





**Fiscal
      year ended December 31, 2007 as compared to the fiscal year ended December
      31,
      2006**




**Revenue**




Total
      revenue was $2,220,154 for the fiscal year ended December 31, 2007 as compared
      to total revenue of $3,901,873 for the fiscal year ended December 31, 2006,
      a
      decrease of $1,681,719 or approximately 43%. This decrease in total revenue
      was
      due primarily to a decrease in the sales of our CyberDefender Anti-Spyware
      2006
      product, which was directly attributable to our decision to change our focus
      from being a marketing software publisher - that is, creating and marketing
      individual software products - to providing SCM software. We started earning
      advertising revenue in 2007 from our CyberDefender Early Detection
      Center/CyberDefender FREE 2.0 product.




**Operating
      Expenses**





Total
      operating expenses decreased by $2,485,922, or approximately 35%, to $4,631,302
      during the fiscal year ended December 31, 2007, as compared to $7,117,224 in
      operating expenses incurred during the fiscal year ended December 31, 2006.
      Operating expenses include advertising, product development, selling, general
      and administrative expense, interest and depreciation. A detailed explanation
      of
      the decrease in operating expenses is provided in the discussion
      below.





*Advertising*





Advertising
      costs are comprised primarily of media and channel fees, including online
      advertising and related functional resources. Media and channel fees fluctuate
      by channel and are higher for the direct online consumer market than for the
      OEM, reseller and SMB markets. Advertising expenses decreased by $342,012,
      or
      approximately 43%, from $787,607 during the fiscal year ended December 31,
      2006
      to $445,595 during the fiscal year ended December 31, 2007. This decrease was
      due to the redirection of our financial resources from advertising toward
      developing our new suite of Internet security software. During the fiscal year
      ended December 31, 2007 and 2006, four vendors accounted for approximately
      45%
      and 58% of our advertising expenses, respectively. These vendors provide
      Internet search and related marketing services, programming services and design
      services for us. These types of vendors are plentiful and can be easily
      replaced.




*Product
      Development*




Product
      development expenses are primarily comprised of research and development costs
      associated with the continued development of our products. Product development
      expenses decreased by $1,662,343, from $2,199,901 during the fiscal year ended
      December 31, 2006 to $537,558 during the fiscal year ended December 31, 2007.
      The decrease is primarily attributable to the completion of the development
      of
      our CyberDefender Early Detection Center/CyberDefender FREE 2.0 product suite.
      In 2006 the majority of the product development expense related to programmers
      that were employed by us and outside consultants that were hired to develop
      our
      new product.




27




*Selling,
      General and Administrative*





Selling,
      general and administrative expenses are primarily comprised of salaries,
      commissions, rent, stock based compensation and professional fees.




Selling,
      general and administrative expenses decreased by $486,727, from $4,033,851
      during the fiscal year ended December 31, 2006 to $3,547,124 during the fiscal
      year ended December 31, 2007. The decrease is primarily attributable to a
      decrease in commissions of approximately $176,000 due to the decrease in sales,
      a decrease in marketing of approximately $159,000 due to less spending on
      marketing the CyberDefender Anti-Spyware 2006 product, a decrease in legal
      fees
      of approximately $90,000, a decrease in salaries of approximately $71,000 due
      to
      turnover of personnel and a decrease of approximately $71,000 in rent expense
      resulting from the move of our corporate offices. These decreases were partially
      offset by an increase of approximately $66,000 in accounting fees that we
      incurred because we are a publicly-traded company and an increase in stock
      based
      compensation expense of approximately $73,000 related to a change in the vesting
      of Bing Liu’s options, as more fully described in Note 6 to our financial
      statements.




*Interest
      expense*




Interest
      expense increased by $1,134,212, from $2,230,686 in the fiscal year ended
      December 31, 2006 to $3,364,898 in the fiscal year ended December 31, 2007.
      The
      increase in interest expense was primarily due to an increase in interest in
      the
      amount of approximately $144,000 accrued on our 10% Secured Convertible
      Debentures, an increase of approximately $740,000 of accretion on the note
      discount associated with our 10% Secured Convertible Debentures, an increase
      of
      approximately $371,000 on the amortization of placement fees related to our
      10%
      Secured Convertible Debentures, interest in the amount of approximately $31,000
      on our 7.41% Senior Secured Notes, approximately $148,000 of amortization of
      the
      discount on the 7.41% Senior Secured Notes, approximately $374,000 of
      amortization of placement fees related to the 7.41% Senior Secured Notes,
      approximately $253,000 of accretion on the note discount, $128,000 of
      amortization of placement fees due to conversion of $400,000 in principal amount
      of the 10% Secured Convertible Debentures and approximately $477,000 incurred
      from the issuance of 37,500 shares of common stock and 362,500 warrants for
      the
      purchase of common stock issued in exchange for services. These increases were
      offset by a decrease of approximately $80,000 of interest on bridge notes that
      were converted in 2006, $755,173 associated with the value of the beneficial
      conversion feature arising from the conversion of the bridge notes into our
      common stock at a price below market value, $506,896 associated with the
      amortization of the discount of the bridge notes and approximately $200,000
      incurred from the issuance of 186,354 shares of common stock valued at $1.07
      per
      share to the holders of the bridge notes as additional consideration for
      converting the bridge notes.




*Public
      company costs*




We
      expect
      to incur increased professional fees for audit, legal and investor relations
      services, and for insurance costs as a result of being a public company. We
      also
      anticipate that we may be required to hire additional accounting personnel
      as a
      public company.




**Liquidity
      and Capital Resources**




At
      December 31, 2007, we had cash and cash equivalents totaling $236,995. In the
      fiscal year ended December 31, 2007, we generated negative cash flows of
      $312,686. Uses of cash during the fiscal year ended December 31, 2007 included
      $1,744,418 of net cash used in operations, $5,424 of cash used for purchases
      of
      property and equipment and $17,344 for payment on capital lease
      obligations.




28




*Operating
      Activities*




Net
      cash
      used in operating activities during the fiscal year ended December 31, 2007
      was
      primarily the result of our net loss of $5,866,123. Net loss for the fiscal
      year
      ended December 31, 2007 was adjusted for non-cash items such as accretion of
      loan discount of $1,459,575, a loss on registration rights agreement for the
      effect of partial liquidated damages of $84,864, compensation expense for vested
      stock options of $498,431 amortization of deferred financing fees of $1,032,089,
      shares issued for penalties and interest of $363,153, shares issued for services
      of $604,069 and depreciation and amortization of $101,025. Other changes in
      working capital accounts include an increase in accounts payable and accrued
      expenses of $269,999 and a decrease of $356,941 in deferred revenue resulting
      from lower new customer and renewal sales.




Historically,
      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 2007 and 2006, 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, accrued taxes and other
      liabilities was $269,999. 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, 2007 and 2006, we did
      not
      make any significant changes to the timing of payments to our vendors, although
      our financing activities caused an increase in this category.




Our
      working capital deficit at December 31, 2007, defined as current assets minus
      current liabilities, was ($1.9) million as compared to a working capital deficit
      of ($0.8) million at December 31, 2006. The decrease in working capital of
      approximately $1.1 million from December 31, 2006 to December 31, 2007 was
      primarily attributable to a decrease in cash of $312,686, an increase in
      accounts receivable of approximately $15,000, a decrease in prepaid expenses
      and
      other assets of approximately $39,000, a decrease in deferred processing fees
      of
      approximately $41,000, an increase in accounts payable and accrued expenses
      of
      approximately $397,000, an increase in the current portion of notes payable
      of
      $705,000, and a decrease in deferred revenue of approximately $357,000 as a
      result of lower new customer and renewal sales. We anticipated this decrease
      in
      deferred revenue would result as part of redirecting our business from being
      a
      marketing software publisher to providing SCM software.




*Investing
      Activities*




Net
      cash
      used in investing activities during the fiscal year ended December 31, 2007
      resulted primarily from property and equipment purchases totaling approximately
      $5,000. We anticipate that we will continue to purchase property and equipment
      necessary 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
      our hiring of employees and the rate of change in computer hardware and software
      used in our business.




*Financing
      Activities*




Cash
      provided by financing activities during the fiscal year ended December 31,
      2007
      was primarily the result of issuances of notes payable totaling $800,000 and
      the
      sale of stock totaling $654,500. Cash used in financing activities was primarily
      used for payments on capital lease obligations.




We
      expect
      to meet our obligations through the end of July 2008. However, we cannot predict
      whether our evolution from a marketing-focused software publisher to a developer
      of a suite of Internet security products will be successful or what the effect
      on our business might be from the competitive environment in which we operate.
      We have eliminated certain operating costs since November 2006 through employee
      attrition, a reduction in executive salaries and a reduction in the number
      of
      independent contractors we employ due to the completion of the development
      and
      launch of our CyberDefender Early Detection Center/CyberDefender FREE 2.0
      product. These changes have significantly decreased the rate at which we use
      cash, from approximately $375,000 per month to a current average of
      approximately $250,000 per month. We continue to manage our operating costs
      and
      expect to continue to reduce the rate at which we use cash for operations.
      We
      are currently attempting to raise cash through the sale of our equity securities
      although there is no guarantee that we will be successful in doing so. To the
      extent it becomes necessary to raise additional cash in the future, we will
      seek
      to raise it through the sale of debt or equity securities, funding from
      joint-venture or strategic partners, debt financing or short-term loans, or
      a
      combination of the foregoing. We may also seek to satisfy indebtedness without
      any cash outlay through the private issuance of debt or equity securities.
      We
      currently do not have any binding commitments for, or readily available sources
      of, additional financing. We cannot provide any assurances that we will be
      able
      to secure the additional cash or working capital we may require to continue
      our
      operations, either now or in the future. If we are unable to secure financing,
      we may be required to severely curtail, or even to cease, our
      operations.




29




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 require public companies to maintain
      “disclosure controls and procedures,” which are defined to mean a company’s
      controls and other procedures that are designed to ensure that information
      required to be disclosed in the reports that it files or submits under the
      Securities Exchange Act of 1934 is recorded, processed, summarized and reported,
      within the time periods specified in the Commission’s rules and
      forms.





We
      conducted an evaluation, with the participation of our Chief Executive Officer
      and Chief Financial Officer, of the effectiveness of the design and operation
      of
      our disclosure controls and procedures, as defined in Rules 13a-15(e) and
      15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange
      Act, as of December 31, 2007, to ensure that information required to be
      disclosed by us in the reports filed or submitted by us under the Exchange
      Act
      is recorded, processed, summarized and reported, within the time periods
      specified in the Securities Exchange Commission’s rules and forms, including to
      ensure that information required to be disclosed by us in the reports filed
      or
      submitted by us under the Exchange Act is accumulated and communicated to our
      management, including our principal executive and principal financial officers,
      or persons performing similar functions, as appropriate to allow timely
      decisions regarding required disclosure. Based on that evaluation, our Chief
      Executive Officer and Chief Financial Officer have concluded that as of December
      31, 2007, our disclosure controls and procedures were not effective at the
      reasonable assurance level due to the material weaknesses described
      below.




30




In
      light
      of the material weaknesses described below, we performed additional analysis
      and
      other post-closing procedures to ensure our financial statements were prepared
      in accordance with generally accepted accounting principles. Accordingly, we
      believe that the financial statements included in this report fairly present,
      in
      all material respects, our financial condition, results of operations and cash
      flows for the periods presented.





A
      material weakness is a control deficiency (within the meaning of the Public
      Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
      combination of control deficiencies, that results in more than a remote
      likelihood that a material misstatement of the annual or interim financial
      statements will not be prevented or detected. Management has identified the
      following three material weaknesses which have caused management to conclude
      that, as of December 31, 2007, our disclosure controls and procedures were
      not
      effective at the reasonable assurance level:





1.  We
      do not
      have written documentation of our internal control policies and procedures.
      Written documentation of key internal controls over financial reporting is
      a
      requirement of Section 404 of the Sarbanes-Oxley Act and will be applicable
      to
      us for the year ending December 31, 2008. Management evaluated the impact of
      our
      failure to have written 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 material
      weakness.





2.  We
      do not
      have sufficient segregation of duties within accounting functions, which is
      a
      basic internal control. Due to our size and nature, segregation of all
      conflicting duties may not always be possible and may not be economically
      feasible. However, to the extent possible, the initiation of transactions,
      the
      custody of assets and the recording of transactions should be performed by
      separate individuals. Management evaluated the impact of our failure to have
      segregation of duties on our assessment of our disclosure controls and
      procedures and has concluded that the control deficiency that resulted
      represented a material weakness.





3.  We
      have
      had, and continue to have, a significant number of audit adjustments. Audit
      adjustments are the result of a failure of the internal controls to prevent
      or
      detect misstatements of accounting information. The failure could be due to
      inadequate design of the internal controls or to a misapplication or override
      of
      controls. Management evaluated the impact of our significant number of audit
      adjustments and has concluded that the control deficiency that resulted
      represented a material weakness.





To
      address these material weaknesses, management performed additional analyses
      and
      other procedures to ensure that the financial statements included herein fairly
      present, in all material respects, our financial position, results of operations
      and cash flows for the periods presented.





**Remediation
      of Material Weaknesses**





We
      have
      attempted to remediate the material weaknesses in our disclosure controls and
      procedures identified above by working with our independent registered public
      accounting firm and refining our internal procedures. To date, we have not
      been
      successful in reducing the number of audit adjustments, but will continue our
      efforts in the coming fiscal year.





**Internal
      Control over Financial Reporting**





This
      annual report does not include a report of management's assessment regarding
      internal control over financial reporting or an attestation report of the
      company's registered public accounting firm due to a transition period
      established by rules of the Securities and Exchange Commission for newly public
      companies.


31


**Changes
      in Internal Control over Financial Reporting**





There
      have been no changes in the Company’s 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 2007 that have materially affected, or are
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.





**Item
                9B.**
            **Other
                Information**





On
      October 1, 2007 our Chief Executive Officer, Gary Guseinov, provided us with
      a
      short term interest free loan in the amount of $28,078.. The loan was repaid
      on
      November 19, 2007.




32


**PART
      III**


**Item
                    10.**
              **Directors,
                    Executive Officers and Corporate
                    Governance**


The
      following table identifies our current executive officers and
      directors.




**Name**
            **Age**
            **Position
                Held**Gary
                Guseinov
            38
            Chief
                Executive Officer, and Chairman of the Board of
                DirectorsMichael
                Barrett
            37
            Chief
                Financial OfficerIgor
                Barash
            37
            Chief
                Information Officer, Secretary and DirectorBing
                Liu
            48
            Director




There
      are
      no family relationships between any two or more of our directors or executive
      officers. Our executive officers are appointed by our board of directors and
      serve at the board’s discretion. There is no arrangement or understanding
      between any of our directors or executive officers and any other person pursuant
      to which any director or officer was or is to be selected as a director or
      officer, and there is no arrangement, plan or understanding as to whether
      non-management shareholders will exercise their voting rights to continue to
      elect the current board of directors. There are also no arrangements, agreements
      or understandings to our knowledge between non-management shareholders that
      may
      directly or indirectly participate in or influence the management of our
      affairs.




None
      of
      our directors or executive officers has, during the past five
      years,




·
            had
                any bankruptcy petition filed by or against any business of which
                such
                person was a general partner or executive officer, either at the
                time of
                the bankruptcy or within two years prior to that
                time,




·
            been
                convicted in a criminal proceeding and none of our directors or executive
                officers is subject to a pending criminal
                proceeding,




·
            been
                subject to any order, judgment, or decree, not subsequently reversed,
                suspended or vacated, of any court of competent jurisdiction, permanently
                or temporarily enjoining, barring, suspending or otherwise limiting
                his
                involvement in any type of business, securities, futures, commodities
                or
                banking activities, or




·
            been
                found by a court of competent jurisdiction (in a civil action), the
                Securities and Exchange Commission or the Commodity Futures Trading
                Commission to have violated a federal or state securities or commodities
                law, and the judgment has not been reversed, suspended, or
                vacated.




**Business
      Experience**





***Gary
      Guseinov*** is one
      of our co-founders and has served as our Chief Executive Officer and as a
      director since our inception in August of 2003. Mr. Guseinov has over 12 years
      of start-up business experience in the e-commerce sector in addition to direct
      marketing expertise. In 1994, Mr. Guseinov rapidly grew Digital Media Concepts,
      a web development firm, by establishing business relationships with AT&T and
      Pacific Bell. While at Digital Media Concepts, Mr. Guseinov built a client
      base
      of over 475 clients in less than two years. In 1998, Digital Media Concepts
      merged with Synergy Ventures Inc., a direct marketing firm focusing on online
      marketing and customer acquisition. By 1999, Mr. Guseinov developed the first
      Automated Media Planning System (SynergyMPS), allowing media buyers and media
      sellers to communicate on a single platform and issue insertion orders. While
      building SynergyMPS, Mr. Guseinov developed business relationships with over
      2,500 media companies in the U.S., U.K., and Japan. In 2002, Mr. Guseinov
      developed one of the largest enterprise email transmission systems capable
      of
      handling over 1 billion email messages per month. While at Synergy, Mr. Guseinov
      was responsible for acquiring such clients as Lucent Technologies, Wells Fargo
      Bank, Citibank, Chase, New Century Financial, JD Powers and Associates, Sears,
      GoToMyPC and many other Fortune 1000 clients. Under Mr. Guseinov’s management,
      DirectSynergy was able to generate over $2 billion in revenues for its clients.
      Mr. Guseinov earned his B.A. from the California State University at Northridge,
      School of Social and Behavioral Sciences.




33




***Michael
      Barrett*** joined
      us as our Consulting Chief Financial Officer in February 2008. Mr. Barrett,
      who
      is a certified public accountant, is the Vice President, Finance for Mesa West
      Capital, LLC, a position he has held since November 2005. Prior to joining
      Mesa
      West Capital, LLC, Mr. Barrent was a manager for BDO Seidman, LLP from January
      2005 to November 2005. From June 2004 through December 2004, Mr. Barrett was
      the
      controller for Network Dynamics, from February 2002 through May 2004 he was
      the
      Vice President , Finance for Mantra Films, Inc. and from September 2000 through
      February 2002 he was the controller for uWink.com. Mr. Barrett graduated from
      the University of Virginia McIntire School of Commerce with a B.S. degree in
      accounting.





