UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




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





For
the fiscal year ended December 31, 2009





OR





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





For
the transition period from  to





Commission
file number:  000-51443


RAPTOR
NETWORKS TECHNOLOGY, INC.


(Exact
name of registrant as specified in its charter)





Colorado
            84-1573852(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)1508
      S. Grand Avenue,  Santa Ana, CA
            92705-4411(Address
      of principal executive offices)
            (Zip
      Code)





Registrant’s
telephone number, including area code   (714)
380-6659







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





Securities
registered pursuant to Section 12(g) of the Act:


Common
Stock, $0.001 par value


(Title
of class)









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


Yes o   No x





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 x




Note – Checking the box above
will not relieve any registrant required to file reports pursuant to Section 13
or 15(d) of the Exchange Act from their obligations under those
Sections.




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


Yes x  
No o




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


o o









Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, indefinitive proxy or
information statements incorporated by reference in Part III of the 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 x




The
aggregate market value of the voting and non-voting stock held by non-affiliates
computed by reference to the price at which the common equity was sold as of the
last business day of the registrant’s second quarter of 2009 (June 30, 2009) of
$0.25 per share was $18,474,701.  For the purpose of this calculation,
shares owned by officers, directors and 10% stockholders known to the registrant
have been deemed to be owned by affiliates.  This determination of
affiliate status is not a determination for other purposes.




APPLICABLE
ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY


PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:




Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court.


o o




(APPLICABLE
ONLY TO CORPORATE REGISTRANTS)




Indicate
the number of shares outstanding of each registrant’s classes of common stock,
as of the latest practicable date:  85,922,744 shares of common stock
$0.001 par value as of March 26, 2010.












TABLE
OF CONTENTS




PagePART
      IItem
      1.
            Business
            2Item
      1A.
            Risk
      Factors
            8Item
      1B.
            Unresolved
      Staff Comments
            16Item
      2.
            Properties
            16Item
      3.
            Legal
      Proceedings
            17Item
      4.
            (Removed
      and Reserved)
            17PART
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            18Item
      6.
            Selected
      Financial Data
            19Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            19Item
      8.
            Financial
      Statements and Supplementary Data
            27Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            27Item
      9A(T).
            Controls
      and Procedures
            28Item
      9B.
            Other
      Information
            28PART
      IIIItem
      10.
            Directors,
      Executive Officers and Corporate Governance
            29Item
      11.
            Executive
      Compensation
            32Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            37Item
      13.
            Certain
      Relationships and Related Transactions and Director Independence
            38Item
      14.
            Principal
      Accountant Fees and Services
            39PART
      IVItem
      15.
            Exhibits
      and Financial Statement Schedules
            39Signatures
            43Index
      to Financial Statements
            F-1Index
      to Exhibits
            44












PART
I




Cautionary
statement regarding forward-looking statements.




When used in this report on Form 10-K
(this “Report”), the words “plan,” “estimate,” “expect,” “believe,” “should,”
“would,” “could,” “anticipate,” “may,” “forecast,” “project,” “pro forma,”
“goal,” “continues,” “intend,” “seek” and other expressions that convey
uncertainty of future events or outcomes are intended to identify
“forward-looking statements.”  We caution readers not to place undue
reliance on any such forward-looking statements, which speak only as of the date
of this Report.  While forward-looking statements represent our
management's best judgment as to what may occur in the future, they are subject
to risks, uncertainties and important factors beyond our control that could
cause actual results and events to differ materially from historical results of
operations and events as well as those presently anticipated or
projected.  These factors include, but are not limited to, adverse
economic conditions, entry of new and stronger competitors, capital
availability, unexpected costs and failure to establish relationships with and
capitalize upon access to new customers.  We disclaim any obligations
subsequently to revise any forward-looking statements to reflect events or
circumstances after the date of such statement or to reflect the occurrence of
anticipated or unanticipated events.













-1-





Item
      1.
            Business




Overview




We were
organized under the laws of the State of Colorado on January 22, 2001 under the
name Pacific InterMedia, Inc.  We originally were engaged in the
business of offering EDGAR filing services to companies outsourcing the
formatting and electronic filing of registration statements, periodic reports
and other forms with the U. S. Securities and Exchange Commission (“SEC” or
“Commission”), but generated minimal revenues from these
operations.  On October 17, 2003, we completed a business combination
transaction with Raptor Networks Technology, Inc., a California corporation
(“Raptor”), whereby we acquired all of the issued and outstanding capital stock
of Raptor in a cashless common stock share-for-share exchange in which Raptor
became our wholly-owned subsidiary.




Upon the
completion of this acquisition transaction, we changed our name to Raptor
Networks Technology, Inc., terminated our EDGAR filing services operations and,
by and through our subsidiary Raptor, became engaged in the data network
switching industry.  Since that time, our focus has been to design,
produce and sell standards-based, proprietary high-speed network switching
technologies.  Our “distributed network switching technology” allows
users to upgrade their traditional networks with our switches to allow for more
efficient management of high-bandwidth applications.  The
implementation of our products in a user’s network provides increased speed and
greater capacity and, we believe, a cost-effective alternative to existing
switching and routing technologies.