***Igor
      Barash*** is one
      of our co-founders and has served as our Chief Information Officer and as a
      director since our inception in August of 2003. Mr. Barash has over 10 years
      of
      senior level management experience with tier one Internet service providers.
      In
      1997, Mr. Barash became the first employee of Hostpro, a Los Angeles based
      ISP.
      With his extensive knowledge of the Internet based systems, servers,
      administration and development, Hostpro grew to become one of the largest
      hosting service providers in the world. After Hostpro’s purchase by Micron PC,
      Mr. Barash took a key roll in Micron’s Internet services business, including
      developing value added features on enterprise level service models,
      restructuring its data center, and participating as Micron’s representative to
      Microsoft. Later, Mr. Barash became the technical due diligence leader during
      Micron’s procurement of other ISPs, and Mr. Barash delivered assessments of all
      companies in contention to be purchased and incorporated under the Micron
      umbrella. In 1999, Mr. Barash was given the task of restructuring and
      incorporating WorldWide Hosting in Boca Raton, an acquisition he led. Since
      January 2000, Mr. Barash has been operating his own consulting firm, supplying
      high level IT solutions and management services. Mr. Barash earned his B.S.
      from
      the California State University at Northridge, School of Computer
      Science.





***Bing
      Liu*** has
      served as our Chief Software Architect (first as an employee and now as an
      independent contractor) from January 2005 and as a director since October 2006.
      Mr. Liu has worked in the software technology field for over 22 years. Mr.
      Liu
      started his technology career in the U.S. in 1989. In 1991, Mr. Liu founded
      Unionway International Corporation and developed the most popular Asian language
      software called AsianSuite. AsianSuite is used by Wal-Mart, the U.S. Army,
      the
      Library of Congress and millions of consumers worldwide. Mr. Liu also worked
      as
      Senior Software Architect for CyberMedia Corporation. While at CyberMedia,
      Mr.
      Liu developed ActiveHelp technology, which was later integrated into FirstAID
      and GuardDog - popular software marketed to Microsoft Windows users. In 1997,
      Mr. Liu was instrumental in selling CyberMedia to McAfee for over $200 million.
      In 2001, Mr. Liu founded Cyber-Defender, an innovative Internet security company
      focusing on antivirus technology. Cyber-Defender’s technology is based on a
      sophisticated secure adaptive peer network that we believe is far superior
      than
      any other competitive product on the market. In January 2005, we acquired the
      software application Cyber-Defender. Mr. Liu holds five different software
      patents in the U.S. Mr. Liu also holds a Masters and Bachelors Degree in
      Computer Science from Tsinghua University, Beijing China.





All
      directors serve until the next annual meeting of common shareholders and until
      their successor is elected and qualified by our common shareholders, or until
      the earlier of their death, retirement, resignation or removal.




34




**Significant
      Employees**





In
      addition to our executive officers and directors, we value and rely upon the
      services of the following significant employee in the support of our business
      and operations.





**Alan
      Wallace, age 43**


**Senior
      Vice President, Corporate Communications**





Alan
      Wallace joined us in October 2006 as Senior Vice President, Corporate
      Communications. Mr. Wallace has over 15 years of public relations and corporate
      communications experience. Before joining us, Mr. Wallace served in similar
      positions with MeziMedia Corporation from 2003 to 2006, Panda Software from
      2001
      to 2003 and with Live365 from 2000 to 2001. Mr. Wallace also has experience
      working with startup organizations and startup technology. In 1995, Mr. Wallace
      founded and, until 2000, served as the Chief Executive Officer of, iAgency
      - the
      first Internet-based public relations, marketing and advertising firm devoted
      to
      the Internet. Mr. Wallace has been honored to be included in “The Top 50 in
      Streaming” as designated by Streaming Magazine and he was named by Digital Coast
      Reporter as one of “The Top 50 Industry Executives”. Mr. Wallace also led teams
      that won two Webby Awards and two Invision awards. During the course of his
      career, Mr. Wallace has appeared on major broadcast outlets such as CNN, TechTV,
      KTLA, KABC and been featured in various business and trade publications,
      including Business 2.0, Forbes and Esther Dysons “Release 2.0”. Mr. Wallace is a
      graduate of Belmont University, Nashville, Tennessee.




**Compensation
      of Directors**





Directors
      do not currently receive compensation for their services as directors nor are
      they reimbursed for expenses incurred in attending board meetings. On November
      1, 2006, as an inducement to join our board of directors, we issued an option
      to
      purchase 40,000 shares of common stock to John LaValle. The exercise price
      for
      the option is $1.00 per share and the term of the option is 10 years. The value
      of the option was $38,910 on the date of grant. The assumptions used to compute
      this value are included in Note 5 to our financial statements.





**Section
      16(a) Beneficial Ownership Reporting Compliance**





Section
      16(a) of the Securities Exchange Act of 1934 requires executive officers,
      directors and persons who own more than ten percent of a registered class of
      our
      equity securities to file reports of ownership with the Securities and Exchange
      Commission. Our securities are not registered under section 12 of the Securities
      Exchange Act of 1934, therefore our executive officers, directors and persons
      who own more than ten percent of our securities are not required to file these
      reports.





**Code
      of Ethics**





We
      have
      adopted a code of ethics that applies to all of our employees, including our
      principal executive officer and principal financial officer. We will provide
      to
      any person, upon request and without charge, a copy of our Code of Ethics.
      Requests should be in writing and addressed to Mr. Gary Guseinov, c/o
      CyberDefender Corporation, 617 West 7 th Street,
      Suite 401, Los Angeles, California 90017.





**Corporate
      Governance**





Our
      board
      of directors has not yet adopted procedures by which shareholders may recommend
      nominees to the board of directors.




35


**Item
                11.**
            **Executive
                Compensation**





**Summary
      of Compensation**





The
      following table reflects all compensation awarded to, earned by or paid to
      our
      Chief Executive Officer, our two most highly compensated officers other than
      the
      Chief Executive Officer and any other individuals who are no longer serving,
      but
      who did serve, as an officer during the last two completed fiscal
      years.




**Summary
                Compensation Table**Name
                and principal position
            
            
            Year
            
            
            Salary
                ($)
            
            
            Bonus
              ($)
            
            
            Stock
                Awards
              ($)
            
            
            Option
                Awards
              ($)
            
            
            Non-Equity
                Incentive Plan Compen-sation
              ($)
            
            
            Nonquali-fied
                Deferred Compen-sation Earnings
              ($)
            
            
            All
                Other Compen-sation ($)
            
            
            Total
                ($)Gary
                Guseinov, Chief Executive Officer and President
            
            
            2007
            
            $
            225,000
            (1)
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            $
            13,575
            
            $
            238,5752006
            
            $
            287,809
            (1)
            $
            91,250
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            $
            16,474
            
            $
            395,533(2)Ivan
                Ivankovich, former Consulting Chief Financial Officer
            
            
            2007
            
            $
            132,000
            (3)
            
            0
            
            
            0
            
            $
            144,401
            (9)
            
            0
            
            
            0
            
            
            0
            
            $
            276,4012006
            
            $
            37,500
            (3)
            
            0
            
            
            0
            
            $
            38,910
            (8)
            
            0
            
            
            0
            
            
            0
            
            $
            76,410Igor
                Barash, Chief Information Officer
            
            
            2007
            
            $
            135,000
            (4)
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            $
            3,201
            
            $
            138,2012006
            
            $
            135,000
            (4)
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            $
            1,601
            
            $
            136,601Bing
                Liu, Chief Software Architect
            
            
            2007
            
            $
            70,825
            (5)
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            $
            70,8252006
            
            $
            175,938
            (5)
            
            -0-
            
            $
            691,395
            (9)
            $
            326,623
            (8)
            
            -0-
            
            
            -0-
            
            
            -0-
            
            $
            1,193,956Riggs
                Eckelberry, former Chief Operating Officer(6)
            
            
            2006
            
            $
            260,000
            
            $
            162,121
            
            
            -0-
            
            $
            194,922
            (8)
            
            -0-
            
            
            -0-
            
            $
            21,667
            (7)
            $
            638,710




(1)
      From
      March 19, 2005 through September 30, 2006, Mr. Guseinov’s base salary was
      $285,000. As of October 1, 2006, Mr. Guseinov’s base salary has been set,
      pursuant to his employment agreement, at $225,000 per year. While Mr. Guseinov’s
      employment agreement requires a matching contribution to a 401(k) plan in the
      amount of $2,500 per month and a life insurance policy the premium of which
      is
      no more than $3,000 per year, we have not provided either of these benefits
      to
      him. In November 2006, in order to conserve cash, Mr. Guseinov agreed to defer
      payment of one-half of his base salary. In 2007, compensation in the amount
      of
      $107,813 was deferred and has been accrued for Mr. Guseinov’s
      benefit.


(2)
      In
      2006, we advanced a total of $89,059 to Mr. Guseinov, which we have reclassified
      as compensation and included in this table in the column titled
“Salary”.


(3)
      Mr.
      Ivankovich began providing consulting services to us on September 1, 2006.
      Under
      the Consulting Agreement signed on that date, Mr. Ivankovich agreed to provide
      services to us on a 40% basis in exchange for $8,000 per month. The Consulting
      Agreement was amended on October 30, 2006. Pursuant to the amendment, Mr.
      Ivankovich agreed to provide services to us on a half-time basis in exchange
      for
      $11,000 per month. In October 2007, we signed another amendment to Mr.
      Ivankovich’s Consulting Agreement, pursuant to which we paid him $12,000 per
      month for his services. Mr. Ivankovich separated from service on January 31,
      2008.


(4)
      From
      March 19, 2005 through September 30, 2006, Mr. Barash’s base salary was
      $145,000. As of October 1, 2006, Mr. Barash’s base salary has been set, pursuant
      to his employment agreement, at $135,000 per year. In November 2006, in order
      to
      conserve cash, Mr. Barash agreed to defer payment of one-half of his base
      salary. In 2007, compensation in the amount of $64,688 was deferred and has
      been
      accrued for Mr. Barash’s benefit.


(5)
      From
      January 2006 to September 2006, Mr. Liu’s annual salary was $165,000. In
      September 2006 Mr. Liu’s annual salary was increased to $202,000. In November
      2006, in order to conserve cash, Mr. Liu agreed to defer payment of one-half
      his
      base salary. Mr. Liu resigned as an employee in August 2007 and became an
      independent contractor thereafter. In 2007, compensation in the amount of
      $43,125 was deferred and has been accrued for Mr. Liu’s benefit.


(6)
        Mr.
        Eckelberry was hired in November 2005. His employment with us was terminated
        on
        December 31, 2006.
 (7)
        Represents consideration paid to Mr. Eckelberry in November 2006 for his
        agreement to amend his employment agreement to change the termination date
        from
        December 31, 2008 to December 31, 2006.
 (8)
        For
        the assumptions used in calculating the value of this grant, please see Note
        6
        of our financial statements for the fiscal year ended December 31,
        2007.
 (9)
        For
        the assumptions used in calculating the value of this grant, please see Note
        6
        of our financial statements for the fiscal year ended December 31,
        2007.


36




**Discussion
      of Compensation**





Our
      compensation program consists of the following three components:





·
            base
                salary;





·
            bonuses;
                and





·
            awards
                of restricted stock or stock options from our 2005 Equity Incentive
                Plan
                and our Amended and Restated 2006 Equity Incentive
                Plan.





We
      believe that a combination of cash and common stock or options will allow us
      to
      attract and retain the services of the individuals who will help us achieve
      our
      business objectives, thereby increasing value for our shareholders.





In
      setting the compensation for our officers our board of directors, which until
      November 2006 was comprised of Mr. Gary Guseinov and Mr. Igor Barash, looked
      primarily at the person’s responsibilities, at salaries paid to others in
      businesses comparable to ours, at the person’s experience and at our ability to
      replace the individual. We expect the salaries of our executive officers to
      remain relatively constant unless the person’s responsibilities are materially
      changed.





Bonuses
      are used to reward exceptional performance, either by the individual or by
      the
      company. Bonuses are discretionary. There is no single method of computing
      bonuses. The board of directors may use any criteria to determine the amount
      of
      a bonus. In 2006, the board of directors determined to award a bonus to Mr.
      Guseinov for his efforts in redirecting our operations from a marketing-focused
      software publisher to a developer of a suite of Internet security products.
      We
      signed an employment agreement with Mr. Guseinov which allows him to participate
      in any incentive bonus compensation plan we adopt, so long as any bonus award
      does not exceed 50% of his salary. During 2006 we also paid bonus compensation
      of $162,121 to Mr. Riggs Eckelberry, our former President and Chief Operating
      Officer. The bonus compensation was earned on a quarterly and on an annual
      basis. A list of objectives to be met was mutually agreed to by Mr. Eckelberry
      and Mr. Guseinov at the beginning of each new quarter. If the goals were met,
      we
      paid Mr. Eckelberry that percentage of the full quarterly bonus ($60,000) that
      was accomplished during the quarter. At the end of each year, we evaluated
      a
      similar list of yearly objectives and paid the appropriate percentage of the
      full annual bonus ($100,000 in 2006). Mr. Eckelberry was also instrumental
      in
      helping us with our transition to a developer of a suite of Internet security
      products. No bonuses were paid in 2007.





In
      2006
      and 2007 we granted restricted stock or options to purchase our common stock
      to
      Messrs. Liu, Ivankovich, Barash and Eckelberry. We grant options or restricted
      stock because we believe that share ownership by our employees is an effective
      method to deliver superior shareholder returns by increasing the alignment
      between the interests of our employees and our shareholders. No employee is
      required to own common stock in our company.





In
      October 2006 we issued to Mr. Bing Liu a total of 832,511 shares of common
      stock. The common stock was issued to him, in part, for his agreement to accept
      186,347 shares of our common stock as full payment of a promissory note owed
      by
      us to Unionway International LLC, an entity controlled by Mr. Liu. We issued
      the
      remaining 646,164 shares of common stock to Mr. Liu in consideration for his
      continued contribution to the development of our products and technology. The
      common stock issued to Mr. Liu in consideration for his continued contributions
      to us had a value of $691,395 on the date of grant.




37





The
      following table sets forth certain information concerning stock option awards
      granted to our executive officers and our directors. No options were exercised
      by our executive officers or directors during the last fiscal year.





**OUTSTANDING
                EQUITY AWARDS AT FISCAL YEAR-END****OPTION
                AWARDS**
            **STOCK
                AWARDS**Name
            
            
            Number
                of securities underlying unexercised options (#)
                Exercisable
            
            
            Number
                of securities underlying unexercised options (#)
              Unexercis-able
            
            
            Equity
                Incentive Plan Awards: Number of Securities underlying unexercised
                unearned options (#)
            
            
            Option
                exercise price ($)
            
            
            Option
                expiration date
            
            
            Number
                of shares or units of stock that have not vested (#
            )
            
            Market
                value of shares or units of stock that have not vested ($
            )
            
            Equity
                incentive plan awards: number of unearned shares, units or other
                rights
                that have not vested (#
            )
            
            Equity
                incentive plan awards: Market or payout value of unearned shares,
                units or
                other rights that have not vested (#
            )Bing
                Liu
            
            
            326,107
            
            
            -0-
            
            
            -0-
            
            $
            0.0107
            
            
            12/31/2009
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Bing
                Liu
            
            
            335,777
            
            
            -0-
            
            
            279,814
            
            $
            1.00
            
            
            12/31/2009
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Ivan
                Ivankovich
            
            
            40,000
            
            
            -0-
            
            
            -0-
            
            $
            1.00
            
            
            11/1/2016
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Ivan
                Ivankovich
            
            
            60,000
            
            
            -0-
            
            
            60,000
            
            $
            1.00
            
            
            4/24/2017
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Ivan
                Ivankovich
            
            
            30,000
            
            
            -0-
            
            
            10,000
            
            $
            1.00
            
            
            9/9/2017
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Igor
                Barash
            
            
            12,500
            
            
            -0-
            
            
            12,500
            
            $
            1.00
            
            
            12/11/2016
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-





**Employment
      Agreements, Termination of Employment and Change-in-Control Arrangements**





The
      following discussions provide only a brief description of the documents
      described below. The discussions are qualified by the full text of the
      agreements.





We
      entered into an employment agreement with Mr. Gary Guseinov as of August 31,
      2006. The term
      of the agreement is three years, however if the agreement is not terminated
      during that period, then it will be renewed for a period of one year until
      terminated pursuant to its terms. Mr. Guseinov receives compensation of $225,000
      per year and is reimbursed for business related expenses. Under the employment
      agreement, we are required to match Mr. Guseinov’s monthly contribution to our
      401(k) plan up to the sum of $2,500 per month and we have agreed to provide
      a
      term life insurance policy with coverage in the face amount of $1,000,000,
      so
      long as the premium for any such policy does not exceed the sum of $3,000 per
      year, however, we do not currently, and we have not in the past, provided these
      benefits. We also agreed to obtain officers and directors liability insurance
      with coverage of not less than $1,000,000, which we obtained in November 2007.
      Mr. Guseinov receives three weeks of paid vacation per year. We are entitled
      to
      terminate Mr. Guseinov’s employment upon a change of control, upon Mr.
      Guseinov’s disability or for cause. Constructive termination is defined as a
      change in Mr. Guseinov’s position, authority, duties, responsibilities or
      status, an adverse change in his title, any reduction in his salary with which
      he does not agree (unless such reduction is concurrent with and part of a
      company-wide reduction for all employees), any breach by us of a material
      obligation to Mr. Guseinov under this agreement, any requirement that Mr.
      Guseinov relocate to an office that is outside of Los Angeles County, California
      or outside of a 30 mile radius from his home, any termination of this agreement
      (other than as permitted by the agreement) and the failure of Mr. Guseinov
      to be
      elected to the board of directors. Mr. Guseinov may terminate his employment
      upon 30 days written notice to us or in the event that he is constructively
      terminated. If Mr. Guseinov’s employment is terminated for any reason other than
      voluntarily by him or for cause, he is entitled to receive upon termination
      all
      accrued but unpaid salary, earned and pro rata bonus compensation, vested stock
      and stock options and post termination benefits. Post termination benefits
      are
      defined as Mr. Guseinov’s right to receive his monthly base salary in effect at
      termination for a period of one year following termination and to continue
      to
      receive coverage under our health and dental insurance program (if any) for
      a
      period of six months following his termination. By signing the agreement, Mr.
      Guseinov assigned and agreed to assign in the future, to us or to our nominees,
      all intellectual property defined in the agreement as “Relevant Intellectual
      Property”.