We
design, produce and sell standards-based, proprietary high-speed network
switching and related “virtualized fabric” technologies.  Our
“distributed hybrid fabric” networking and integrated systems’ technologies
allow users to upgrade both their traditional networks as well as their server
and storage arrays with our products to allow for more efficient management of
high-bandwidth transport, applications and security.  The
implementation of our products in a user’s network provides architectural
solution alternatives, at a systems level, unavailable from existing switching,
routing and server technologies.




We have
designed and produced a family of virtualized network switching products branded
the “Ether-Raptor” line, which consist of core and edge switch products that
operate together in a unique and highly efficient manner.  In a
departure from traditional, centralized chassis-based switch architectures that
were originally designed to handle latency (a time delay in the transfer of
data) insensitive traffic such as email and block data transfers, we have
developed the ability to “bind” physically separated network switches into a
common “virtual chassis,” creating the ability for a single network device to
exist in multiple locations at the same time.  This contiguous
transport architecture allows for very fast data transport while removing the
limitations of active/passive link states common in legacy
networks.  This functionality is believed to be essential to new
high-bandwidth, latency sensitive applications such as Voice over Internet
Protocol (“VoIP”), streaming video, Internet Protocol Television (“IPTV”) and
cloud computing and storage, none of which existed when traditional
chassis-based network switch designs were originally designed.  We
believe that our “distributed fabric” architecture and associated products may
redefine the manner in which data distribution occurs for service providers
offering VOIP, streaming video, IPTV and cloud computing and
access.  Due to the full, open-standards compatibility of our
Ether-Raptor product line, our network switching products have nearly universal
applicability on legacy as well as newly installed Ethernet networks where
speed, high bandwidth, cyber resiliency, and survivability are
essential.




We
believe the unique features of our products can best be summarized as
follows:




●
              we
      were first to market with “distributed common core fabric,” a network
      switch technology that eliminates dependency on complex and costly chassis
      products;




●
              our
      simplified architectures improve redundancy and
  resiliency;




●
              the
      reduced complexity, tighter hardware integration and common components
      (including common software components) of our products provides users the
      opportunity for economies of scale and reduced
  costs;




●
              the
      open standards of our products provide for compatibility with legacy
      products;




-2-




●
              our
      products’ low transport latency can support emerging converged video,
      voice and data applications without sacrificing Quality-of-Service;
      and




●
              the
      Layer 2-7 Classification of our products provides full feature sets across
      a user’s network.




In 2009,
we have advanced our architecture and intellectual property to design a
next-generation network appliance that becomes a “hybrid fabric” device; part
core network transport product, part embedded applications server, part content
caching device and part secure communications appliance.  Management’s
belief is that the IT world will ultimately adopt “hybrid fabric” architectures,
blurring the distinction between a network device, a computing device and a
security device, creating the same degree of convergence in the systems arena
that has already occurred in the telecom space.  We are thus designing
our first “hybrid fabric” converged machine comprising a high performance,
virtualized fabric core networking device with a multi-core, applications ready
processor and accompanying storage embedded in the transport fabric
itself.




We remain
an early stage technology company and, commencing with our inception, have
operated, and are now operating, at a significant loss.  We currently
have no commitments for any additional financing and there can be no assurance
that we will be able to obtain requisite financing on acceptable terms, if at
all.  In October 2008, we shifted our principal operating model from
product development to licensing, enabling a reduction in headcount, footprint
and infrastructure to reduce costs.  While we shifted principally to
licensing, we continue to pursue product and service revenue at a much
diminished rate.  This change of model enabled the Company to
substantially reduce expenses throughout 2009, contributing to a positive cash
flow for the year.  There can be no assurance that this shift in
business model will be successful.  Should the licensing model prove
to be unsuccessful, our investors could lose their entire investment in
us.




Our
principal headquarters are located at 1508 S. Grand Ave., Santa Ana,
California  92705 and our phone number is 714-380-6659.  Our
Internet address is www.raptor-networks.com.  Our
Code of Ethics, Audit Committee Charter, Nominating and Governance Committee
Charter and Compensation Committee Charter may be found on our website at the
Internet address set forth above.  Our filings with the SEC may be
read and copied at the SEC’s Public Reference Room at 100 F Street N.E.,
Washington, D.C. 20549.  You may obtain information on the operation
of the Public Reference Room by calling the SEC at
1-800-SEC-0330.  The SEC maintains an Internet site that contains
reports, proxy and information statements, and other information regarding
issuers, such as us, that file electronically with the SEC.  The SEC’s
web site address is www.sec.gov.




Industry
Background




Distributed
computing and accelerating use of the Internet for information access as well as
communication have driven an exponential expansion in the use of internetworking
for more than thirty years.  Most of today’s networks were engineered
based upon standards and technology optimized for handling a single data type –
character data, which was previously the prevalent form of
data.  However, today’s sophisticated applications often require
multiple data types with speed and bandwidth requirements so high that
prevailing network technology becomes stressed.  Often times the
system upgrades required to support these new applications is not cost
justifiable, thereby slowing the rate of adoption and utilization of advanced
network applications.




New
converged applications including video on demand, remote synchronous data
storage mirroring, global server clustering, business continuity, disaster
recovery and distance collaboration are just a few of the high-bandwidth network
applications that can have great value to an enterprise embracing
them.  However, the cost to replace or upgrade existing networks with
the requisite efficient, high-bandwidth infrastructure to support these new
applications is, in many cases, financially prohibitive.  For example,
a typical chassis-based upgrade, the type of which is offered by some of our
competitors, involves replacing the power supplies, management units, backplane,
fan trays and interconnect blades in the unit being upgraded.  It is
not unusual for the upgrade to cost as much or more than the original
machine.




Our
Strategy




Our
answer to the cost barrier of the adoption of high-bandwidth (full 10 Gigabit)
networking is the introduction of next-generation networking and “hybrid fabric”
systems products that are fundamentally less complex, more architecturally
flexible, compatible with legacy products and faster than traditional
chassis-based alternatives. Most importantly, our next-generation appliances
were designed to work together seamlessly, “binding” into a common, virtualized
chassis despite being physically or geographically separated. We believe that
being in a position to offer customers a low cost-of-entry network and systems
alternative will ultimately allow us to achieve success in the network and large
scale systems market place.




-3-




The core
philosophy underlying our technological approach is to do at Layer 2 (the Data
Link Layer) in hardware what traditional, chassis based network transport
architectures require Layer 3 protocols (the Network Layer) in software to
achieve.  Our “distributed switch fabric” approach provides a means to
achieve seamless and coherent peer-to-peer communication between physically
separated switches at Layer 2.  The result is, effectively, a single
network switch consisting of a cluster of standalone, high-performance blades
physically separated from one another by currently up to 120 kilometers per hop
(in line with what optics technology allows; distance can be increased using
lighted fiber).  This flexibility permits the use of unique network
topologies that allow for highly-robust, super-redundant networks to be designed
and implemented that provide data transport at wire-speed (the maximum speed at
which the equipment is built to operate) with the versatility to run
latency-sensitive data applications (such as VoIP or streaming video) at a
cost-effective price without sacrificing quality.




The
ultimate goal in networking is to maximize effective transport bandwidth without
sacrificing quality.  In our architecture, Quality-of-Service is
maintained by providing for intelligent management of the different data types
traveling from the same source to the same destination.  Latency
variations caused by heavy traffic can be devastating to certain data types and
applications.  In traditional centralized architectures, latency
problems are resolved with the costly deployment of dedicated parallel networks,
increasing system complexity and hampering system scalability.  Our
technology optimizes the handling of all data packets on a single, common
network by monitoring and differentiating between data types and adjusting
transport parameters accordingly, thus assuring low latency on common transport
paths.




Our
proprietary Raptor Adaptive Switch Technology (“RAST”) provides an innovative
new way to connect local and wide area networks, allowing users new options in
the way they design their distribution networks.  Simply stated, RAST
allows discrete network elements, separated in distance by more than 1,000
kilometers, to “bind” into a common “virtual switch,” providing for ultra-fast
Layer 2 transport across those distances.  Compatible with existing
open standards legacy products, RAST allows customers to add significant
capability to converge voice, video and all data types on to their existing
network without the need for expensive, end-to-end upgrades.  RAST
also allows highly resilient networks to be created at lower costs, both in
terms of initial capital expenditure and ongoing operating costs, than
traditional legacy chassis-based systems.  Because RAST allows
virtually any network size and topology to be engineered from our common
“building block” switches, the cost of adoption, as well as the cost of support,
is minimized.




One of
the most difficult data types for networks to handle is VoIP.  By
optimizing the handling of all data packet types on a given network, treating
them as though they were all video data, our architecture enables the
construction of true wire-speed networks and achieves multiple objectives for
the user community.  First, it allows for voice, video, storage and
other sophisticated applications that can improve operations and establish new
revenue streams.  Second, it augments, rather than replaces, the
existing internetworking infrastructure already in place, leveraging the user’s
existing capital investment and minimizing the incremental capital outlay
required to support these new applications.




To date,
we have filed multiple patents with respect to a range of “distributed fabric”
technologies and architectures, including the application of these architectures
to network transport, security, resiliency, encryption and satellite
communications.  To date, 5 of these patents were approved, published
and issued.  We believe the newly issued patents and the patents still
pending will give us a substantial competitive advantage because of the added
level of functionality these technologies provide our products.




Our
Products




Our flagship product in 2009 is a
virtualized fabric network core switch, the Ether-Raptor-1010E (“ER-1010E”),
which superceded the ER-1010A/B/C in March 2008.  The ER-1010E is a
combination 10Gb/GbE switch.  We also offer a pure edge switch, the
Ovi-Raptor-1048 (“OR-1048”) and three types of NIC cards.  All our
switches are based upon a common family of merchant silicon and embedded
software.