38




On
      September 1, 2003 we entered into an employment agreement with Igor Barash,
      our
      Chief Information Officer. Mr. Barash is an “at-will” employee and we can
      terminate his employment at any time. As compensation for the services he
      renders to us, Mr. Barash is paid the sum of $135,000 per year. We reimburse
      Mr.
      Barash for reasonable business expenses. Currently, Mr. Barash is entitled
      to
      one week’s paid personal time and three sick days for each 12 months of
      employment. After three years of continuous employment, Mr. Barash is entitled
      to 14 days of paid personal time.




On
      August
      30, 2007 and again on March 4, 2008 we entered into Independent Contractor
      Agreements with Mr. Bing Liu pursuant to which Mr. Liu will continue to provide
      services to us as Chief Software Architect. Complete descriptions of these
      agreements are included in the section of this report titled “Item 13. Certain
      Relationships and Related Transactions”.




On
      January 3, 2005 we entered into an Incentive Stock Option Agreement with Mr.
      Liu. Pursuant to this agreement, Mr. Liu is granted the right to purchase
      326,106 shares of our common stock at an exercise price of $0.0107 per share.
      The right to purchase 186,347 of the shares vests at the rate of 1/24 shares
      per
      month for each month of Mr. Liu’s employment. Mr. Liu will be entitled to the
      right to purchase an additional 46,587 shares of common stock if we enter into
      a
      binding agreement to issue or sell shares of our common stock to one or more
      third parties or to sell all or materially all of our assets in a transaction
      which is valued at between $201 million and $249,999,999.99, and he is entitled
      to the right to purchase an additional 93,173 shares of common stock if we
      enter
      into such an agreement having a value of $250 million. In its discretion, the
      board of directors may agree to accelerate the vesting of any portion of the
      option that is unvested if Mr. Liu’s employment is terminated without cause
      within 24 months of the start of his employment or if he has good reason to
      terminate his employment. Furthermore, if Mr. Liu’s employment is terminated
      either without cause or for good reason within one year after a change in
      control, then that part of the option that is unvested on the termination date
      will immediately vest. If Mr. Liu’s employment is terminated for any reason, we
      have the right, for a period of 90 days, to purchase all or any portion of
      the
      unvested shares at the fair market value of the shares at the time of
      termination. Mr. Liu also agreed that in connection with an underwritten public
      offering of our common stock, upon our request or that of the underwriter,
      he
      would not sell, offer for sale or otherwise dispose of any shares he acquires
      upon exercise of the option for a period of at least 180 days after the
      execution of the underwriting agreement, or such longer period of time as the
      board of directors may reasonably determine, so long as all of our directors
      and
      executive officers agree to be similarly bound. This obligation will remain
      effective for all underwritten public offerings with respect to which we have
      filed a registration statement on or before two years after the closing of
      our
      initial public offering. On August 30, 2007, Mr. Liu resigned as an employee
      and
      began providing services to us as a consultant. In accordance with the terms
      of
      his consulting agreement, the right to purchase all of the shares included
      in
      the Incentive Stock Option Agreement vested as of December 31,
      2007.




We
      entered into an Independent Contractor Agreement with Michael Barrett, our
      Chief
      Financial Officer. A complete description of this agreement is included in
      the
      section of this report titled “Certain Relationships and Related Transactions.”





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





The
      following tables set forth certain information regarding beneficial ownership
      of
      our securities as of March 28, 2008 by (i) each person who is known by us to
      own
      beneficially more than 5% of the outstanding shares of each class of our voting
      securities, (ii) each of our directors and executive officers, and (iii) all
      of
      our directors and executive officers as a group. Unless otherwise stated, the
      address of our directors and executive officers is c/o CyberDefender
      Corporation, 617 West 7th Street, Suite 401, Los Angeles, California
      90017.




39




We
      have
      determined beneficial ownership in accordance with the rules of the Securities
      and Exchange Commission. Under these rules, beneficial ownership generally
      includes voting or investment power over securities. The number of shares shown
      as beneficially owned in the tables below are calculated pursuant to Rule
      13d-3(d)(1) of the Securities Exchange Act of 1934. Under Rule 13d-3(d)(1),
      shares not outstanding that are subject to options, warrants, rights or
      conversion privileges exercisable within 60 days are deemed outstanding for
      the
      purpose of calculating the number and percentage owned by such person, but
      not
      deemed outstanding for the purpose of calculating the percentage owned by each
      other person listed. Except as otherwise indicated, we believe that the
      beneficial owners listed below, based on the information furnished by these
      owners, have sole investment and voting power with respect to the securities
      indicated as beneficially owned by them, subject to applicable community
      property laws. As of March 28, 2008, there were 14,565,688 shares of common
      stock issued and outstanding.




**Name
                of Director, Officer and Beneficial Owner**(1)
            
            
            **Number
                of Shares of Common Stock****Beneficially
                Owned**
            
            
            **Percentage
                of Common Stock**Named
                Executive Officers and Directors:Gary
                Guseinov, Chief Executive Officer and director
            
            
            6,665,376
            
            
            45.8
            %Igor
                Barash, Chief Information Officer, Secretary and director
            
            
            649,055(2
            )
            
            4.5
            %Bing
                Liu, Chief Software Architect and director
            
            
            1,453,727(3
            )
            
            9.5
            %Michael
                Barrett, Chief Financial Officer
            
            
            0(4
            )
            
            0Camofi
                Master LDC
            
            
            2,279,881(5
            )
            
            13.7
            %ITU
                Ventures
            
            
            1,819,382(6
            )
            
            12.0
            %Bushido
                Capital Master Fund LP and BCMF Trustees
            
            
            1,224,477(7
            )
            
            8.1
            %Pierce
                Diversified Strategy Master Fund LLC, Series BUS
            
            
            1,460,122(8
            )
            
            9.2
            %Oceana
                Partners, LLC
            
            
            890,000(9
            )
            
            5.9
            %TOTAL
            
            
            16,442,020
            
            
            79.2
            %All
                officers and directors as a group (4 persons)
            
            
            8,768,158
            
            
            55.3
            %


*
        Less
        than one percent beneficially owned.
 (1)
        The
        address for each of our officers and directors is 617 West 7th Street, Suite
        401, Los Angeles, California 90017.
 (2)
        This
        number includes an option to purchase 12,500 shares of our common stock that
        was
        approved by our board of directors on December 11, 2006. The option exercise
        price is $1.00 per shares. The option was granted from our 2006 Equity Incentive
        Plan.
 (3)
        This
        number consists of 791,843 shares of common stock, an option to purchase
        326,106
        shares of our common stock that was granted from our 2005 Equity Incentive
        Plan
        and an option to purchase 335,777 shares of our common stock that was approved
        by our board of directors on November 2, 2006. The option was granted from
        our
        Amended and Restated 2006 Equity Incentive Plan. The option exercise prices
        are $0.0107 per share and $1.00 per share, respectively.
 (4)
        Mr.
        Barrett received an option to purchase 20,000 shares of our common stock
        on
        March 31, 2008. Of this amount, the right to purchase 10,000 shares of common
        stock vests on April 30, 2008 and the right to purchase 10,000 shares of
        common
        stock vests at the end of the term of the consulting agreement that was approved
        by the board of directors on March 31, 2008. Because the option is not
        exercisable within 60 days of March 31, 2008, no shares of common stock have
        been included for Mr. Barrett in this table.
 (5)
        This
        number represents 233,633 shares of common stock, 1,000,000 shares of common
        stock issuable upon conversion of the outstanding principal amount of a
        debenture, 1,000,000 shares of common stock that would be issuable upon exercise
        of a debenture warrant and 46,248 shares of common stock issuable upon the
        exercise of a common stock purchase warrant issued in conjunction with a
        Consent
        and Waiver. The address of Camofi Master LDC is c/o Centrecourt Asset Management
        LLC, 350 Madison Avenue, 8th Floor, New York, New York 10017.
 (6)
        This
        number represents 1,252,475 shares of common stock and 566,907 shares of
        common
        stock issuable upon the exercise of a common stock purchase warrant. The
        address
        of ITU Ventures is 1900 Avenue of the Stars, Suite 2701, Los Angeles, California
        90067.
 (7)
        This
        number represents 72,279 shares of common stock, 561,575 shares of common
        stock
        issuable upon the conversion of the outstanding principal amount of a debenture,
        561,479 shares of common stock that would be issuable upon exercise of a
        debenture warrant and 29,144 shares of common stock issuable upon the exercise
        of a common stock purchase warrant issued in conjunction with a Consent and
        Waiver. The address of Bushido Capital Master Fund LP and BCMF Trustees is
        275
        7th Avenue, Suite 2000, New York, New York 10001.
 (8)
        This
        number represents 149,625 shares of common stock, 640,439 shares of common
        stock
        issuable upon the conversion of the outstanding principal amount of a debenture,
        640,439 shares of common stock that would be issuable upon exercise of a
        debenture warrant and 29,619 shares of common stock issuable upon the exercise
        of a common stock purchase warrant issued in conjunction with a Consent and
        Waiver. The address of Pierce Diversified Strategy Master Fund LLC is 275
        7th
        Avenue, Suite 2000, New York, New York 10001.
 (9)
        This
        number represents 437,500 shares of common stock, 105,000 shares of common
        stock
        issuable upon the exercise of a unit purchase option, 105,000 shares of common
        stock issuable upon the exercise of a common stock purchase warrant and 242,500
        shares of common stock issuable upon the exercise of a common stock purchase
        warrant.




40




**Item
                13.**
            **Certain
                Relationships and Related Transactions and Director
                Independence**





Using
      the
      definition of “independent” as set forth in the Sarbanes-Oxley Act of 2002 and
      the rules and regulations of the Securities and Exchange Commission, we have
      determined that none of our three directors qualifies as an independent
      director.




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
      three completed fiscal years, other than compensation arrangements that are
      otherwise required to be described under “Executive Compensation.”




In
      2005
      and 2006 we made a series of advances to Mr. Guseinov for personal expenses
      which advances totaled $146,170 and $89,059 respectively. In 2005 we also made
      a
      series of advances to Mr. Barash for personal expenses, which advances totaled
      $6,285. These advances did not bear interest and had no scheduled repayment
      date. As of September 30, 2006, all advances were either repaid or reclassified
      as salary. Since October 1, 2006, no further advances have been made to Mr.
      Guseinov or Mr. Barash.




On
      May 1,
      2005 we entered into a lease agreement for a condominium located in Las Vegas,
      Nevada with International Equity Partners, a Nevada limited liability company.
      Mr. Guseinov is the manager of International Equity Partners. The monthly base
      rent for this space is $3,750. The term of the lease is from May 1, 2005 until
      May 31, 2008, however, the lease was terminated by the mutual agreement of
      the
      parties in February 2006. We paid
      International Equity Partners $2,775 in rent in 2007 for the rental of the
      condominium which we used during a trade show in which we exhibited our
      products.




In
      January 2005 we entered into an asset purchase agreement with Unionway
      International, LLC whereby
      we purchased certain of its assets, including the software application
      Cyber-DefenderTM and associated rights, for $200,000. We paid $8,333 at closing
      and issued a promissory note in connection with the purchase to Unionway
      International, LLC for $191,667. The terms of the note require monthly payments
      due on the first of each month in the amount of $8,333. Interest accrues at
      the
      rate of 7% per annum and is payable in a lump sum on September 1, 2007, provided
      that such interest will be waived if all payments are received by Unionway
      International, LLC by the third day of each month. In addition we retained
      the
      principal of Unionway International, LLC, Mr. Bing Liu, as an employee and
      we
      issued to him an incentive stock option for the purchase of 326,106 shares
      of
      our common stock. The exercise price is $0.0107 per share. The right to purchase
      186,347 shares vests in equal increments over a period of 24 months; the right
      to purchase 46,587 shares of common stock will vest if we enter into a binding
      agreement to sell our business for at least $201 million; and the right to
      purchase 93,173 shares of common stock will vest if we enter into a binding
      agreement to sell our business for at least $250 million. At September 30,
      2006
      the balance outstanding on the promissory note was $83,335. Unionway
      International, LLC agreed to accept payment of the remaining balance on the
      note
      and any accrued but unpaid interest in exchange for 186,347 shares of our common
      stock. We issued 186,347 shares of common stock to Mr. Liu for this payment.
      For
      the assumptions made in computing the value of these shares, please see Notes
      6
      and 7 of our financial statements.




41




Unionway
      International, LLC provided software development services to us during the
      2006
      fiscal year. We paid $6,500 per month for these services. During the fiscal
      year
      ended December 31, 2006, we paid Unionway International, LLC $84,500 for
      software development services. We did not pay Unionway International LLC any
      money during the 2007 fiscal year. Because Mr. Liu continues to act as our
      Chief
      Software Architect and is a director, the negotiation of the monthly fee was
      not
      done “at arm’s length”. However, we believe that we receive 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.




On
      January 3, 2005 we entered into an employment agreement with Mr. Bing Liu,
      our
      Chief Software Architect, wherein we agreed to pay him an annual salary of
      $100,000. In December 2005 we increased Mr. Liu’s salary to $165,000. Mr. Liu’s
      annual salary was increased again in September 2006, and, until his resignation
      as an employee, he was paid the sum of $202,000 per year. Pursuant to this
      agreement, Mr. Liu was entitled to receive a bonus, calculated as two percent
      of
      the net revenue we earn from any invention created by him during the course
      of
      his employment. “Net revenue” was defined as gross receipts less direct
      marketing and shipping costs less returns and discounts. Inventions created
      by
      Mr. Liu were defined as any and all ideas, processes, trademarks, service marks,
      inventions, technology, computer programs, original works of authorship,
      designs, formulas, discoveries, patents, copyrights, and all improvements,
      rights, and claims related to the foregoing that are conceived, developed,
      or
      reduced to practice by Mr. Liu alone or with others that result from any work
      performed by him for us or in which our equipment, supplies, facilities or
      trade
      secret information is used. This provision survived the termination of Mr.
      Liu’s
      employment. Pursuant to this agreement, we were required to reimburse Mr. Liu
      for reasonable business expenses. Mr. Liu agreed that following termination
      of
      his employment, he would not take any action to induce or influence any person
      who provides services to us to terminate his or her employment nor will he
      attempt to employ any such person within six months of the date that person’s
      employment with us terminated. Mr. Liu agreed to keep secret our confidential
      information during his employment and for a period of one year following the
      termination of his employment. This agreement was terminated on August 30,
      2007
      when we entered into an independent contractor agreement with Mr. Liu. A
      discussion of this agreement is included below.




On
      September 1, 2006 Mr. Ivan Ivankovich signed an independent contractor agreement
      with us for part-time financial management and reporting services. The term
      of
      the agreement was 90 days. We may terminate the agreement at any time by giving
      Mr. Ivankovich 10 days written notice of termination or, upon a breach of the
      agreement, immediately by giving written notice to Mr. Ivankovich. Mr.
      Ivankovich can terminate the agreement by giving us 30 days written notice
      of
      termination. Pursuant to this agreement, Mr. Ivankovich received compensation
      in
      the amount of $8,000 per month through October 15, 2006. The agreement was
      amended on October 15, 2006, January 12, 2007, April 24, 2007 and October 22,
      2007. Pursuant to the amendment dated April 24, 2007, Mr. Ivankovich’s salary
      was set at $9,000 per month through June 30, 2007, and on July 1, 2007 Mr.
      Ivankovich’s salary was increased to $12,000 per month. By signing the amendment
      dated October 22, 2007, we extended the term of the Independent Contractor
      Agreement through January 31, 2008. We also agreed to grant Mr. Ivankovich
      options to purchase 40,000 shares of our common stock. The right to purchase
      the
      common stock will vest in equal increments through January 31, 2008 with the
      right to purchase an initial 10,000 shares vesting as of October 1, 2007. In
      exchange for this compensation, Mr. Ivankovich provided services to us for
      at
      least 20 hours per week. The agreement expired on January 31, 2008 without
      renewal. Mr. Ivankovich no longer provides services to us.




On
      September 12, 2006 Mr. Guseinov agreed to transfer an aggregate of 186,347
      shares of common stock back to us for cancellation.  In turn, we agreed to
      issue an aggregate of 186,347 shares of common stock to our bridge
      investors on a pro rata basis.  The shares were issued to the bridge
      investors in consideration for their agreement to enter into the Note
      Conversion and Warrant Lock-Up Agreement. Mr.
      Guseinov transferred this stock because the terms of the 10% Convertible Secured
      Note financing had been agreed to and, as part of that transaction, we had
      agreed not to issue additional securities without the consent of the
      lender.




42




On
      October 30, 2006 we entered into Indemnification Agreements with Mr. Guseinov,
      Mr. Ivankovich, Mr. Liu and Mr. Barash and on November 6, 2007 we entered into
      an Indemnification Agreement with Mr. John LaValle, a former director, 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





·
            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




43


·
            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.





In
      October 2006 Mr. Guseinov and Mr. Igor Barash, our Chief Information Officer
      and
      a director, agreed to transfer an aggregate of 646,164 shares of common stock
      back to us for cancellation.  In turn, we agreed to issue an aggregate of
      646,164 shares of common stock to Mr. Bing Liu, our Chief Software
      Architect.  The shares were issued in consideration of Mr. Liu’s continued
      contribution to the development of our products and technology. As with the
      transfer of common stock in the paragraph above, Mr. Guseinov transferred this
      stock because the terms of the 10% convertible secured note financing had been
      agreed to and, as part of that transaction, we had agreed not to issue
      additional securities without the consent of the lender.





In
      January 2007, we paid to International Equity Partners, a Nevada limited
      liability company, a fee in the amount of $2,700 for use of property during
      a
      trade show. Mr. Guseinov is the manager of International Equity
      Partners.





In
      conjunction with his agreement to render services to us, we granted options
      to
      Mr. Ivan Ivankovich, our former consulting Chief Financial Officer. The options
      were granted from our Amended and Restated 2006 Equity Incentive Plan. The
      options permit Mr. Ivankovich to purchase a total of 200,000 shares of our
      common stock at a price of $1.00 per share. With the exception of the right
      to
      purchase 30,000 shares, which vested on July 19, 2007, the right to purchase
      the
      remaining shares of common stock vests at the rate of 10,000 shares per month.
      The options have terms of 10 years. The fair value for the initial option grant
      of 40,000 shares was estimated at the date of grant using a Black-Scholes option
      pricing model, as more fully described in Note 6 of our financial statements
      for
      the fiscal year ended December 31, 2006. The fair value of the subsequent grant
      of 120,000 shares was estimated at the date of grant using a Black-Scholes
      option pricing model with the following weighted-average assumptions: risk-free
      interest rate of 4.62%, dividend yields of 0% and volatility factors of the
      expected market price of our common shares of 128%. **** The
      fair
      value of the grant of 40,000 shares made in October 2007 was also estimated
      using a Black-Scholes option pricing model with the following weighted average
      assumptions: risk-free interest rate of 3.99%, dividend yields of 0% and
      volatility factors of the expected market price of our common shares of
      116%.