-4-




ER-1010E




Our
ER-1010E 1Gb/GbE and 10Gb/GbE network switch significantly reduces the cost of
adoption of ten gigabit networking by allowing for the construction of an entire
network from a series of our common, high performance “building
blocks.”  The ER-1010E consists of 24 ports of 1Gb/GbE and six ports
of 10Gb/GbE.  The ER-1010E is built in a 1U high, self-powered,
self-managed enclosure.  Unlike the large and complex chassis-based
switches from which they evolved, our network switches are physically placed
near the devices or clients they serve.  When these switches are then
subsequently connected together, either over copper or fiber links, they
collectively “bind” into a single “virtual” network switch.  This
patented “distributed virtual switch” architecture, filed under Raptor Networks
Technology, Inc.’s name, scales linearly, reduces inter-network disconnects and
moves data at very high speeds.  Because the topology consists of a
collection of self-managed, interconnected building blocks of identical
composition, the architecture of the ER-1010E improves redundancy, keeps latency
very low across broad distances, allows for simpler management and is priced
lower than chassis-based alternatives.  In 2008 we began offering an
ER-1010E version with dual redundant power supply capabilities.




OR-1048




The
OR-1048 is a 48-port 1GbE edge switch with the option for two 10GbE uplinks and
four optional 1GbE fiber ports.  The OR-1048’s standard features
include comprehensive management functions and Web management.




Network Interface Cards
(NICs)




Raptor
provides three types of NIC cards providing users with 2, 4, or 6 1Gigabit
Ethernet ports for hooking up personal computers and servers to the network
through Ethernet switches.




Research
and Development




We spent
$114,387 and $983,546 in 2009 and 2008, respectively, on research and
development. The significant reduction in R&D expense can be attributed to
completion of ER-1010E development in 2008 and a sharp downsizing in response to
the distressed economic environment in 2009.




We
commenced our transition into the data network switching industry in October
2003.  From October 2003 until early 2005, we worked to develop our
first flagship product, the ER-1010.  By the end of the third quarter
of 2004, our design team had finalized the design work on a fiber based RAST
card.  This card enables all our network switching systems employed in
a network connected through fiber to work as one “virtual chassis” system, even
if such systems are located up to 120 kilometers apart.  In September
and October 2004, we developed a 10-Giga-fiber card, which enables our systems
to communicate with other brands of network switches.




During
2005, our research and development resources were mainly focused on adding
features to the ER-1010, such as Data Management Software (software enabling
analysis of data flows handled by the ER-1010) and other enriching
functions.  Throughout 2005, substantial testing of the ER-1010 was
carried out internally for the purpose of ensuring that product features worked
as expected and extensive external testing was conducted to validate the quality
of our products.  In the fourth quarter of 2005, certain parts of the
ER-1010 were upgraded, including the replacement of certain cables to reduce
manufacturing costs, and an upgrade to a more powerful processor.  We
also made significant progress in 2005 debugging software included in the
ER-1010, resulting in substantial improvement of the ER-1010’s performance in
terms of reduced failover time, increased stacking possibilities and smooth
running of jumbo frames.




During
2006, our research and development team completed various enhancements to the
ER-1010, resulting in an improvement of the control plane and increasing memory
and processing power.  We also began work on upgrading the existing
ER-1010 to a more powerful product.  During the second half of 2006,
we continued testing various applications that may better position our products
for various markets.  We also began testing our products with a
government approved test organization.




In 2007,
we successfully finished testing of our product with a U.S. Federal
government-approved test organization.  The research and development
team spent considerable time developing the ER-1010E, an enhanced version of the
ER-1010 as described above under the caption “Our Products.”  In
addition, we developed a redundant power supply version of the ER-1010E and
designed various new boards, which improved the stability of the ER-1010 and
ER-1010E and suitability of our core system for the data storage
market.  Our software development group upgraded our software to
include additional protocols addressing customer-reported issues as well as
additional supported protocols.




-5-




In the
first half of 2008, we finished the development of the ER-1010E, including the
redundant power supply version, which we made available for shipment in late
March 2008.  During the remainder of 2008 we started the hardware
design of an” IPv6” capable unit.  “IPv6” is a feature that
facilitates an increase of the number of users on the internet and is a key
requirement for obtaining government business.  In addition, we are
considering developing various security related enhancements.




In 2009,
we billed one customer for research and development activities.  In
the future, we expect that there may be additional periodic opportunities to
engage in customer specific projects for which we can bill a portion of our
research and development expenses to such customers.




Sales
and Marketing




We market
and sell our products to customers through a combination of direct sales to end
users and sales through resellers.  Our sales offices are located at
our principal headquarters in Santa Ana, California.  In addition, we
have finder’s fee and consulting agreements in place with a number of
independent third parties to facilitate the sale of our products on a global
basis.




Competition




We
believe the key competitive factors in today’s network switching market are, in
order of priority:  price, speed, features, brand recognition and
interoperability (compatibility with legacy products).  We intend to
become competitive by offering products that offer architectural performance,
resiliency and power efficiency advantages at a price that cannot be matched by
today’s centrally-architected legacy networks alternatives.  We seek
to gain and expand a market presence through aggressive marketing and sales
efforts.  However, our market continues to evolve and we may not be
able to compete successfully against current and future
competitors.




We
operate in a competitive industry with many established and well-recognized
competitors.  In particular, Cisco Systems maintains a dominant
position in our industry and several of its products compete directly with our
products.  We also compete with, among others, Extreme Networks,
Alcatel/Lucent, Enterasys Networks, 3Com, Huawei Technologies, Force 10
Networks, Juniper Networks and Avaya.  Most of our competitors
(including all of the competitors referenced above) have substantially greater
market leverage, distribution networks, vendor relationships, longer operating
histories and industry experience, greater financial, technical, sales,
marketing and other resources, more name recognition and larger installed
customer bases than we do and can be expected to react strongly to our marketing
efforts.




In
addition, many competitors exist who, because of their substantial resources,
distribution relationships and customer base, could temporarily drop prices to
stave off a potential successful market launch by us.  Other
competitive responses might include, without limitation, intense and aggressive
price competition and offers of employment to our key marketing or management
personnel.  There can be no assurance that we will be successful in
the face of increasing competition from existing or new competitors, or that
competition will not have a material adverse effect on our business, financial
condition and results of operations.




Competitive
pressures and other factors, such as new product or technology introductions by
us or our competitors, may result in price or market share erosion that could
have a material adverse effect on our business, results of operations and
financial condition.  In addition, there can be no assurance that our
products and services will achieve broad market acceptance or will successfully
compete with other products targeting the same customers.




Manufacturing
and Suppliers




Our
success will depend on partnerships in both technology and related
support.  Our primary technology provider is Broadcom
Corporation.  Broadcom’s 10 Gigabit Ethernet, Gigabit Ethernet and
fast Ethernet transceivers provide the Ethernet and 10 Gigabit switching fabric
in our distributed architecture.  Another major supplier is TTM
Corporation, which supplies PCB fabrication and PCB design and analyses
support.  Our operating system is based on WindRiver’s VxWorks, which
is widely used throughout the information technology industry.




-6-




All of
our manufacturing activities have been outsourced to Express Manufacturing Inc.
(“EMI”), a subcontractor located in the same vicinity as our principal
headquarters.  EMI’s manufacturing activities for us consist of
printed circuit board assembly and final assembly of our
products.  All of our inventory is stored at our principal
headquarters and we supply it to EMI as needed to meet our orders.  We
currently conduct final systems testing at our principal
headquarters.




We
utilize high quality providers of merchant silicon, embedded software,
production circuit boards and loss-free interconnects to craft our switch
products.  No extraordinary investments in custom ASICs, software or
infrastructure were required to engineer our family of products.  In
August 2004 we relocated our operations to a Federal Empowerment Zone and local
enterprise zone, directly between EMI, our contract manufacturer, and Broadcom,
our merchant silicon provider, in order to minimize facility costs and speed the
design-to-production transition of new silicon switching
innovations.  In October of 2008, we moved once again, remaining
within the Federal Empowerment Zone, but reducing our footprint and lease rate
to further cut expenses in order to attempt to survive the economic
downturn.




Employees




As of
March 22, 2010 we had 7 full-time employees.  None of our employees
are a party to any collective bargaining agreements with us.  We
consider our relations with our employees to be good.




Patents,
Trademarks, and Licensing Agreements




We have
twelve U.S. patent applications pending, five issued, two foreign applications
pending and ten additional U.S. provisional applications pending with broad
claim sets covering numerous aspects of our Ethernet Distributed Switch
Fabrics.  The foreign applications pending are in Europe (“EPO”) and
Japan.




While we
see no evidence that the technology encompassed in the Ethernet Distributed
Switch Fabrics patent applications is neither infringed upon by any third party,
nor infringes on any prior art of any third party, we are unable to assess the
validity, scope or defensibility of our patent applications, and any challenge
to or claim of infringement relating to one or more of the patent applications
could materially and adversely affect our business and results of
operations.




We have
not entered into any licensing or franchising agreements for revenue generating
purposes.




Organization




We were
organized under the laws of the State of Colorado on January 22, 2001 under the
name Pacific InterMedia, Inc.  We originally were engaged in the
business of offering EDGAR filing services to companies outsourcing the
formatting and electronic filing of registration statements, periodic reports
and other forms with the SEC, but generated minimal revenues from these
operations.  On October 17, 2003, we completed a business combination
transaction with Raptor Networks Technology, Inc., a California corporation
(“Raptor”), whereby we acquired all of the issued and outstanding capital stock
of Raptor in a cashless common stock share-for-share exchange in which Raptor
became our wholly-owned subsidiary (the “Raptor Acquisition”).




The
Raptor Acquisition was structured as a share-for-share exchange whereby we
issued to Raptor’s shareholders, on a one-for-one basis, an aggregate of
19,161,256 shares of our authorized but previously unissued common stock in
exchange for the 19,161,256 shares of Raptor common stock collectively held by
them.




As of the
date of the Raptor Acquisition, both we and Raptor were start-up, development
stage companies and had each realized negligible revenues.  We are
unable to locate any documentation or other information regarding how the value
of our common stock or Raptor’s common stock was calculated in determining that
the stock be exchanged on a one-for-one basis in the Raptor
Acquisition.  In addition, there was no public market for either our
or Raptor’s stock at the time of the Raptor Acquisition on which to base such an
evaluation.   We have no reason to believe the Raptor Acquisition
was not an arms-length transaction or that the terms of the Raptor Acquisition
were not reasonable at the time the transactions were entered
into.  However, we can provide no assurance that our common stock or
Raptor’s common stock was not over-valued or under-valued in the Raptor
Acquisition.