On
      August
      30, 2007 Mr. Bing Liu, our Chief Software Architect, resigned as an employee
      and
      began providing services to us as a consultant pursuant to a Consulting
      Agreement entered into on the same day. The term of the agreement is six months,
      but the agreement may be terminated by either party upon 30 days notice, or
      immediately if Mr. Liu fails to discharge his obligations under the agreement.
      Upon execution of the agreement we paid Mr. Liu the sum of $7,500 and we have
      agreed to pay him the sum of $4,000 per month in exchange for his services.
      We
      will reimburse Mr. Liu for expenses incurred by him in rendering services under
      the agreement. We have also agreed that Mr. Liu will have a period of 24 months
      to exercise any vested options, that one-half of any options remaining unvested
      on December 31, 2007 will vest and that the remaining unvested options will
      vest
      in equal increments over 34 months. The agreement further states that if we
      failed to pay to Mr. Liu any unpaid salary due to him by December 31, 2007,
      then
      any unvested options would immediately vest. Mr. Liu is currently owed $63,281
      in unpaid salary, which was not paid to him by December 31, 2007. Mr. Liu has
      options to purchase a total of 661,884 shares of our common stock, all of which
      are now vested. Pursuant to the agreement, Mr. Liu will continue his duties
      as
      Chief Software Architect and will assist us with recruiting a Chief Technology
      Officer or Vice-President of Software Development. Mr. Liu continues to provide
      services to us as a member of our board of directors.




44




On
      March
      4, 2008 we entered into a second Independent Contractor Agreement with Mr.
      Liu.
      The term of the agreement is five months, but the agreement may be terminated
      by
      either party upon 30 days notice, or immediately if Mr. Liu fails to discharge
      his obligations under the agreement. We have agreed to pay Mr. Liu the sum
      of
      $8,000 per month in exchange for his services. We will reimburse Mr. Liu for
      expenses incurred by him in rendering services under the agreement.





On
      October 1, 2007 Mr. Guseinov loaned us the sum of $28,078. The loan did not
      accrue interest. We repaid the loan on November 19, 2007. No loan agreement
      or
      promissory note was signed in conjunction with the loan.





On
      February 4, 2008 our board of directors approved an independent contractor
      agreement with Mr. Michael Barrett. The term of the agreement is six months.
      Pursuant to the agreement, Mr. Barrett provides consulting services to us as
      our
      Chief Financial Officer. We have 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 will be reduced to $4,000 per month. We have also
      issued to Mr. Barrett an option to purchase 20,000 shares of our common stock.
      The right to purchase 10,000 shares will vest on April 30, 2008. The right
      to
      purchase the remaining 10,000 shares of common stock will vest at the end of
      the
      term. The fair value of the grant was estimated using a Black-Scholes option
      pricing model with the following weighted average assumptions: expected term
      of
      5 years, a risk-free interest rate of 2.48 %, a dividend yield of 0%, volatility
      of 173% and a forfeiture rate of 4%.





As
      of
      December 31, 2007 we have accrued a total of $22,165 in deferred compensation
      for Mr. Guseinov and Mr. Barash. This amount represents automobile lease
      payments we agreed to pay on their behalf. Information including these payments
      in included in the Summary Compensation Table included in Item 11 of this
      report.




**Item
                14.**
            **Principal
                Accounting Fees and
                Services**





The
      following table sets forth fees billed to us by AJ. Robbins, PC during the
      fiscal years ended December 31, 2007 and December 31, 2006 and by KMJ Corbin
      & Company LLP during the fiscal year ended December 31, 2007 for: (i)
      services rendered for the audit of our annual financial statements and the
      review of our quarterly financial statements, (ii) services that were reasonably
      related to the performance of the audit or review of our financial statements
      and that are not reported as Audit Fees, (iii) services rendered in connection
      with tax compliance, tax advice and tax planning, and (iv) all other fees for
      services rendered.





December
                31, 2007
            
            
            December
                31, 2006(i)
            
            
            Audit
                Fees
            
            $
            169,935
            
            $
            119,199(ii)
            
            
            Audit
                Related Fees
            
            $
            0
            
            $
            0(iii)
            
            
            Tax
                Fees
            
            $
            6,207
            
            $
            6,322(iv)
            
            
            All
                Other Fees
            
            $
            0
            
            $
            0




45


**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)10.1
            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
                agreement between the registrant and Bing Liu dated January 3, 2005
                (1)**10.7
            Form
                of 8% Secured Note dated July 27, 2006 (1)10.8
            Form
                of Securities Purchase Agreement dated September 12, 2006
                (1)10.9
            Form
                of 10% Secured Convertible Debenture dated September 12, 2006
                (1)10.10
            Form
                of Registration Rights Agreement dated September 12, 2006
                (1)10.11
            Form
                of Warrant dated September 12, 2006 (1)10.12
            Form
                of Security Agreement dated September 12, 2006 (1)10.13
            Form
                of Subsidiary Guarantee dated September 12, 2006 (1)10.14
            Form
                of Escrow Agreement dated September 12, 2006 (1)10.15
            Form
                of Lock Up Agreement dated September 12, 2006 (1)10.16
            Standard
                Sublease dated March 26, 2004 between Networks Dynamics Corp. and
                The
                Paladin Companies, Inc. for the real property located at 12121 Wilshire
                Boulevard, Suite 305, Los Angeles, California (1)10.17
            Asset
                Purchase Agreement dated January 3, 2005 between Unionway International,
                LLC and Network Dynamics, Inc. (1)10.18
            Monthly
                Installment Note in the amount of $191,666.59 made by Network Dynamics,
                Inc. in favor of Unionway International, LLC (1)10.19
            Irrevocable
                Bill of Sale, Assignment and Conveyance dated January 3, 2005 between
                Network Dynamics, Inc. and Unionway International, LLC
                (1)10.20
            Form
                of Indemnification Agreement entered into between the registrant
                and Gary
                Guseinov, Riggs Eckelberry, Ivan Ivankovich, Bing Liu, Igor Barash
                and
                John LaValle (1)**10.21
            Engagement
                letter between the registrant and Oceana Partners LLC
                (1)10.22
            Agreement
                date July 11, 2006 between the registrant and ARC Investment Partners,
                LLC
                (1)10.23
            Independent
                Contractor Agreement dated September 1, 2006 between the registrant
                and
                Ivan Ivankovich (1)**10.24
            Amendment
                dated October 15, 2006 to Independent Contractor Agreement dated
                September
                1, 2006 between registrant and Ivan Ivankovich (1)**10.25
            Agreement
                to Defer Piggyback Registration Rights dated September 12, 2006
                (1)10.26
            Form
                of Note Conversion and Warrant Lock-Up Agreement (1)10.27
            Amendment
                to Registration Rights Agreement dated October 11, 2006 between the
                registrant and the purchasers of the registrant’s 10% secured convertible
                debentures (1)10.28
            Amended
                and Restated Key Executive Employment Agreement dated November 22,
                2006
                between the registrant and Riggs Eckelberry (1)**10.29
            Amendment
                No. 2 to Independent Contractor Agreement dated January 12, 2007
                between
                the registrant and Ivan Ivankovich (1)**10.30
            Consent
                and Waiver dated as of March 23, 2007 between the registrant and
                the
                holders of the 10% Convertible Debentures dated September 12, 2006
                (1)10.31
            Description
                of agreement relating to advances between the registrant and Gary
                Guseinov
                (1)**10.32
            Description
                of agreement relating to advances between the registrant and Igor
                Barash
                (1)**10.33
            Settlement
                Agreement and Mutual General Release between Wellbourne Limited,
                the
                registrant and Gary Guseinov (1)**10.34
            Amendment
                No. 3 to Independent Contractor Agreement dated April 24, 2007 between
                the
                registrant and Ivan Ivankovich
                (1)**




46




10.35
            Independent
                Contractor Agreement dated August 30, 2007 between the registrant
                and Bing
                Liu(2)**10.36
            Form
                of 7.41% Senior Secured Note*10.37
            Form
                of Registration Rights Agreement executed in conjunction with the
                sale of
                7.41% Senior Secured Notes*10.38
            Form
                of Amended and Restated Security Agreement executed in conjunction
                with
                the sale of 7.41% Senior Secured Notes*10.39
            Form
                of Securities Purchase Agreement executed in conjunction with the
                sale of
                7.41% Senior Secured Notes*10.40
            Form
                of Common Stock Purchase Warrant issued in conjunction with the sale
                of
                7.41% Senior Secured Notes*10.41
            Consent
                and Waiver dated as of September 21, 2007 between the registrant
                and the
                holders of the 10% Convertible Debentures dated September 12, 2006
                (5)10.42
            Form
                of Securities Purchase Agreement executed in conjunction with the
                sale of
                Units beginning in October 2007 (6)10.43
            Form
                of Warrant to Purchase Common Stock executed in conjunction with
                the sale
                of Units beginning in October 2007 (6)10.44
            Reserved10.45
            Lease
                Agreement dated October 19, 2007 between the registrant and 617
                7thStreet Associates, LLC (3)10.46
            Amendment
                No. 4 to Independent Contractor Agreement dated April 24, 2007 between
                the
                registrant and Ivan Ivankovich(4)**10.47
            Independent
                Contractor Agreement dated January 29, 2007 between the registrant
                and
                Michael Barrett(5)**23.1
            Consent
                of KMJ Corbin & Company LLP*23.2
            Consent
                of AJ. Robbins, PC*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 August 31, 2007.


(3)
      Incorporated by reference from the registrant’s Current Report on Form 8-K filed
      with the Securities and Exchange Commission on November 19, 2007.


(4)
      Incorporated by reference from the registrant’s Current Report on Form 8-K filed
      with the Securities and Exchange Commission on October 24, 2007.


(5)
      Incorporated by reference from the registrant’s Quarterly Report on Form 10-QSB
      filed with the Securities and Exchange Commission on November 16,
      2007.


(6)
      Incorporated by reference from the registrant’s Current Report on Form 8-K filed
      with the Securities and Exchange Commission on February 8, 2008.





47





**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:
              April 15, 2008
            CYBERDEFENDER
              CORPORATIONBy:
            /s/
              Gary
              GuseinovGary
              GuseinovChief
              Executive Officer


By:
              /s/
                Michael BarrettMichael
                  BarrettChief
                Financial Officer





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities indicated below on this 15th day of April 2008.




SIGNATURE, TITLE/s/
              Gary
              GuseinovGary
              GuseinovPresident,
              Chief
              Executive Officer, and Director


/s/
                Michael
                BarrettMichael
                BarrettChief
                Financial
                Officer
 /s/
                Igor
                BarashIgor
                BarashDirector /s/
                  Bing
                  LiuBing
                  LiuDirector


**CYBERDEFENDER
        CORPORATION**
 **Table
        of Contents**
  PageReport
                  of Independent Registered Public Accounting Firm
              F-2Report
                  of Independent Registered Public Accounting Firm
              F-3Balance
                  Sheets - December 31, 2007 and 2006
              F-4Statements
                  of Operations - For the Years Ended December 31, 2007 and
                  2006
              F-5Statements
                  of Stockholders’ Equity (Deficit) - For the Years Ended December 31, 2007
                  and 2006
              F-6Statements
                  of Cash Flows - For the Years Ended December 31, 2007 and
                  2006
              F-7Notes
                  to the Financial Statements
              F-9
  F
            - 1
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  Board
        of
        Directors and Stockholders
 
 Cyberdefender
        Corporation
  We
        have
        audited the accompanying balance sheet of Cyberdefender Corporation (the
        “Company”) as of December 31, 2007 and the related statements of
        operations, stockholders’ equity (deficit) and cash flows for the year then
        ended. Cyberdefender’s management is responsible for these financial statements.
        Our responsibility is to express an opinion on these financial statements
        based
        on our audit.
  We
        conducted our audit in accordance with 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 has determined
        that it
        is not required to have, nor were we engaged to perform, an audit on 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
        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, 2007 and the results of its operations and its cash flows for
        the year then ended in conformity with accounting principles generally accepted
        in the United States of America.
  The
        accompanying financial statements have been prepared assuming that the Company
        will continue as a going concern. As discussed in Note 1 to the financial
        statements, the Company has recurring losses from operations and has not
        generated significant revenues to cover costs to date. If management is not
        successful in implementing its operating plan, additional capital will be
        required to continue to fund its losses. These matters, among others, raise
        substantial doubt about the Company’s ability to continue as a going concern.
        Management’s plans in regard to these matters are also described in Note 1. The
        financial statements do not include any adjustments that might result from
        the
        outcome of this uncertainty.
  By:
              /s/  KMJ | Corbin & Company
                LLPKMJ
                | Corbin & Company LLP
 Irvine,
        California
 April
        15,
        2008
  F
            - 2
  **AJ.
        ROBBINS, PC**
 **CERTIFIED
        PUBLIC ACCOUNTANTS**
 **216
        SIXTEENTH STREET**
 **SUITE
        600**
 **DENVER,
        COLORADO 80202**
 
 **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 The
        Board
        of Directors
 CyberDefender
        Corporation
 Los
        Angeles, California
 
 We
        have
        audited the accompanying balance sheet of CyberDefender Corporation (F/K/A
        Network Dynamics Corp.) as of December 31, 2006, and the related statement
        of
        operations, changes in stockholders' equity (deficit), and cash flows for
        the
        year 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 audit.
 
 We
        conducted our audit in accordance with 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 has determined
        that it
        is not required to have, nor were we engaged to perform, an audit on 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
        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 (F/K/A
        Network Dynamics Corp.) as of December 31, 2006, and the results of its
        operations and its cash flows for the year then ended, in conformity with
        generally accepted accounting principles in the United States of
        America.
 
 As
        discussed in Note 13 to the financial statements, the statements of operations,
        changes in stockholders’ equity (deficit) and cash flows for the year ended
        December 31, 2006 have been restated to properly account for the deferred
        tax
        asset valuation allowance.
 
 The
        accompanying financial statements have been prepared assuming that the Company
        will continue as a going concern. As discussed in Note 1 to the financial
        statements, the Company has experienced recurring losses and negative cash
        flows
        from operations and has both a working capital and a capital deficit at December
        31, 2006, that raises substantial doubt about its ability to continue as
        a going
        concern. Management’s plans in regard to these matters are also described in
        Note 1. The financial statements do not include any adjustments that might
        result from the outcome of this uncertainty.
 By:
                **/s/ AJ. ROBBINS, PC****CERTIFIED
                  PUBLIC ACCOUNTANTS**
 Denver,
        Colorado
 March
        29,
        2007
  F
            - 3
  **CYBERDEFENDER
        CORPORATION**
 **BALANCE
        SHEETS**
 
 December
                  31,
              
              
              December
                  31,2007
              
              
              2006**ASSETS**
              
              
              
              
              
              (restated)**CURRENT
                  ASSETS:**Cash and cash equivalents
              
              $
              236,995
              
              $
              549,681Accounts receivable, net of allowance for doubtful accounts of
                  $0 and
                  $0
              
              
              19,053
              
              
              4,207Deferred financing costs, current
              
              
              596,917
              
              
              530,682Prepaid expenses
              
              
              21,885
              
              
              56,772Deferred processing fees
              
              
              40,560
              
              
              81,813Total
                  Current Assets
              
              
              915,410
              
              
              1,223,155**PROPERTY
                  AND EQUIPMENT, net**
              
              
              129,643
              
              
              135,861**INTANGIBLE,
                  net**
              
              
              -
              
              
              66,667**DEFERRED
                  FINANCING COSTS, net of current portion**
              
              
              331,146
              
              
              901,432**OTHER
                  ASSETS**
              
              
              26,097
              
              
              30,244Total
                  Assets
              
              $
              1,402,296
              
              $
              2,357,359
  **LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT****CURRENT
                  LIABILITIES:**Accounts
                  payable
              
              $
              647,976
              
              $
              627,148Accrued
                  expenses
              
              
              619,805
              
              
              180,837Accrued
                  expenses - registration rights agreement
              
              
              166,297
              
              
              225,415Deferred
                  revenue
              
              
              629,442
              
              
              986,383Notes
                  payable, net of discount
              
              
              705,298
              
              
              -Current
                  portion of capital lease obligations
              
              
              24,271
              
              
              17,300Total
                  Current Liabilities
              
              
              2,793,089
              
              
              2,037,083**CONVERTIBLE
                  NOTES PAYABLE, net of discount**
              
              
              1,235,035
              
              
              383,110**CAPITAL
                  LEASE OBLIGATIONS, less current portion**
              
              
              41,347
              
              
              42,946Total
                  Liabilities
              
              
              4,069,471
              
              
              2,463,139**COMMITMENTS
                  AND CONTINGENCIES****STOCKHOLDERS’
                  DEFICIT:**Common
                  stock, no par value; 50,000,000 shares authorized; 13,994,597 and
                  12,173,914 shares
                issued
                  and outstanding at December 31, 2007 and 2006
              
              
              4,788,349
              
              
              3,561,821Additional
                  paid-in capital
              
              
              7,105,428
              
              
              5,027,228Accumulated
                  deficit
              
              
              (14,560,952
              )
              
              (8,694,829
              )Total
                  Stockholders’ Deficit
              
              
              (2,667,175
              )
              
              (105,780
              )Total
                  Liabilities and Stockholders’ Deficit
              
              $
              1,402,296
              
              $
              2,357,359
 
 See
        accompanying notes to financial statements
  F
            - 4
  **CYBERDEFENDER
        CORPORATION**
 **STATEMENTS
        OF OPERATIONS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
 
 **2007**
              
              
              **2006**(restated)**REVENUES:**Net
                  sales
              
              $
              2,220,154
              
              $
              3,901,873**OPERATING
                  EXPENSES:**Advertising
              
              
              445,595
              
              
              787,607Product
                  development
              
              
              537,558
              
              
              2,199,901Selling,
                  general and administrative
              
              
              3,547,124
              
              
              4,033,851Depreciation
                  and amortization
              
              
              101,025
              
              
              95,865Total
                  Operating Expenses
              
              
              4,631,302
              
              
              7,117,224**LOSS
                  FROM OPERATIONS:**
              
              
              (2,411,148
              )
              