-7-




Upon the
completion of the Raptor Acquisition, we changed our name to Raptor Networks
Technology, Inc., terminated our EDGAR filing services operations and, by and
through our subsidiary Raptor, became engaged in the data network switching
industry.  The Raptor Acquisition has been treated as a reverse
merger, with Raptor being considered the acquiring entity for accounting
purposes.




Item
      1A.
            Risk
      Factors




Our independent registered public
accounting firms have issued a report questioning our abilty to continue as a
going concern.  This report may impair our ability to raise additional
financing and adversely affect the price of our common stock.  In an
attempt to address the Company’s ability to continue as a going concern, the
Company changed its principal operating model from product development to
licensing.  There can be no assurance that this shift in business
model will be successful.




Our independent registered public
accounting firms have qualified their opinions with respect to our financial
statements to include an explanatory paragraph related to our ability to
continue as a going concern in their report for each of our fiscal years ended
December 31, 2003 through December 31, 2009.  Reports of independent
registered public accounting firms questioning a company’s ability to continue
as a going concern generally are viewed very unfavorably by analysts and
investors.  There are a number of risks and challenges associated with
such a qualified report including, but not limited to, a significant impediment
to our ability to raise additional capital or seek financing from entities that
will not conduct such transactions in the face of such increased level of risk
of insolvency and loss, increased difficulty in attracting talent and the
diversion of the attention of our executive officers and other key employees to
raising capital or financing rather than devoting time to the day-to-day
operations of our business.  We urge potential investors to review the
report of our independent registered public accounting firm and our consolidated
financial statements and related notes beginning on page F-1 of this Report and
to seek independent advice concerning the substantial risks related thereto
before making a decision to invest in us.  Our consolidated financial
statements have been prepared on a going concern basis, which contemplates the
realization of assets and satisfaction of liabilities in the normal course of
business.  The financial statements and financial information included
in this filing do not reflect any adjustments that might be necessary if we are
unable to continue as a going concern.  We currently have no
commitment for any additional financing and there can be no assurance that we
will be able to obtain requisite financing on acceptable terms, if at
all.  Because revenues decreased in 2008, structural changes to our
business model that had been under consideration (and previously disclosed in
our public filings) became necessary to continue operations.  The
principal operating model of the Company was shifted from product development to
licensing, enabling a reduction in headcount, footprint and infrastructure to
reduce costs.  There can be no assurance that this shift in business
model will be successful.  Should the licensing model prove to be
unsuccessful, our investors could lose their entire investment in
us.  While the Company will continue to rigorously pursue new product
opportunities, there can be no assurance that our new model will generate
sufficient revenues to support our reduced SG&A expense.  In the
event that we are unable to generate sufficient revenue, Raptor may be forced to
sell its assets, cease its operations or file a bankruptcy petition under the US
Bankruptcy Code.




Our
substantial accumulated deficit, limited working capital and expectation of
future losses may require that we obtain additional financing to continue
operations, which we may not be able to secure on acceptable terms, if at
all.  We are an early stage company and have had no significant
revenues from operations to date.  As of December 31, 2009, we had an
accumulated deficit of $83,923,177.  We have operated at a loss since
our inception and expect to continue to experience losses from our operations
for the foreseeable future.  Our net losses for fiscal 2009 and 2008
were $12,694,997 and $1,029,859 respectively.  We will be required to
conduct product feature enhancement and testing activities which, together with
expenses to be incurred for the establishment of a sustainable marketing and
sales presence and other general and administrative expenses, are expected to
result in operating losses through the foreseeable
future.  Accordingly, there is a risk that we will not achieve
profitable operations in the near future, if at all.




We funded
our deficits in 2007 and 2008 largely by obtaining debt and equity financing
from outside providers.  In 2009, we changed our operating model to
reduce our expenses and financed our operations with the cash flow we generated
from operating activities.  There can be no assurance that cash from
operations will be sufficient to finance our operations in the
future.




-8-




If we are
unable to continue generating positive cash flows from operations and if we
become unable to finance our operations, investors in our common stock or other
securities could lose their entire investments.




We
have no profitable operating history and may never achieve
profitability.




We are an
early stage company and have a limited history of operations and have not
generated meaningful revenues from operations since our inception.  We
are faced with all of the risks associated with a company in the early stages of
development.  Our business is subject to numerous risks associated
with a relatively new, low-capitalized company engaged in the network switch
industry.  Such risks include, but are not limited to, competition
from well-established and well-capitalized companies, technological obsolescence
and unanticipated difficulties regarding the development and marketing of our
products.  There can be no assurance that we will ever generate
significant commercial sales or achieve profitability.  Should this be
the case, investors in our common stock or other securities could lose their
entire investment.




We
do not presently have a traditional credit facility with a financial
institution.  This absence may adversely impact our
operations.




We do not
presently have a traditional credit facility with a financial
institution.  The absence of a traditional credit facility could
adversely impact our operations.  If adequate funds are not otherwise
available, we may be required to delay, scale back or eliminate portions of our
operations and product development efforts.  In addition, the terms of
our senior convertible note financings subject us to certain covenants that
prohibit us from borrowing additional funds unless certain conditions are
satisfied, including, but not limited to, the closing price of our common stock
being greater than $1.00 per share for 40 consecutive trading days or the
aggregate dollar trading volume of our common stock being greater than $200,000
per day for 40 consecutive trading days.  Further, the terms of our
July 2007, April 2008 and July 2008 senior secured convertible note financings
provide that while the notes are outstanding, we will not conduct any other
securities offerings or be party to any solicitations, negotiations or
discussions regarding any other security offerings, except for offerings solely
to one or more of the convertible note investors.




Our
level of indebtedness reduces our financial and operational flexibility, and our
level of indebtedness may increase.




As of
March 22, 2010, the principal amount of our total indebtedness was $10,341,369
(see Note 5).  This balance includes $166,220 of accrued interest
added to principal on January 12, 2010.  Our level of indebtedness
affects our operations in several ways, including the following:





●
              A
      significant portion of our cash flow may be required to service our
      indebtedness;●
              A
      high level of debt increases our vulnerability to general adverse economic
      and industry conditions;●
              The
      covenants contained in the agreements governing our outstanding
      indebtedness significantly limit our ability to borrow additional funds,
      dispose of assets, pay dividends, sell common stock and make certain
      investments;●
              Our
      debt covenants may also affect our flexibility in planning for, and
      reacting to, changes in the economy or in our industry;●
              A
      high level of debt may impair our ability to obtain additional financing
      in the future for working capital, capital expenditures, acquisitions or
      general corporate purposes; and●
              A
      default under our debt covenants could result in required principal
      payments that we may not be able to meet, resulting in higher penalty
      interest rates and/or debt maturity
  acceleration.




We may
incur additional debt, including significant secured indebtedness, in order to
fund our continuing operations or to develop and/or improve our
products.  A higher level of indebtedness increases the risk that we
may default on our debt obligations.  Our ability to meet our debt
obligations and to reduce our level of indebtedness depends on our future
performance.  General and industry specific economic, financial and
business conditions and other factors affect our operations and our future
performance.  Many of these factors are beyond our
control.  We may not be able to generate sufficient cash flow to
fulfill our interest or principal payment obligations on our debt and future
working capital, borrowings or equity financing may not be available to pay or
refinance such debt.




-9-




If we default on our senior secured convertible notes,
we could lose all of our assets.




Pursuant to the July 2007, March 2008 and July 2008
senior secured convertible note financings, we granted the investors a security
interest in all of our assets.  If we default on our obligations
relating to those notes, the investors could foreclose on all of our assets,
both tangible and intangible, leaving us with no assets.




There
is a risk that there may be procedural issues related to our acquisition of
Raptor Networks Technology, Inc., a California corporation, which could have a
material adverse effect on our business, financial condition and results of
operations.




We were organized under the laws of the
State of Colorado on January 22, 2001 under the name Pacific InterMedia,
Inc.  On October 17, 2003, we completed a transaction with Raptor
Networks Technology, Inc., a California corporation (“Raptor”), whereby we
acquired all of the issued and outstanding capital stock of Raptor in a cashless
common stock share-for-share exchange in which Raptor became our wholly-owned
subsidiary.  With the completion of the acquisition transaction we
changed our name to Raptor Networks Technology, Inc., terminated our previous
operations (consisting of the “EDGARization” of SEC securities filings) and, by
and through our subsidiary Raptor, became engaged in the data network switching
industry.  After the transaction, our Board of Directors engaged new
management to, among other things, review our operating and legal
status.




As a result of management’s review of
our historical corporate records, it appears that certain material documents and
approvals regarding the transaction were not properly
retained.  Furthermore, it appears that, from a review of the records
available to us, certain procedural irregularities may exist regarding the
structure and approval of the acquisition transaction under applicable
law.  After a review of available documents and records relating to
the acquisition transaction, Colorado counsel engaged by us has determined that
the shares issued in the transaction were lawfully issued.  However,
there is a risk, given the lack of complete records regarding the transaction,
that the acquisition was not properly structured or approved.  The
inability to resolve such deficiencies, should such deficiencies exist, could
have a material adverse effect on our business, financial condition and results
of operations.  Furthermore, there is a risk that we may be subject to
currently unknown liabilities resulting from our operations, or the operations
of Raptor, prior to the acquisition transaction.  Should a claimed
liability arise, we could expend significant time and resources defending or
satisfying such claim, including, without limitation, the amount of any judgment
or settlement required to satisfy any such claim and the payment of attorneys’
fees and other costs incurred in defending any such claim.




Evaluation
of internal control and remediation of potential problems may be costly and time
consuming and could expose weaknesses in financial reporting.




Our
independent registered public accounting firm will be required to confirm in
writing whether management’s assessment of the effectiveness of the internal
control over financial reporting is fairly stated in all material respects, and
separately report on whether they believe management maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2010.