              (3,215,351
              )**OTHER
                  INCOME AND (EXPENSE):**Other
                  income
              
              
              (4,413
              )
              
              52,755Loss
                  on registration rights agreement
              
              
              (84,864
              )
              
              (113,518
              )Interest
                  expense
              
              
              (3,364,898
              )
              
              (2,230,686
              )Total
                  Other Expenses
              
              
              (3,454,175
              )
              
              (2,291,449
              )**LOSS
                  BEFORE INCOME TAX EXPENSE**
              
              
              (5,865,323
              )
              
              (5,506,800
              )**INCOME
                  TAX EXPENSE**
              
              
              800
              
              
              800**NET
                  LOSS**
              
              $
              (5,866,123
              )
              $
              (5,507,600
              )Basic
                  and fully diluted net loss per share
              
              $
              (0.47
              )
              $
              (0.55
              )**Weighted
                  Average Shares Outstanding:**Basic
                  and fully diluted
              
              
              12,439,759
              
              
              10,089,328
 
 See
        accompanying notes to financial statements
  F
            - 5
 
 **CYBERDEFENDER
        CORPORATION**
 **STATEMENTS
        OF STOCKHOLDERS’ EQUITY (DEFICIT)**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **Additional****Common
                  Stock**
              
              **Paid-in**
              
              
              **Accumulated****Shares**
              
              
              **Amount**
              
              
              **Capital**
              
              
              **Deficit**
              
              
              **Total**Balance
                  at December 31, 2005 (restated)
              
              
              9,317,342
              
              $
              323,422
              
              $
              ---
              
              $
              (3,187,229
              )
              $
              (2,863,807
              )Exercise
                  of stock options
              
              
              100,939
              
              
              1,083
              
              
              ---
              
              
              ---
              
              
              1,083Conversion
                  of bridge notes
              
              
              1,755,118
              
              
              1,262,071
              
              
              ---
              
              
              ---
              
              
              1,262,071Beneficial
                  conversion feature of convertible debt
              
              
              ---
              
              
              ---
              
              
              755,173
              
              
              ---
              
              
              755,173Value
                  of warrants issued with conversion of debt
              
              
              ---
              
              
              ---
              
              
              506,896
              
              
              ---
              
              
              506,896Beneficial
                  conversion feature of convertible debt
              
              
              ---
              
              
              ---
              
              
              1,589,844
              
              
              ---
              
              
              1,589,844Value
                  of warrants issued with convertible debt
              
              
              ---
              
              
              ---
              
              
              1,477,948
              
              
              ---
              
              
              1,477,948Stock
                  contributed by founders
              
              
              (1,018,865
              )
              
              ---
              
              
              ---
              
              
              ---
              
              
              ---Issuance
                  of shares to bridge holders
              
              
              186,354
              
              
              200,000
              
              
              
              
              
              ---
              
              
              200,000Issuance
                  of shares in payment of balance of note payable
              
              
              186,347
              
              
              83,335
              
              
              ---
              
              
              ---
              
              
              83,335Issuance
                  of shares to officer and director for compensation
              
              
              646,164
              
              
              691,395
              
              
              ---
              
              
              ---
              
              
              691,395Issuance
                  of shares for financing costs
              
              
              1,000,515
              
              
              1,000,515
              
              
              ---
              
              
              ---
              
              
              1,000,515Issuance
                  of unit purchase options for financing costs
              
              
              ---
              
              
              ---
              
              
              374,531
              
              
              ---
              
              
              374,531Compensation
                  expense on vested options
              
              
              ---
              
              
              ---
              
              
              322,836
              
              
              ---
              
              
              322,836Net
                  loss (restated)
              
              
              ---
              
              
              ---
              
              
              ---
              
              
              (5,507,600
              )
              
              (5,507,600
              )Balance
                  at December 31, 2006
              
              
              12,173,914
              
              
              3,561,821
              
              
              5,027,228
              
              
              (8,694,829
              )
              
              (105,780
              )Value
                  of warrants issued with debt
              
              
              ---
              
              
              ---
              
              
              370,390
              
              
              ---
              
              
              370,390Conversion
                  of bridge notes
              
              
              460,000
              
              
              460,000
              
              
              ---
              
              
              ---
              
              
              460,000Issuance
                  of shares for penalties and interest
              
              
              418,683
              
              
              363,153
              
              
              ---
              
              
              ---
              
              
              363,153Sale
                  of shares with warrants attached, net of issuance costs of
                  $45,815
              
              
              654,500
              
              
              218,252
              
              
              390,433
              
              
              ---
              
              
              608,685Issuance
                  of shares and warrants
                for
                  services
              
              
              287,500
              
              
              185,123
              
              
              418,946
              
              
              ---
              
              
              604,069Shares
                  contributed to third party directly by officers and directors for
                  financing costs
              
              
              ---
              
              
              ---
              
              
              400,000
              
              
              ---
              
              
              400,000Compensation
                  expense on vested options
              
              
              ---
              
              
              ---
              
              
              498,431
              
              
              ---
              
              
              498,431Net
                  loss
              
              
              ---
              
              
              ---
              
              
              ---
              
              
              (5,866,123
              )
              
              (5,866,123
              )Balance
                  at December 31, 2007
              
              
              13,994,597
              
              $
              4,788,349
              
              $
              7,105,428
              
              $
              (14,560,952
              )
              $
              (2,667,175
              )
 
 See
        accompanying notes to financial statements
  F
            - 6
  **CYBERDEFENDER
        CORPORATION**
 **STATEMENTS
        OF CASH FLOWS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
 
 **2007**
              
              
              **2006****CASH
                  FLOWS FROM OPERATING ACTIVITIES:**
              
              
              
              
              
              (restated)Net
                  loss
              
              $
              (5,866,123
              )
              $
              (5,507,600
              )Adjustments
                  to reconcile net loss to net cash provided by (used in) operating
                  activities:Beneficial
                  Conversion - debt converted at below market
              
              
              -
              
              
              755,173Value
                  of warrants issued with conversion of debt
              
              
              -
              
              
              506,896Additional
                  shares issued to bridge note holders
              
              
              -
              
              
              200,000Shares
                  issued to officer and director for compensation
              
              
              -
              
              
              691,395Loss
                  on registration rights agreement
              
              
              84,864
              
              
              113,518Amortization
                  of debt discount
              
              
              1,459,575
              
              
              319,421Depreciation
                  and amortization
              
              
              101,025
              
              
              95,865Compensation
                  expense from vested stock options
              
              
              498,431
              
              
              322,836Amortization
                  of deferred financing costs
              
              
              1,032,089
              
              
              159,932Shares
                  issued for penalties and interest
              
              
              363,153
              
              
              -Shares
                  issued for services
              
              
              604,069
              
              
              -Changes
                  in operating assets and liabilities:Restricted
                  cash
              
              
              -
              
              
              26,748Accounts
                  receivable
              
              
              (14,846
              )
              
              32,163Prepaid
                  and other assets
              
              
              39,034
              
              
              (232,755
              )Deferred
                  processing fees
              
              
              41,253
              
              
              94,764Accounts
                  payable and accrued expenses
              
              
              269,999
              
              
              273,603Deferred
                  revenue
              
              
              (356,941
              )
              
              (1,002,120
              )Cash
                  Flows Used In Operating Activities:
              
              
              (1,744,418
              )
              
              (3,150,161
              )**CASH
                  FLOWS FROM INVESTING ACTIVITIES:**Purchase
                  of fixed assets
              
              
              (5,424
              )
              
              (14,540
              )Proceeds
                  from return of equipment
              
              
              -
              
              
              14,926Cash
                  Flows Provided By (Used In) Investing Activities
              
              
              (5,424
              )
              
              386**CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Proceeds
                  from notes payable
              
              
              800,000
              
              
              3,575,000Payments
                  on note payable
              
              
              -
              
              
              (100,000
              )Payments
                  on note payable - related party
              
              
              -
              
              
              (16,667
              )Principal
                  payments on capital lease obligation
              
              
              (17,344
              )
              
              (11,932
              )Proceeds
                  from the exercise of stock options
              
              
              -
              
              
              1,083Proceeds
                  from sale of stock
              
              
              654,500
              
              
              -Cash
                  Flows Provided By Financing Activities
              
              
              1,437,156
              
              
              3,447,484**NET
                  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS**
              
              
              (312,686
              )
              
              297,709**CASH
                  AND CASH EQUIVALENTS, beginning of period**
              
              
              549,681
              
              
              251,972**CASH
                  AND CASH EQUIVALENTS, end of period**
              
              $
              236,995
              
              $
              549,681
 
 See
        accompanying notes to financial statements
  F
            - 7
  **CYBERDEFENDER
        CORPORATION**
 **STATEMENTS
        OF CASH FLOWS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **2007**
              
              
              **2006****Supplemental
                  disclosures of cash flow information:**Income
                  taxes paid
              
              $
              18,211
              
              $
              800Cash
                  paid for interest
              
              $
              17,769
              
              $
              13,937Supplemental
                  schedule of non-cash financing activities:Assets
                  acquired through capital lease obligation
              
              $
              22,716
              
              $
              18,410Conversion
                  of convertible debt
              
              $
              460,000
              
              $
              1,262,071Discount
                  on debt financing
              
              $
              370,390
              
              $
              3,067,792Discount
                  on conversion of debt
              
              $
              -
              
              $
              1,262,071Deferred
                  financing costs paid by issuance of stock based
                  compensation
              
              $
              -
              
              $
              1,000,515Deferred
                  financing costs paid by issuance of stock to third party
                directly
                  by officers and directors
              
              $
              400,000
              
              $
              -Exchange
                  of accounts payable for convertible notes payable
              
              $
              -
              
              $
              62,500Exchange
                  of notes payable for stock
              
              $
              -
              
              $
              83,335Issuance
                  of shares to officer and director
              
              $
              -
              
              $
              691,395Warrants
                  issued in connection with sale of stock
              
              $
              436,248
              
              $
              -Issuance
                  of unit purchase options for financing costs
              
              $
              -
              
              $
              374,531
 
 See
        accompanying notes to financial statements
  F
            - 8
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
        POLICIES**
 
 **Organization
        and Business**
 CyberDefender
        Corporation (the “Company”), based in Los Angeles, California, is a provider of
        secure content management software. The Company develops and licenses security
        software and related services. The Company continues to bring to market advanced
        solutions to combat and prevent online information theft, unwanted
        advertisements, spam, Internet viruses, spyware and related computer
        threats.
 
 On
        October 30, 2006, the Company’s board of directors and those shareholders
        holding a majority of the voting power approved a 0.93173414-for-1 reverse
        split
        of the Company’s common stock. The effective date of the split was October 31,
        2006. All common stock amounts are shown on a post-split basis in these
        financial statements and notes.
 
 **Going
        Concern and Management’s Plans**
  Historically,
        the Company’s revenues were derived from subscriptions to 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. The Company acquired new users with an online direct purchase offer.
        The offer, to****scan
        a
        computer for spyware and then pay for removal of spyware, was broadcast in
        emails, banners and search ads.
  In
        November 2006, the Company launched its new Internet security suite called
        CyberDefender FREE 2.0 that is free to the subscriber. Revenues are earned
        from
        advertising networks which pay the Company to display the advertiser’s
        advertisements inside the software. CyberDefender Early Detection Center
        is a
        version of the same software, without the advertising, which is paid for
        by the
        subscriber. The annual subscription rate for the version without ads ranges
        from
        $11.99 to $39.99, depending on the marketing or distribution channels used
        by
        the Company.
 
 On
        September 27, 2007 the Company announced the launch of CyberDefenderULTIMATETM
and CyberDefenderCOMPLETETM. These are enhanced versions of its security
        software. For an annual fee, CyberDefenderULTIMATETM provides year round support
        for any software or hardware connected to a subscriber’s computer while
        CyberDefenderCOMPLETETM provides year-round unlimited anti-malware support for a
        subscriber’s computer. These new security suites also include 2 gigabytes of
        online backup. These products are sold for $59.95 to $199.95 per
        year.
 
 The
        Company’s financial statements have been presented on the basis that it is a
        going concern, which contemplates the realization of assets and the satisfaction
        of liabilities in the normal course of business. The Company has incurred
        net
        losses of $5,866,123 and $5,507,600 during the years ended December 31, 2007
        and
        2006, respectively, and has negative working capital of $1,877,679 and an
        accumulated deficit of $14,560,952 at December 31, 2007, which raises
        substantial doubt about its ability to continue as a going concern. Until
        sales
        of the products provide the Company with the revenue it needs to attain
        profitability, the Company intends to continue to raise money for operating
        capital through sales of its securities or by borrowing money.  From
        inception through December 31, 2007, the Company has raised $5,075,000 from
        debt financing and $654,500 from equity financing to develop software and
        to
        build out a management team to deliver a new product to market. The Company’s
        ability to continue as a going concern is dependent upon its ability to develop
        additional sources of capital. Management cannot assure that any financing
        arrangements will be available in amounts or on terms acceptable to the Company.
        If additional financing is not available or is not available on acceptable
        terms, the Company may be unable to continue its operations. The accompanying
        financial statements do not include any adjustments that might result from
        the
        outcome of these uncertainties.
  The
        Company currently has no firm agreements with any third parties for any future
        transactions and future financings.
 
 **Reclassification**
 To
        conform to the current year's presentation, as a result of management's
        continuing analysis of its operating activities, the Company reclassified
        interest expense from operating expenses to other income and (expenses).
        In
        addition, the Company reclassified $172,432 from selling, general and
        administrative to interest expense.
  F
            - 9
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        1 -**  **NATURE
        OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**  **(Continued)**
 
 **Use
        of Estimates**
 The
        preparation of financial statements in conformity with generally accepted
        accounting principles requires management to make estimates and assumptions
        that
        affect the reported amounts of assets and liabilities 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, realization of
        accounts receivables, recoverability of long-lived assets, determination
        of
        useful lives of intangibles, value of shares and options/warrants granted
        and
        valuation of deferred tax assets. Actual results could differ from those
        estimates and assumptions.
 
 **Cash
        and Cash Equivalents**
 Cash
        and
        cash equivalents include cash on hand and investments with original maturities
        of three months or less.
 
 **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 seven years, using the straight-line
        method. Total depreciation expense was $34,358 and $29,198 for the years
        ended
        December 31, 2007 and 2006, respectively.
  **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 the estimated useful lives.
 
 **Fair
        Value of Financial Instruments**
 Unless
        otherwise specified, the Company believes the carrying value of financial
        instruments approximates their fair value.
 
 **Revenue
        Recognition**
 The
        Company recognizes revenue from the sale of software licenses under the guidance
        of Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” as
        amended by SOP No. 98-9, “Modification of SOP 97-2, Software Revenue
        Recognition, With Respect to Certain Transactions” and SEC Staff Accounting
        Bulletin (“SAB”) Nos. 101 and 104.
 
 Specifically,
        the Company recognizes revenues from its CyberDefender Anti-Spyware 2006,
        CyberDefenderULTIMATETM and CyberDefenderCOMPLETETM (“CyberDefender TM ”)
        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, andiv.
              
              collection
                  of the resulting receivable is reasonably
                  assured.
 
 The
        Company sells its CyberDefender TM software
        over the Internet. Customers order the product and simultaneously provide
        their
        credit card information to the Company. Upon receipt of authorization from
        the
        credit card issuer, the Company licenses the customer to download CyberDefender TM over the
        Internet. As part of the sales price, 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”) does not exist for one or more of the elements. The arrangement is in
        substance a subscription and the entire fee is deferred until the month
        subsequent to the delivery date of the product and is recognized ratably
        over
        the term of the arrangement according to the guidance in SOP 97-2 paragraph
        49.
  F
            - 10
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        1 -**  **NATURE
        OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**  **(Continued)**
 
 **Revenue
        Recognition (Continued)**
 In
        November 2006, the Company launched a new product, CyberDefender FREE 2.0,
        which
        is free to the subscriber. Revenues are earned from advertising networks
        which
        pay the Company to display the advertiser’s advertisements inside the software.
        Under the guidance of SAB 104, 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. At the present time
        the
        Company’s obligations do not include guarantees of a minimum number of
        impressions. In the future if the Company’s obligations would include guarantees
        of a minimum number of impressions, to the extent minimum guaranteed impressions
        are not met, the Company would defer recognition of the corresponding revenues
        until the remaining guaranteed impression levels are achieved. Customers
        may
        choose to download a version of the same software, without advertising, and
        pay
        for the term license which allows the customer to use the products and receive
        product support coverage and content updates for a specified period, generally
        twelve months. The Company recognizes revenue on the paid software in accordance
        with SOP No. 97-2 as amended by SOP No. 98-9, as described above.
 
 **Deferred
        Processing Fees**
 The
        Company uses a third party to process its product sales. The Company pays
        a
        direct acquisition fee to the processor for each completed sale. These direct
        acquisition fees are deferred and recognized ratably over the term of the
        arrangement of the associated sale in accordance with FASB Technical Bulletin
        90-1, “Accounting for Separately Priced Extended Warranty and Product
        Maintenance Contracts”. The third party processor refunds any direct acquisition
        fee paid to it on any credit card chargeback or on any product that is returned.
        The refunds are matched against the associated chargebacks and product
        returns.
 
 **Reserves
        for Product Returns and Chargebacks**
 The
        Company’s policy with respect to product returns is defined in its End User
        License Agreement (“EULA”), which states “...products purchased that are
        downloadable are refundable within the first 30 days after the date of
        purchase.” Product returns are generally received within 30 days of the original
        sale and are charged against the associated sale upon receipt of the
        return.  A chargeback occurs after a customer is automatically charged for
        a renewal license and subsequently, within 30 days of renewal, decides not
        to
        continue using the license or the credit card processed for renewal is no
        longer
        valid.  The Company’s third party processor of renewal sales is usually
        notified within 30 days by customers that they no longer wish to license
        the
        Company’s product.  The third party processor reduces the amounts due to
        the Company as a result of any chargeback during the preceding 30 day
        period.  As a result, a majority of chargebacks occur within 30 days of the
        rebilling event and are recorded prior to closing the previous month’s
        accounting records.  As stated in the Company’s revenue recognition policy,
        revenue is deferred until the month subsequent to the renewal date and
        recognized ratably over the term of the arrangement. For the years ended
        December 31, 2007 and 2006, the Company had accrued $0 for customer returns
        and
        chargebacks. The Company may voluntarily accept returns from a customer from
        time to time. The returns are charged against revenues upon
        receipt.
 
 **Concentrations
        of Risk**
 Revenues
        are concentrated in the software industry which is highly competitive and
        rapidly changing. **** Significant technological changes in the industry or customer requirements,
        or
        the emergence of competitive products with new technologies or capabilities
        could adversely affect operating results.
 
 The
        Company maintains all cash in bank accounts, which at times may exceed federally
        insured limits. The Company has not experienced a loss in such
        accounts.
 
 For
        the
        year ended December 31, 2007 and 2006, advertising purchased from four (4)
        vendors accounted for 45% and 58% of the Company’s total advertising
        expense.
  F
            - 11
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        1 -**  **NATURE
        OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**  **(Continued)**
 
 **Income
        Taxes**
 The
        Company has adopted the liability method of accounting for income taxes pursuant
        to Statement of Financial Accounting Standard (“SFAS”) No. 109, “Accounting for
        Income Taxes.” Under SFAS No. 109, deferred income taxes are recorded to reflect
        tax consequences on future years for the differences between the tax bases
        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
        bases. 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.
 
 Effective
        January 1, 2007, the Company adopted the provisions of Financial Accounting
        Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in
        Income Taxes,” (“FIN 48”). FIN 48 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. Under FIN 48, an entity may
        only
        recognize or continue to recognize tax positions that meet a “more likely than
        not” threshold. The Company did not make any adjustment to opening retained
        earnings as a result of the implementation.
 
 Based
        on
        its evaluation, the Company has concluded that there are no significant
        uncertain tax positions requiring recognition in its financial statements.
        The
        Company’s evaluation was performed for the tax years ended December 31,
        2004 through 2007 for U.S. Federal Income Tax and for the tax years ending
        December 31, 2003 through 2007 for the State of California Income
        Tax.
 
 The
        Company does not have any unrecognized tax benefits as of December 31, 2007
        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, 2007 or 2006.
 
 **Software
        Development Costs**
 The
        Company accounts for software development costs in accordance with SFAS No.
        86,
“Computer Software to Be Sold, Leased, or Otherwise Marketed.” Such costs are
        expensed prior to achievement of technological feasibility and thereafter
        are
        capitalized. There has 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.
        For
        the years ended December 31, 2007 and 2006, product development costs were
        $537,558 and $2,199,901, respectively. Further, as discussed in Note 4, the
        Company acquired the CyberDefender TM software
        application during 2005.
  **Advertising
        Expenses**
  Advertising
        expenses are expensed as incurred and consist primarily of various forms
        of
        media purchased from Internet-based marketers and search engines. For the
        years
        ended December 31, 2007 and 2006, advertising expense amounted to $445,595
        and
        $787,607, respectively.
  F
            - 12
  **CYBERDEFENDER**  **CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        1 -**  **NATURE
        OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**  **(Continued)**
 
 **Recently
        Issued Accounting Pronouncements**
 The
        Company has adopted all accounting pronouncements effective before
        December 31, 2007, which are applicable to the Company.
 
 In
        February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
        Financial Assets and Financial Liabilities, including an amendment of
        SFAS No. 115.” SFAS No. 159 permits companies to choose to
        measure certain financial instruments and certain other items at fair value
        and requires unrealized gains and losses on items for which the fair value
        option has been elected to be reported in earnings. SFAS No. 159 is
        effective for fiscal years beginning after November 15, 2007. The Company
        is currently in the process of evaluating the impact of SFAS No. 159
        on its financial statements.
 
 In
        September 2006, the FASB issued SFAS No. 157, “Fair Value
        Measurements.” This statement clarifies the definition of fair value,
        establishes a framework for measuring fair value and expands the disclosures
        on
        fair value measurements. SFAS No. 157 is effective for fiscal years
        beginning after November 15, 2007. Management has not determined the
        effect, if any, the adoption of this statement will have on the financial
        statements.
 
 FASB
        Staff Position No. FAS 157-2 (“FSP 157-2”), *Effective
        Date of FASB Statement No. 157* was
        issued in February 2008. FSP 157-2 delays the effective date of SFAS
        No. 157, for nonfinancial assets and nonfinancial liabilities, except for
        items that are recognized or disclosed at fair value at least once a year,
        to
        fiscal years beginning after November 15, 2008, and for interim periods
        within those fiscal years.
  **Loss
        Per Share**
 In
        accordance with SFAS No. 128, “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. For the years ended December
        31, 2007 and 2006, there were 10,138,067 and 9,239,922 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 loss per share since their effect would be anti-dilutive
        for that reporting period.
 
 **Stock
        Based Compensation**
 The
        Company adopted SFAS No. 123 (Revised 2004), “Share Based Payment”
(“SFAS No. 123R”), under the modified-prospective transition method on
        January 1, 2006. SFAS No. 123R 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. Share-based compensation
        recognized under the modified-prospective transition method of SFAS
        No. 123R includes share-based compensation based on the grant-date fair
        value determined in accordance with the original provisions of SFAS
        No. 123, Accounting for Stock-Based Compensation, for all share-based
        payments granted prior to and not yet vested as of January 1, 2006 and
        share-based compensation based on the grant-date fair-value determined in
        accordance with SFAS No. 123R for all share-based payments granted after
        January 1, 2006. For non-employee stock based compensation the Company
        recognizes an expense in accordance with SFAS No. 123 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 which ever is more readily available.
        Stock option awards are valued using the Black-Scholes option-pricing
        model.
 
 **NOTE
        2 - RESTRICTED CASH**
 
 Under
        a
        credit card processing agreement with a financial institution the Company
        was
        required to maintain a security reserve deposit as collateral. The amount
        of the
        deposit that was at the discretion of the financial institution and as of
        December 31, 2007 and 2006 was $8,592 and $402, respectively. This amount
        is
        included in prepaid expenses on the accompanying balance
        sheets.
  F
            - 13
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        3 - PROPERTY AND EQUIPMENT**
 
 Property
        and equipment consists of the following:
 December
                  31,
              
              
              December
                  31,2007
              
              
              2006Furniture
                  and fixtures
              
              $
              119,007
              
              $
              96,291Office
                  equipment
              
              
              88,294
              
              
              82,870Software
              
              
              8,481
              
              
              8,481215,782
              
              
              187,642Less
                  accumulated depreciation
              
              
              (86,139
              )
              
              (51,781
              )Net
                  property and equipment
              
              $
              129,643
              
              $
              135,861
 
 **NOTE
        4- INTANGIBLE**
 
 In
        January 2005, the Company entered into an asset purchase agreement with Unionway
        Int’l, LLC whereby the Company purchased certain assets of Unionway Int’l, LLC
        that principally included the software application Cyber-DefenderTM and
        associated rights for $200,000 through the issuance of a note payable as
        disclosed in the following Note 7. The software technology purchased from
        Unionway Int’l, LLC is the core of the Company’s existing product. The asset is
        being amortized over the expected life of three years on a straight line
        basis.
        The amortization for the years ended December 31, 2007 and 2006 was $66,667
        and
        the accumulated amortization was $200,000 and $133,333 as of December 31,
        2007
        and 2006, respectively.
 
 **NOTE
        5 - INCOME TAXES**
 
 The
        primary components of temporary differences that give rise to the Company’s net
        deferred tax are as follows:
  The
        components of deferred income tax are as follows:
 
 **2007**
              
              
              **2006**Deferred
                  tax asset:Net
                  operating losses
              
              $
              3,671,742
              
              $
              2,289,368Temporary
                  differences
              
              
              438,746
              
              
              173,576Total
              
              
              4,110,488
              
              
              2,462,944Valuation
                  allowance
              
              
              (4,110,488
              )
              
              (2,462,944
              )$
              --
              
              $
              --
 The
          components of deferred income tax expense (benefit) are as
          follows:
  Net
                  operating income (losses)
              
              $
              (1,382,374
              )
              $
              (1,312,475
              )Temporary
                  differences
              
              
              (265,170
              )
              
              (183,919
              )Total
              
              
              (1,647,544
              )
              
              (1,496,394
              )Increase
                  in valuation allowance
              
              
              1,647,544
              
              
              1,496,394Deferred
                  income tax expense
              
              
              --
              
              
              --Income
                  taxes, current
              
              
              800
              
              
              800Income
                  tax expense
              
              $
              800
              
              $
              800
 
 F
            - 14
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        5 - INCOME TAXES (Continued)**
 
 The
        following is a reconciliation of the amount of income tax expense that would
        result from applying the statutory federal income tax rates to pre-tax loss
        and
        the reported amount of income tax expense:
  **2007**
              
              
              **2006**Tax
                  benefit at federal statutory rate
              
              $
              (1,994,481
              )
              $
              (1,868,100
              )Beneficial
                  conversion feature
              
              
              -
              
              
              256,759Accretion
                  of discount on convertible debt
              
              
              496,256
              
              
              280,948Other
              
              
              (5,957
              )
              
              (21,395
              )Depreciation
                  and organization costs
              
              
              7,009
              
              
              4,695State
                  income tax benefit
              
              
              (149,571
              )
              
              (148,501
              )Increase
                  in valuation allowance
              
              
              1,647,544
              
              
              1,496,394Income
                  tax expense
              
              $
              800
              
              $
              800
 
 At
        December 31, 2007, the Company has provided a valuation allowance for the
        deferred tax assets since management has not been able to determine that
        the
        realization of that asset is more likely than not.
 
 As
        of
        December 31, 2007, the Company had federal net operating loss carry forwards
        and
        state net operating loss carry forwards of approximately $9,765,000 and
        $9,596,000 respectively. The net federal operating loss carry forwards expire
        through 2027 and net state operating loss carry forwards expire through
        2017.
 
 **NOTE
        6- STOCKHOLDERS’ EQUITY**
 
 Common
        Stock
 During
        the year ended December 31, 2006, 100,939 of the employee stock options were
        exercised for total proceeds to the Company of $1,083. The Company issued
        100,939 shares of its common stock to two employees.
 
 On
        September 12, 2006, the holders of the Company’s convertible promissory notes
        entered into the Note Conversion and Warrant Lock-Up Agreement as described
        in
        Note 6 and converted the outstanding principal and accrued interest on the
        convertible notes of $1,262,071 into 1,755,118 shares of the Company’s common
        stock. The rate of conversion of these notes was lower than the market price
        of
        the Company’s common stock on the date of issuance resulting in the recognition
        of the beneficial  conversion
        feature of $755,173. The warrants issued in connection with this transaction
        were valued at $506,896 using the Black-Scholes option pricing model with
        the
        following assumption: term of 5 years, a risk-free interest rate of 4.62%,
        a
        dividend yield of 0% and volatility of 128% and was charged to interest expense.
        There were no fees paid in connection with this agreement.
 
 On
        September 12, 2006, Gary Guseinov, the Chief Executive Officer, transferred
        an
        aggregate of 186,354 shares of common stock back to the Company for
        cancellation.  In turn, the Company issued an aggregate of 186,354 shares
        of common stock to its bridge lenders, on a pro rata basis; in consideration
        of
        the bridge lenders agreeing to enter into the Note Conversion and Warrant
        Lock-Up Agreement described above.  The value of the shares issued to
        the bridge lenders was $1.073 per share or $200,000 and was charged to interest
        expense.
 
 On
        October 1, 2006, Gary Guseinov and Igor Barash, the Chief Technology Officer,
        transferred an aggregate of 832,511 shares of common stock to the Company
        for
        cancellation.  In turn, the Company issued 646,164 shares of common stock
        to Bing Liu, the Chief Software Architect, for his contribution to
        the **** development
        of the Company’s product and technology. The value of the shares issued to Bing
        Liu was $1.07 per share for a total of $691,395 and was charged to operating
        expenses as compensation.
 
 On
        October 1, 2006, the Company issued 186,347 shares of common stock to Bing
        Liu
        in consideration of his agreement to exchange the balance of the Unionway,
        International LLC note, as described in Note 7 below. The value of the shares
        issued to Bing Liu was $83,335.
  F
            - 15
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        6- STOCKHOLDERS’ EQUITY (Continued)**
 
 On
        November 1, 2006, the Company issued 1,000,515 shares of common stock to
        entities assisting the Company in the sale of its 10% secured convertible
        debentures to accredited investors, as more fully described in Note 8. The
        value
        of the shares issued to the entities was $1,000,515. These costs were charged
        to
        Deferred Financing Costs and are being amortized over the term of the 10%
        secured convertible debentures.
 
 In
        addition, the Company issued 217,000 unit purchase options, which are
        subscriptions to purchase shares of the Company’s common stock, with each unit
        consisting of one share of common stock and one warrant to purchase one share
        of
        common stock for $1.00 per share, to entities assisting the Company in the
        sale
        of its 10% secured convertible debentures to accredited investors, as more
        fully
        described in Note 9. The value of the unit purchase options issued to these
        entities was $374,531 and was valued using the Black-Scholes option pricing
        model with the following assumptions: term of 5 years, a risk-free interest
        rate
        of 4.62%, a dividend yield of 0%, and volatility of 128%. These costs were
        charged to Deferred Financing Costs and are being amortized over the term
        of the
        10% secured convertible debentures.
 
 On
        August
        15, 2007, the Company issued to Oceana Partners 50,000 shares of the Company’s
        common stock in consideration for research coverage valued at $50,000 for
        a
        twelve month period commencing August 1, 2007 thru July 31, 2008. The entire
        $50,000 was recognized as selling, general and administrative costs in the
        accompanying statement of operations for the year ended December 31, 2007.
        On
        October 22, 2007, the Company entered into an agreement with Oceana Partners
        pursuant to which the Company agreed to issue to Oceana Partners warrants
        to
        purchase 400,000 shares of our common stock in exchange for research coverage
        valued at $477,071 for services provided in 2007. The agreement was amended
        on
        November 30, 2007. Pursuant to the amendment, the Company agreed to issue
        37,500
        shares of common stock to designees of Oceana Partners and to reduce the
        number
        of shares of common stock covered by the warrants issued to Oceana Partners
        from
        400,000 shares to 362,500 shares. The entire $477,071 was recognized in interest
        expense in the accompanying statement of operations for the year ended December
        31, 2007.
 
 On
        August
        17, 2007, the Company issued to Richardson & Patel, its legal counsel,
        100,000 shares of the Company’s common stock as payment for general corporate
        legal services rendered that amounted to $23,578 that was recognized as sales,
        general and administrative expense in the accompanying statement of operations
        for the year ended December 31, 2007.
 
 On
        October 18, 2007, the Company began an offering of stock units. Each unit
        consisted of 25,000 shares of common stock and a warrant to purchase 18,750
        sharse of common stock at an exercise price of $1.25 per share. The warrants
        have a term of five years with anti-dilution protection whereas in the event
        stock sells for less than $1.00 will receive additional shares of common
        stock
        without consideration. The purchase price is $25,000 per unit. As of December
        31, 2007, the Company issued 654,500 shares and raised $654,500 through this
        offering. The 490,875 warrants issued in connection with the units were valued
        at $436,248 using the Black-Scholes option pricing model with the following
        assumptions: term of 5 years, a risk-free interest rate of 4.52%, a dividend
        yield of 0% and volatility of 142%. Issuance costs consisted of a 7% cash
        fee
        and additional warrants at $1.00 per share to purchase 7% of offering with
        the
        following assumptions: term of 5 years, a risk-free interest rate of 4.52%,
        a
        dividend yield of 0% and volatility of 142%. Issuance costs of $45,815 as
        of
        December 31, 2007 are recorded in accrued expenses on the accompanying balance
        sheet.
 
 On
        October 24, 2007, the Company issued to Richardson & Patel, its legal
        counsel, 100,000 shares of the Company’s common stock as payment for general
        corporate legal services rendered that amounted to $53,420 that was recognized
        as sales, general and administrative expense in the accompanying statement
        of
        operations for the year ended December 31, 2007.
 
 Stock
        Options
 In
        January 2005, the Company implemented an Employee Stock Option Plan (“2005
        Plan”), which consists of equity programs that provide 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 and approved 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 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 1,375,000
        shares.
  F
            - 16
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        6- STOCKHOLDERS’ EQUITY (Continued)**
 
 On
        November 2, 2006 and December 11, 2006, the Company’s Board of Directors
        approved option grants in the amount of 1,148,944 shares to employees and
        consultants, under the Amended and Restated 2006 Equity Incentive Plan, at
        prices between $0.85 and $1.00 with an estimated fair value of
        $1,118,165 using
        the Black-Scholes option pricing model with the following assumptions: term
        of
        10 years, a risk-free interest rate of 4.52% and 4.57%, a dividend yield
        of 0%,
        and volatility of 134% .
 
 On
        February 13, 2007, the Company granted to various employees options to purchase
        54,000 shares of common stock under the 2006 Plan, at price of $1.00 per
        share with an estimated fair value of $51,922 using the Black-Scholes option
        pricing model with the following assumptions: a term of 10 years, a risk-free
        interest rate of 4.82%, a dividend yield of 0%, volatility of 123% and a
        forfeiture rate of 0%.
 
 On
        April
        24, 2007, the Company granted to Ivan Ivankovich, the Company’s former Chief
        Financial Officer, the option to purchase 120,000 shares of common stock
        under
        the 2006 Plan, at price of $1.00 per share with an estimated fair value of
        $99,932 using the Black-Scholes option pricing model with the following
        assumptions: expected term of 5.09 years, a risk-free interest rate of 4.62%,
        a
        dividend yield of 0%, volatility of 128% and a forfeiture rate of
        0%.
 
 On
        August
        1, 2007, the Company granted to various employees options to purchase 126,500
        shares of common stock under the 2006 Plan, at price of $1.00 per share
        with an estimated fair value of $45,341 using the Black-Scholes option pricing
        model with the following assumptions: an expected term of 6 years, a risk-free
        interest rate of 4.76%, a dividend yield of 0%, volatility of 124% and a
        forfeiture rate of 20%.
 
 On
        August
        30, 2007, Mr. Bing Liu, a consultant performing the services of Chief Software
        Architect, resigned as an employee and began providing services to us as
        a
        consultant under a Consulting Agreement (the “Agreement”). The term of the
        Agreement is six months, but the Agreement may be terminated by either party
        upon 30 days notice, or immediately if Mr. Liu fails to discharge his
        obligations under the Agreement. Upon execution of the Agreement the
        Company paid Mr. Liu the sum of $7,500 and it agreed to pay him the
        sum of $4,000 per month in exchange for his services. The Company will
        reimburse Mr. Liu for expenses incurred by him in rendering services under
        the
        Agreement. The Company also agreed that Mr. Liu will have a period of 24
        months to exercise any vested options and that one-half of any options remaining
        unvested on December 31, 2007 will vest. Mr. Liu will also have a period
        of 24
        months to exercise these options. Any options remaining unvested will vest
        in
        equal increments over 34 remaining months. If Mr. Liu does not receive the
        payment of any unpaid salary due to him by December 31, 2007, then any unvested
        options will immediately vest. Mr. Liu is owed $63,281 in unpaid salary. The
        Company did not pay Mr. Liu his unpaid salary as of December 31, 2007 and
        as
        such his remaining options vested as of December 31, 2007. Mr.
        Liu
        has options to purchase a total of 661,884 shares of the Company’s common stock.
        Due to the modification of the terms of the stock option agreements and the
        failure of the Company to pay the amounts owed to Mr. Liu, the Company
        recognized compensation expense of $233,772, which is recorded in selling,
        general and administrative expenses.  Mr. Liu will continue his duties as a
        consultant performing the services of Chief Software Architect and will assist
        us with recruiting a Chief Technology Officer or Vice-President of Software
        Development. Mr. Liu will continue to provide services to us as a member
        of our
        board of directors.
 
 On
        November 1, 2007, the Company granted to Ivan Ivankovich, the Company’s former
        Chief Financial Officer, the option to purchase 40,000 shares of common stock
        under the 2006 Plan, at price of $1.40 per share with an estimated initial
        fair value of $44,469 using the Black-Scholes option pricing model with the
        following assumptions: expected term of 5 years, a risk-free interest rate
        of
        3.99 %, a dividend yield of 0%, volatility of 116% and a forfeiture rate
        of
        4%.
 
 On
        November 1, 2007, the Company granted to an employee the option to purchase
        10,000 shares of common stock under the 2006 Plan, at price of $1.40 per
        share with an estimated fair value of $7,332 using the Black-Scholes option
        pricing model with the following assumptions: expected term of 6 years, a
        risk-free interest rate of 4.07%, a dividend yield of 0%, volatility of 122%
        and
        a forfeiture rate of 20%.
  F
            - 17
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        6 - STOCKHOLDERS’ EQUITY (Continued)**
 
 A
        summary
        of stock option activity for the 2005 and 2006 plans is as follows:
  **Year
                  Ended****December
                  31, 2007**
              
              
              **December
                  31, 2006****Weighted**
              
              
              
              
              
              
              
              
              
              
              
              **Weighted****Weighted**
              
              
              
              
              
              **Average**
              
              
              
              
              
              
              
              
              **Weighted**
              
              
              **Average****Number**
              
              
              **Average**
              
              
              **Remaining**
              
              
              **Aggregate**
              
              
              **Number**
              
              
              **Average**
              
              
              **Remaining**
              
              
              **Aggregate****of**
              
              
              **Exercise**
              
              
              **Contractual**
              
              
              **Intrinsic**
              
              
              **of**
              
              
              **Exercise**
              
              
              **Contractual**
              
              
              **Instrinsic****Options**
              
              
              **Price**
              
              
              **Term**
              
              
              **Value**
              
              
              **Options**
              
              
              **Prices**
              
              
              **Term**
              
              
              **Value**Outstanding,
                  beginning of period
              
              
              1,441,613
              
              $
              0.75
              
              
              
              
              
              
              
              
              815,268
              
              $
              0.0107Granted
              
              
              350,500
              
              $
              1.06
              
              
              
              
              
              
              
              
              1,148,944
              
              $
              0.97Exercised
              
              
              -
              
              
              -
              
              
              
              
              
              
              
              
              (100,939
              )
              $
              0.0107Cancelled
              
              
              (475,729
              )
              $
              0.98
              
              
              
              
              
              
              
              
              (33,437
              )
              $
              1.00Cancelled
              
              
              -
              
              
              -
              
              
              
              
              
              
              
              
              (388,223
              )
              $
              0.0107Outstanding,
                  end of period
              
              
              1,316,384
              
              $
              0.75
              
              
              8.52
              
              
              732,532
              
              
              1,441,613
              
              $
              0.75
              
              
              8.42
              
              
              -Vested
                  and expected to vest in the future at December 31, 2007
              
              
              1,244,633
              
              $
              0.73
              
              
              8.47
              
              
              712,730
              
              
              1,441,613
              
              $
              0.75
              
              
              8.42
              
              
              -Exercisable,
                  end of period
              
              
              1,087,717
              
              $
              0.68
              
              
              8.37
              
              
              672,930
              
              
              518,359
              
              $
              0.66
              
              
              9.18
              
              
              -
 
 The
        weighted-average grant date fair value of options granted during the years
        ended
        December 31, 2007and 2006 was $0.93 and $0.97 per option, respectively.
  As
        of
        December 31, 2007 and 2006, 228,667 and 923,254 of the options granted are
        not
        vested with an estimated remaining value of $164,219 and $801,026 and a weighted
        average vesting life of 2.77 and 3.14 years, respectively. At December 31,
        2007
        and 2006, 1,087,717 and 518,359 of these options were exercisable with an
        estimated remaining contractual term of 8.37 and 9.18 years. The weighted
        average remaining contractual life of all options outstanding at December
        31,
        2007 is 8.52 years.
  The
        Company recorded compensation expense associated with the issuance and
        modification of stock options of $498,431 and $322,836 for the years ended
        December 31, 2007 and 2006, respectively.
 
 During
        the year ended December 31, 2006, 100,939 of employee stock options were
        exercised for total proceeds to the Company of $1,083. No options were exercised
        during the year ended December 31, 2007.
  F
            - 18
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        7 - NOTE PAYABLE - RELATED PARTY**
 
 In
        January 2005, the Company entered into an asset purchase agreement with Unionway
        International, LLC whereby the Company purchased certain assets of Unionway
        International, LLC that principally include the software application
        Cyber-DefenderTM and associated rights for $200,000. The Company paid $8,333 at
        closing and issued a promissory note in connection with the purchase to Unionway
        International, LLC for $191,667. The terms of the note called for monthly
        payments due on the first of each month in the amount of $8,333.
 
 Interest
        accrued at the rate of 7% per annum and is payable in a lump sum on September
        1,
        2007, provided that such interest was to be waived if all payments were received
        by Unionway International, LLC by the third day of each month. In addition
        the
        Company retained the principal of Unionway International, LLC, Mr. Bing Liu
        (see
        Note 6), as an employee and issued to him an Incentive Stock Option for the
        purchase of 326,106 shares of the Company’s common stock. The exercise price is
        $0.0107 per share. The first 186,347 share options vested over a period of
        24
        months at the rate of 7,765 shares per month. The option to purchase 46,587
        share options was to vest if the Company entered into a binding agreement
        to
        sell all or part of the Company in a transaction in which the Company is
        valued
        at $201 million. The option to purchase the remaining 93,173 share options
        was
        to vest if the company entered into a binding agreement to sell all or part
        of
        the **** Company
        in a transaction in which the Company is valued at $250 million. The Company
        ceased making payments in March 2006 and was in default under the terms of
        the
        note. Unionway International, LLC waived the default and accepted **** payment
        of the remaining balance on the note of $83,335 in exchange for 186,347 shares
        of the Company’s common stock which were issued on October 1, 2006. These
        options were fully modified in 2007 (see Note 6).
 
 **NOTE
        8 - CONVERTIBLE NOTES PAYABLE**
 
 On
        June
        15, 2005, the Company entered into a Note Purchase Agreement with an accredited
        investor in which it issued a Convertible Promissory Note in the amount of
        $50,000. The note bears interest at a rate of 1% per annum and the maturity
        date
        was December 15, 2005. The note is convertible into common stock of the Company.
        On November 8, 2005, in accordance with the terms of the note, the outstanding
        principal and accrued interest of the note was cancelled and the Company
        issued
        to the holder in lieu thereof a secured convertible promissory note in the
        principal amount of $50,000. The note issued on November 8, 2005 in lieu
        of the
        June 15, 2005 note is one of the notes issued between November 8, 2005 and
        March
        31, 2006, as described below.
 
 At
        various times between November 8, 2005 and March 31, 2006, the Company entered
        into Securities Purchase Agreements with accredited investors in which it
        issued
        Senior Secured Convertible Promissory Notes totaling $1,225,000. . The purpose
        of this financing was to consummate a reverse merger transaction pursuant
        to
        which the Company would become a public company by merging into a public
        shell.
        The reverse merger transaction was never consummated. The notes bore interest
        at
        the rate of 9.96% per annum compounded monthly and were to mature between
        November 8, 2006 and March 31, 2007. The notes were secured by a perfected
        first
        priority security interest in all of the assets of the Company except for
        any
        assets that were covered by a security interest granted to other lenders
        that
        existed before November 8, 2005. The notes and any accrued interest could
        be
        voluntarily converted by the holder into shares of the Company’s common stock at
        the conversion price equal to the lesser of (i) 41.46% of the price per share
        of
        common stock based on the price per share of equity securities sold by the
        Company following the closing date in one transaction or a series of related
        transactions in exchange for an aggregate consideration of at least $2,000,000
        (exclusive of any indebtedness of the company) (a “Qualified Offering”)
        subsequent to the closing, provided that if such offering consisted of any
        securities convertible into common stock, then the initial conversion price
        would be 41.46% of the conversion price of such securities (the “Securities
        Conversion Price”), or (ii) $ 0.68 to $.7089 per share (depending on the issue
        date of the notes) in the event that a qualified offering had not occurred
        at
        the time of the conversion. If the Company was a party to any consolidation
        or
        merger with a publicly traded entity the note and any accrued interest would
        be
        automatically converted into shares of the Company’s common stock at a price per
        share equal to the price as necessary to ensure that the holder receives
        common
        stock in the public company at a 33% discount to the offering price of such
        common stock offered by the public company in conjunction with the merger
        of the
        Company.
  F
            - 19
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        8 - CONVERTIBLE NOTES PAYABLE (Continued)**
 
 In
        connection with the issuance of the Secured Convertible Promissory Notes
        as
        described above the Company issued Warrants to Purchase Common Stock to those
        same investors. The Warrants entitled the Holder to purchase a number of
        shares
        of common stock of the Company equal to 50% of the number of shares of common
        stock into which Holder’s Convertible Promissory Note was convertible at the
        time of exercise of the Warrant, or if the Holder’s Convertible Promissory Note
        was converted prior to the time of exercise of the Warrant, then 50% of the
        actual number of shares of common stock into which Holder’s Convertible
        Promissory Note was converted. The Warrants had a term that ended between
        November 8, 2015 and March 31, 2016. The price at which the Warrant could
        be
        exercised was (i) a price per share equal to the price as is necessary to
        ensure
        that the Holder receives stock of the reverse merger company (the “Public
        Company”) at a price equal to the offering price of such common stock offered by
        the Public Company in conjunction with the merger with the Company (the
        "Merger"), or (ii) in the event the Merger had not occurred, 93.9% of the
        price
        per share of common stock based upon the price per share of equity securities
        sold by the Company following the closing date in one transaction or a series
        of
        related transactions in exchange for aggregate consideration of at least
        $2,000,000 (exclusive of the conversion of any indebtedness of the Company)
        (a
“Qualified Offering”), provided that if such offering consisted of securities
        convertible into common stock, then the initial conversion price would be
        93.9%
        of the conversion price of such securities, or (iii) $1.54 per share in the
        event that the Merger **** or
        a
        Qualified Offering had not occurred at the time of exercise, provided that
        exercise under this clause (iii) may not occur within the first 60 days
        following the closing date; in any case, as such exercise price could be
        adjusted from time to time.
 
 On
        July
        27, 2006, the Company entered into a Securities Purchase Agreement with two
        accredited investors pursuant to which the Company sold to each investor
        an 8%
        secured convertible note in the principal amount of $250,000, for aggregate
        gross proceeds of $500,000. The Company paid a total of $35,000 of fees in
        connection with this agreement. On September 12, 2006, in accordance with
        the
        terms of the notes, each note was exchanged for a 10% secured convertible
        debenture, at a conversion rate of $1.15 plus accrued interest, in the principal
        amount of $290,439 and a warrant to purchase 290,439 shares of common stock
        at
        $1.00 per share as more fully described below.
 
 On
        August
        8, 2006, the Company repaid $100,000, plus interest, of the $1,225,000 in Senior
        Secured Convertible Promissory Notes issued between
        November 8, 2005 and March 31, 2006 to one investor.
 
 On
        August
        18, 2006, the Company entered into a Note Conversion and Warrant Lock-Up
        Agreement with the holders of previously outstanding Secured Convertible
        Promissory Notes and outstanding warrants to purchase an aggregate of 877,552
        shares of the Company’s common stock at an exercise price of $1.01 per share.
        Pursuant to the Note Conversion and Warrant Lock-Up Agreement, these security
        holders converted all $1,262,071 of outstanding principal and accrued interest
        of their Secured Convertible Promissory Notes into an aggregate of 1,755,118
        shares of the Company‘s common stock, on September 12, 2006, and they agreed not
        to sell or transfer any of the 877,552 common stock purchase warrants for
        a
        period of one year from the effective date of a Registration Statement to
        be
        filed with the Securities and Exchange Commission. In addition, on September
        12,
        2006, these security holders entered into a Lock-Up Agreement with the Company
        pursuant to which they agreed not to sell or transfer during the six month
        period following the effective date of the Registration Statement any of
        the
        1,755,118 shares that they received upon conversion of their Secured Convertible
        Promissory Notes, and thereafter they may sell or transfer only limited amounts
        of these shares over a period of eighteen months, after which the transfer
        restrictions will have expired. The Company has accounted for the conversion
        of
        the debentures according to FAS 133, EITF 00-19, EITF 98-5 and EITF 00-27.
        The
        Company has recorded the warrants as permanent equity under the guidance
        of FAS
        133 and EITF 00-19. The value of the conversion was allocated between the
        warrants and the beneficial conversion feature which amounted to $506,896
        and
        $755,173, respectively.
 
 The
        Company amortized $506,896 to interest expense for the year ended December
        31,
        2006. The value of the beneficial conversion feature was charged to interest
        expense in the amount of $755,173 for the year ended December 31, 2006. There
        were no fees paid in connection with the Note Conversion and Warrant Lock-Up
        Agreement.
  F
            - 20
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        8 - CONVERTIBLE NOTES PAYABLE (Continued)**
 
 10%
        Senior Convertible Debentures
 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 “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 that also included a
        registration rights agreement. The debenture holders have the right to convert
        the Debentures into 3,243,378 shares of common stock. The Debentures mature
        on September 12, 2009 and bear interest at the rate of 10% per year, payable
        quarterly. If, during the time that the debentures are 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 dispose of or issue 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 debentures will be reduced.  If,
        during the time that the Debentures are outstanding, the Company sells or
        grants
        any option to purchase (other than options issued pursuant to a plan approved
        by
        the board of directors), or sells or grants any right to reprice its securities,
        or otherwise dispose of or issue any common stock or common stock equivalents
        entitling any person to acquire shares of its common stock at a price per
        share
        that is lower than the conversion price of the Debentures (which, for purposes
        of this discussion will be designated as the “Base Conversion Price”) 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 Debentures
        will be reduced.
 
 Under
        the
        terms of the agreement, the Company is obligated to register for resale at
        least
        130% of the shares of its common stock issuable upon the conversion of the
        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
        Debentures, or was not effective 120 days from the date of the sale of the
        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 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)
        will not be liable for liquidated damages with respect to any warrants or
        warrant shares, (2) in no event will the Company be 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 is eighteen percent (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 secured convertible debentures, or $583,808. If the Company
        fails
        to pay any partial liquidated damages in full within seven days after the
        date
        payable, the Company will pay interest at a rate of 18% per annum to the
        holder,
        accruing daily from the date such partial liquidated damages are due until
        such
        amounts, plus all such interest, are paid in full. The partial liquidated
        damages apply on a daily pro-rata basis for any portion of a month.
 
 Pursuant
        to Amendments No.1 and No. 2 to the Registration Rights Agreement, the holders
        of the Company’s Debentures agreed to extend the filing date of the registration
        statement to November 3, 2006, and agreed to waive their rights to enforce
        the
        liquidated damages clause for the initial filing of the registration statement.
        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 have the holders agreed to waive the liquidated
        damages that accrued due to the Company’s failure to have the registration
        statement declared effective by January 10, 2007.
 
 In
        accordance with FASB Staff Position Emerging Issues Task Force (“FSP EITF”)
        00-19-02, “ *Accounting
        for Registration Payment Arrangements* ”,
        the
        Company believed, at the time the Debentures were issued, that it was probable
        that it would be in violation of certain filing provisions within the
        Registration Rights Agreement and has accordingly recorded $111,897 as
        a **** discount
        to the 10% secured convertible debentures. At December 31, 2006, the Company
        estimated its liquidated damages to be $225,415 and therefore recorded an
        additional expense of $113,518 in loss on registration rights agreement in
        the
        statement of operations. 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, resulting in a $55,498 decrease to the
        liability.
  F
            - 21
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        8 - CONVERTIBLE NOTES PAYABLE (Continued)**
 
 The
        Company was also required to make an interest payment to the Debenture holders
        on April 1, 2007. The Consent and Waiver allows 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 Debenture holder’s pro rata portion of the
        April 1 interest payment, the Debenture holder could choose to increase the
        principal amount of his 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 Debenture holders pro rata portion of
        the
        liquidated damages, each Debenture holder has the same choice, that is, either
        to increase his 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 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 could 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 180,187 shares in November
        and
        December 2007 as partial payment for these liquidated damages valued at
        $153,167. At December 31, 2007, $16,750 of these damages remained in accrued
        expenses - registration rights agreement. The Company issued 190,090 shares
        in
        November and December 2007 as partial payment for the April 1 interest payment
        of $161,580. At December 31, 2007, $17,179 remained in accrued interest.
 
 The
        Consent and Waiver allowed the Company to issue to Oceana Partners, LLC,
        without
        triggering the anti-dilution rights, 50,000 shares of common stock in
        consideration for research coverage for a 12-month period (see Note
        6).
 
 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 Debentures a Consent and Waiver
        of
        defaults of the Debentures and of that certain Registration Rights Agreement
        that was signed in conjunction with the issuance of the Debentures. The holders
        of the 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. As of December 31, 2007, the Company has not yet issued
        the
        shares of common stock to pay the interest or damages. The number of shares
        of
        common stock that the Company is required to issue is 346,925 shares.
 
 The
        holders of certain shares and warrants for the purchase of common stock issued
        in conjunction with the sale of the Company’s previously issued Secured
        Convertible Promissory Notes 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 we filed; however, they have maintained the
        rights
        to piggyback on future registration statements filed by the
        Company.
 
 The
        Company has accounted for the Debentures according to Statement of Financial
        Accounting Standards (“SFAS”) No. 133 “ *Accounting
        for Derivative Instruments and Hedging Activities* ” ,
        EITF
        00-19 “ *Accounting
        for Derivative Financial Instruments Indexed to, and Potentially Settled
        in, a
        Company's Own Stock* ”,
        FSP
        EITF 00-19-2, EITF 98-5 “ *Accounting
        for Convertible Securities with Beneficial Conversion Features or Contingently
        Adjustable Conversion Ratios”* and EITF
        00-27 “ *Application
        of Issue No. 98-5 to Certain Convertible Instruments”* .
        The
        Company has accounted for the registration rights arrangement under the guidance
        of FSP EITF 00-19-2 and the warrants as permanent equity under the guidance
        of
        SFAS No. 133 and EITF 00-19. The value of the Debentures was allocated
        between the Debentures, the registration rights arrangement and the warrants,
        including the beneficial conversion feature, 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 beneficial
        conversion feature, is being amortized over the term of the Debentures. The
        Company amortized $1,316,925 and $319,421 to interest expense for the years
        ended December 31, 2007 and 2006. The remaining unamortized warrant and
        beneficial conversion feature value is recorded as a discount on the Debentures
        on the accompanying balance sheet.
 
 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, issued in November 2006,
        were
        valued at $374,531 using the Black-Scholes option pricing model with the
        following assumptions: term of 5 years, a risk-free interest rate of 4.62%,
        a
        dividend yield of 0%, and volatility of 128%. These costs totaling $1,592,045
        are being amortized over the term of the Debentures. The Company recorded
        amortization of $658,789 and $159,932 to interest expense during the years
        ended
        December 31, 2007 and 2006 related to the Debentures. The unamortized amount
        is
        recorded as part of the deferred financing costs in the accompanying balance
        sheets.
  F
            - 22
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        8 - CONVERTIBLE NOTES PAYABLE (Continued)**
 
 In
        November and December 2007, certain holders of the 10% Secured Convertible
        Debentures converted $460,000 of notes and $48,406 of accrued interest into
        508,406 shares of common stock at $1.00 per share. The unamortized discount
        of
        $253,481 on the converted notes was recorded as interest expense in the
        accompanying statement of operations.
 
 Convertible
        notes payable consist of the following:
 December
                  31,
              
              
              2007
              
              
              200610%
                  debentures outstanding
              
              $
              2,783,378
              
              $
              3,243,378Unamortized
                  discount on debentures
              
              
              (1,548,343
              )
              
              (2,860,268
              )Convertible
                  notes payable, net
              
              $
              1,235,035
              
              $
              383,110
  **NOTE
        9 - ORIGINAL ISSUE DISCOUNT NOTES PAYABLE**
 
 7.41%
        Senior Secured Original Issue Discount Notes
 In
        April
        and May 2007, the Company sold $405,000 in face amount of its 7.41% Senior
        Secured Original Issue Discount Notes (“7.41% Notes”) and warrants to purchase
        187,500 shares of the Company’s common stock for a purchase price of $375,000.
        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 six 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. The Company has accounted for the debentures according
        to
        SFAS 133, EITF 00-19, EITF 98-5 and EITF 00-27. The Company has accounted
        for
        the warrants as permanent equity under the guidance of SFAS 133 and EITF
        00-19.
        The value of the 7.41% Notes was allocated between the original issue discount
        (“OID”), the warrants and the debentures which amounted to $30,000, $112,229 and
        $262,771, respectively. The discount related to the OID and warrants of $142,229
        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 with the following assumptions: term of 5 years, a
        risk-free interest rate of 4.69%, a dividend yield of 0% and volatility of
        124%.
 
 In
        August
        2007, the Company sold $297,000 in face amount of the 7.41% Notes and warrants
        to purchase 137,500 shares of the Company’s common stock for a purchase price of
        $275,000. 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
        six
        months after issuance of the warrant. The Company has accounted for the
        debentures according to SFAS 133, EITF 00-19, EITF 98-5 and EITF 00-27. The
        Company has accounted for the warrants as permanent equity under the guidance
        of
        SFAS 133 and EITF 00-19. The value of the 7.41% Notes was allocated between
        the OID, the warrants and the debentures which amounted to $22,000, $86,020
        and $188,980, respectively. The discount related to the OID and the warrants
        of
        $108,020 will be amortized over the 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 with the following assumptions: term of 5 years, a
        risk-free interest rate of 4.60%, a dividend yield of 0% and volatility of
        134%.
  F
            - 23
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        9 - ORIGINAL ISSUE DISCOUNT NOTES PAYABLE (Continued)**
 
 In
        October 2007, the Company sold $162,000 in face amount of the 7.41% Notes
        and
        warrants to purchase 75,000 shares of the Company’s common stock for a purchase
        price of $150,000. 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
        six
        months after issuance of the warrant. The Company has accounted for the
        debentures according to SFAS 133, EITF 00-19, EITF 98-5 and EITF 00-27. The
        Company has accounted for the warrants as permanent equity under the guidance
        of
        SFAS 133 and EITF 00-19. The value of the 7.41% Notes was allocated between
        the OID, the warrants and the debentures which amounted to $12,000, $44,130
        and $105,897, respectively. The discount related to the OID and the warrants
        of
        $56,103 will be amortized over the 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 with the following assumptions: term of 5 years, a
        risk-free interest rate of 4.50%, a dividend yield of 0% and volatility of
        116%.
  The
        Company recorded $147,650 of interest expense related to the amortization
        of the
        7.41% Notes and warrants for the year ended December 31, 2007.
 
 The
        Company recorded amortization of deferred financing costs of $373,300 to
        financing expense related to the 7.41% Notes during the year ended December
        31,
        2007. The unamortized amount of $154,738 is recorded as part of the deferred
        financing costs in the accompanying balance sheet.
 
 7.41%
        Notes payable consist of the following:
 December
                  31,
                20077.41%
                  notes outstanding
              
              $
              864,000Unamortized
                  discount on notes
              
              
              (158,702
              )7.41%
                  notes payable, net
              
              $
              705,298
 
 As
        part
        of the Consent and Waiver, as described above in Note 7, 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 with the following
        assumption: term of 5 years, a risk-free interest rate of 4.52%, a dividend
        yield of 0% and volatility of 124%. 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 will be amortized over the term of the 7.41% Notes. The transfer of shares
        from the officers was recorded in additional paid-in capital.
 
 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. As of December
        31, 2007, the Company was in default of the Registration Rights Agreement
        as to
        holders of $405,000 in principal amount of the 7.41% Notes. If the Company
        fails
        to discharge its obligations under the registration rights agreement, it
        will be
        required to pay the holders of the 7.41% Notes and related Warrants an
        amount in cash equal to 1.5% of the outstanding principal of the 7.41% Notes
        for
        each 30 day period (or part thereof) that the Company's in default. However,
        total liquidated damages under the Registration Rights Agreement are capped
        at
        18% of the outstanding principal amount of the 7.41% Notes. At December 31,
        2007, the Company believed that it would not be able to file the registration
        statement required by the Registration Rights Agreement and accordingly has
        recorded $16,821 in accrued expenses - registration rights
        agreement.
  F
            - 24
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        10 - 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, 2007:
 
 2008
              
              $
              29,7082009
              
              
              27,7042010
              
              
              8,2212011
              
              
              5,5272012
              
              
              5,527Total
                  minimum lease payments
              
              
              76,687Less
                  amount representing interest
              
              
              (11,069
              )Present
                  value of minimum capitalized payments
              
              
              65,618Less
                  current portion
              
              
              (24,271
              )Long-term
                  capital lease obligations
              
              $
              41,347
 
 Property
        and equipment included $103,562 and $80,277 and accumulated depreciation
        included $31,002 and $17,366 acquired through capital leases as of December
        31,
        2007 and 2006, respectively. Depreciation expense of $13,608 and $10,001
        is
        included in the total depreciation expense for the periods ended December
        31,
        2007 and 2006. Interest expense under the lease was $6,881 and $6,234 for
        the
        periods ended December 31, 2007 and 2006, respectively
 
 **NOTE
        11 - RELATED PARTY TRANSACTIONS**
 
 On
        May 1,
        2005, the Company entered into a lease agreement for a condominium located
        in
        Las Vegas, Nevada with International Equity Partners, a Nevada limited liability
        company. Gary Guseinov, the Chief Executive Officer of the Company, is the
        manager of International Equity Partners. The monthly base rent for this
        space
        is $3,750. The term of the lease was from May 1, 2005 until May 31, 2008;
        however, the lease was terminated by the mutual agreement of the parties
        in
        February, 2006. The Company paid International Equity Partners $2,775 in
        rent in
        2007 for the rental of a condominium located in Las Vegas, Nevada for use
        during
        a trade show in which the Company exhibited its products.
 
 Unionway
        International, LLC, an entity controlled by Bing Liu, a former officer, provided
        software development services to the Company. The Company paid $6,500 per
        month
        for such services during 2006. During the years ended December 31, 2007 and
        2006, the Company paid Unionway International, LLC $0 and $84,500, respectively.
        The Company has terminated the use of such services as of March 31,
        2007.
 
 The
        Company has amounts due to two officers as of December 31, 2007 totaling
        $22,165. This amount is included in accounts payable in the accompanying
        balance
        sheet.
 
 On
        October 1, 2007, our Chief Executive Officer, Gary Guseinov, provided the
        Company with a short-term loan in the amount of $28,078. The loan was repaid
        on
        November 19, 2007.
 
 On
        November 5, 2007, the Company entered into a promissory note agreement with
        Chris Carlin, the Company’s financial advisor, whereby Mr. Carlin loaned the
        Company $35,000 at an interest rate of 7% per annum. The principal and accrued
        interest was repaid prior to December 31, 2007.
  F
            - 25
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        12 - COMMITMENTS AND CONTINGENCIES**
 
 **Operating
        Leases**
 The
        Company's primary offices are in Los Angeles, California where it entered
        into a
        lease on October 19, 2007 for office space beginning upon completion of the
        tenant improvements with a term of sixty-two months. The base rent is $10,670
        per month for year one with 3% annual increases. The lease includes an abatement
        of the first two months rent 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. Aside from the monthly rent, the Company is required
        to pay
        its share of common operating expenses. At December 31, 2007 the lease term
        had
        not commenced. In conjunction with the lease above the Company also entered
        into
        a temporary lease for office space beginning on November 1, 2007. The base
        rent
        is $2,994 per month. The temporary lease terminates upon commencement of
        the
        affiliated lease.
 
 Previously,
        the Company had entered into a lease for office space beginning September
        1,
        2004 and terminating August 31, 2007. The base rent was $10,619 per month
        for
        2007.
 
 As
        of
        December 31, 2007, 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:
 
 Period
                  Ending December 31,2008
              
              $
              85,3562009
              
              
              130,5952010
              
              
              134,5132011
              
              
              138,5482012
              
              
              142,704Thereafter
              
              
              72,772Total
              
              $
              704,488
 
 Total
        rent expense for the years ended December 31, 2007 and 2006 was $150,139
        and
        $222,409, respectively.
 
 **Employment
        Agreements**
 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.
 
 On
        November 23, 2005, the Company entered into an employment agreement with
        Igor
        Barash pursuant to which Mr. Barash will act as Chief Information Officer.
        The
        agreement is “at will” and can be terminated at any time. Mr. Barash receives
        compensation of $135,000 per year.
 
 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 salary each pay period. This arrangement can be terminated
        upon approval of the Company’s Board of Directors. The Company has accrued
        $268,658 and $35,726 of deferred compensation as of December 31, 2007 and
        2006.
  F
            - 26
 
 **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        12 - COMMITMENTS AND CONTINGENCIES (Continued)**
 
 **Litigation**
 On
        June
        16, 2006, the Company was named as a defendant in a civil complaint filed
        with
        the United States District Court, Central District of California. The action
        is
        entitled, “Wellbourne Limited, a Seychelles corporation vs. 2Checkout.com Inc.,
        a Delaware corporation; and CyberDefender Corporation, a California
        Corporation.” The Company had recorded a liability of $102,000 when the services
        were rendered.  On
        March
        14, 2007, the Company entered into a settlement agreement with Wellbourne
        Limited. The terms of the settlement agreement require the Company to pay
        Wellbourne Limited the sum of $55,000. At December 31, 2007 the Company has
        paid
        $50,000 towards the settlement. The Company still owes $5,000 plus interest
        at
        December 31, 2007.
 
 On
        November 13, 2007, a former employee, Patrick Hinojosa, filed an action in
        the
        Los Angeles Superior Court, number 8C380620 titled *Patrick
        Hinojosa, plaintiff, vs. CyberDefender, Inc., a California corporation, and
        Does
        1 through 50, inclusive* .
        Mr.
        Hinojosa alleges breach of contract and violations of California Labor Code
        sections 227.3 and 203. Mr. Hinojosa alleges that he has suffered damages
        in
        excess of $25,000. Legal counsel for the Company has advised that at this
        stage,
        there are no unasserted claims which are probable or which, if asserted,
        would
        have an unfavorable outcome. The Company believes the threatened claim is
        without merit and intends to vigorously defend any assertion of the claim,
        if
        one is made. As a result, no amount has been accrued as a liability for this
        contingency.
  In
        addition, the Company in the ordinary course of business is generally subject
        to
        claims, complaints, and legal actions. At December 31, 2007, management believes
        that the Company is not a party to any action, except as discussed above,
        that
        would have a material impact on its financial condition, operations or cash
        flows.
 
 **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.
  On
        October 30, 2006, the Company entered into Indemnification Agreements with
        Mr.
        Guseinov, Mr. Ivankovich, Mr. Liu and Mr. Barash and on November 6, 2007
        the
        Company entered into an Indemnification Agreement with Mr. John LaValle,
        a
        former director, 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 the Company 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 the Company, 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 the Company’s 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 the Company or any
        of its
        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 the Company’s request as a director, officer,
        employee or agent of another corporation, partnership, joint venture, trust
        or
        other enterprise. The Company 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 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 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.
  F
            - 27
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        13 - SUBSEQUENT EVENTS**
  In
        January and February 2008, the Company issued 261,091 shares of its common
        stock
        to holders of the 10% convertible debentures as partial payment for accrued
        penalties and accrued interest outstanding on the debentures as of December
        31,
        2007. The shares issued were for $119,615 of accrued penalties and $123,466
        of
        accrued interest.
  On
        February 4, 2008 our board of directors approved an independent contractor
        agreement with Mr. Michael Barrett. The term of the agreement is six months.
        Pursuant to the agreement, Mr. Barrett provides consulting services to us
        as our
        Chief Financial Officer. We have 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 will be reduced to $4,000 per month. We have also
        issued to Mr. Barrett an option to purchase 20,000 shares of our common stock
        under the 2006 Plan, at price of $1.00 per share. The right to purchase 10,000
        shares will vest on April 30, 2008. The right to purchase the remaining 10,000
        shares of common stock will vest at the end of the term. The estimated fair
        value of the grant of $17,344 was estimated using a Black-Scholes option
        pricing
        model with the following weighted average assumptions: expected term of 5
        years,
        a risk-free interest rate of 2.48 %, a dividend yield of 0%, volatility of
        173%
        and a forfeiture rate of 4%.
  In
        February 2008, the Company sold 110,000 shares of its common stock as part
        of
        the stock unit offering that began in October 2007 as more fully described
        in
        Note 6. The warrants issued in connection with the units were valued using
        the Black-Scholes option pricing model with the following assumptions: term
        of 5
        years, a risk-free interest rate of 4.52%, a dividend yield of 0% and volatility
        of 142%.
 On
        February 12, 2008, the Company entered into a consulting agreement with New
        Castle Consulting.  Pursuant
        to this agreement, they will provide investor relations services to us for
        a
        period of 6 months in exchange for an immediate payment of $4,500, a monthly
        fee
        of $4,500 the payment of which will begin in March 2008, the issuance of
        100,000
        shares of restricted common stock and an indemnity.
 
 On
        February 14, 2008, the Company entered into a consulting agreement with Kulman
        IR. Pursuant to this agreement, Kulman will provide investor relations services
        to us 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, the payment of
        pre-approved expenses incurred by Kulman in discharging its obligations under
        the agreement and cross-indemnities. In regards to the stock that was issued,
        50,000 shares vest immediately, 25,000 shares vest on August 7, 2008 and
        the
        remaining 25,000 shares vest on October 7, 2008.
 
 On
        February 22, 2008 John LaValle resigned as a director. Mr. LaValle’s resignation
        was not as the result of a disagreement with CyberDefender Corporation on
        any
        matter relating to its operations, policies or practices.
 
 In
        March
        2008, Gary Guseinov pledged 750,000 shares of common stock in CyberDefender
        Corporation to Michael and Casey DeBaecke in exchange for a loan of $160,000
        made to the Company. The pledge is non-recourse to Mr. Guseinov in the event
        the
        collateral is foreclosed upon due to the Company’s failure to pay the loan. So
        long as there is no event of default in connection with the loan, Mr. Guseinov
        may continue to vote the shares at any annual or special meeting of the
        shareholders. The loan documentation has not been finalized as of the date
        of
        the report, however, the loan is due to be repaid on the earlier of two months
        from signing of the loan document or two days following our receipt of over
        $500,000 in new equity capital following the date of the promissory note
        evidencing the loan.
  F
            - 28
  **CYBERDEFENDER
        CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2007 AND 2006**
  **NOTE
        14 - RESTATEMENT**
 
 The
        Company’s previously issued financial statements as of and for the year ended
        December 31, 2006 has been restated as follows:
 a)
                Deferred
                    Tax Asset
  The
        Company has increased the valuation allowance in the deferred tax asset by
        $966,550 as a result of changes made to the valuation allowance as of December
        2004. The impact of the adjustment on the financial statements for the year
        ended December 31, 2006 has been quantified below:
 
 **Previously**
              
              
              **As**
              
              
              **Increase/**December
                  31, 2006
              
              
              **Reported**
              
              
              **Restated**
              
              
              **(Decrease**)****$
              
              
              $
              
              
              $**Statement
                  of Operations**Income
                  Tax Expense
              
              
              (966,550
              )
              
              -
              
              
              966,550**Net
                  Loss**
              
              
              (6,474,150
              )
              
              (5,507,600
              )
              
              966,550**Loss
                  per share, basic and diluted**
              
              
              (0.64
              )
              
              (0.55
              )
              
              0.09


F
          - 29