This
process may be expensive and time consuming, and may require significant
attention of management.  Management can give no assurance that
material weaknesses in internal controls will not be discovered.  If a
material weakness is discovered, corrective action may be time consuming, costly
and further divert the attention of management.  The disclosure of a
material weakness, even if quickly remedied, could reduce the market’s
confidence in our financial statements and harm our stock price, especially if a
restatement of financial statements for past periods is required.




Our
inability to successfully achieve sustainable market penetration could adversely
affect our financial condition.




No
assurance can be given that we will be able to successfully achieve sustainable
market penetration with any of our products.  Our success in marketing
our products will be substantially dependent on educating our targeted markets
as to the unique topologies, as well as what we believe are the performance and
cost benefits, of our distributed Ethernet switch architecture.  There
can be no assurance that our efforts or the efforts of others will be successful
in fostering acceptance of our technology among the targeted
markets.




-10-




Many
companies with greater resources and operating experience offer technology
similar to our products.  These companies could successfully compete
with us and negatively affect our opportunity to achieve
profitability.




We
operate in a competitive industry with many established and well-recognized
competitors.  In particular, Cisco Systems maintains a dominant
position in our industry and several of its products compete directly with our
products.  We also compete with Extreme Networks, Juniper Networks, F5
Networks, Nortel Networks, Enterasys Networks, 3Com, Huawei Technologies, Force
10 Networks and Alcatel, among others.  Most of our competitors
(including all of the competitors referenced above) have substantially greater
market leverage, distribution networks and vendor relationships, longer
operating histories and industry experience, greater financial, technical,
sales, marketing and other resources, more name recognition and larger installed
customer bases than we do and can be expected to react strongly to our marketing
efforts.  In addition, many competitors exist who, because of their
substantial resources, distribution relationships and customer base could
temporarily drop prices to stave off a potential successful market launch by our
Company.  Other competitive responses might include, without
limitation, intense and aggressive price competition and offers of employment to
our key marketing or management personnel.  There can be no assurance
that we will be successful in the face of increasing competition from existing
or new competitors, or that competition will not have a material adverse effect
on our business, financial condition and results of operations.




Our
marketing efforts have yielded negligible revenues and there can be no assurance
that our future marketing efforts will lead to sales of our
products.




Our
marketing efforts have yielded negligible revenues and we believe we will have
to significantly expand our sales and marketing capabilities in order to
establish sufficient awareness to launch broader sales of our products and
support services.  There can be no assurance that we will be able to
expand our sales and marketing efforts to the extent we believe necessary or
that any such efforts, if undertaken, will be successful in achieving
substantial sales of our products or support services.




The
industry of network switch products is subject to rapid technological
change.  Our products could become obsolete at any time and our
limited capital prohibits us from devoting a significant amount of resources to
research and development.




Evolving
technology, updated industry standards and frequent new product and service
introductions characterize the network switching market.  Our current
products could become obsolete at any time.  Competitors could develop
products similar to or better than ours, finish development before us or market
their products more successfully than ours, any of which could hinder our
potential success.  In order to be competitive, we must continue to
develop and bring to market new products that offer substantially greater
performance and support a greater number of users, all at lower price points
than our competitors.  Our future success depends in significant part
on our ability to evolve the performance and software of our existing products
and develop and introduce new products and technologies in response to the
evolving demands of the market and competitive product
offerings.  However, unless we are able to raise additional capital or
significantly increase revenues, we will not be able to devote a significant
amount of resources to research and development, which could increase the
likelihood that our current products become obsolete and prevent us from
developing new products to keep up with the industry’s rapid technological
advancements.




Because
we believe that proprietary rights are material to our success, misappropriation
of those rights or claims of infringement or legal actions related to
intellectual property could adversely impact our financial
condition.




Our
success is dependent on our ability to protect our proprietary
technology.  Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology.  Monitoring unauthorized use of our technology
is difficult, and we cannot be certain that the steps we have taken will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the
U.S.  We currently have patented and patent-pending protection for our
proprietary technology and plan to rely on non-disclosure agreements to further
protect this technology.  There can be no assurance that these patents
will be granted or that nondisclosure agreements will provide us meaningful
protection.




-11-




In
addition, the network industry is subject to frequent claims and related
litigation regarding patent and other intellectual property
rights.  In particular, some companies in the network industry claim
extensive patent portfolios.  As a result of the existence of a large
number of existing patents and the rate of issuance of new patents in the
network industry, it is extremely difficult to determine in advance whether a
product or any of its components may infringe upon the intellectual property
rights claimed by others.  Third parties may in the future assert
patent, copyright, trademark and other intellectual property rights claims
against us with respect to existing or future products or
technology.  Regardless of the merits of our position, we may incur
substantial legal fees and related costs defending against third party claims,
in addition to monetary damages that may be assessed against us.  If
there is a successful claim of infringement and we fail or are unable to develop
non-infringing technology or license the infringed or similar technology on a
timely basis, our business and results of operations may be seriously
harmed.




We
rely heavily on our management and other key personnel, and the loss of their
services (or our inability to recruit and retain additional qualified employees)
could materially and adversely affect our business.




Our
future success depends to a significant degree on the continued service of our
key personnel and on our ability to attract, motivate and retain highly
qualified employees.  In particular, we are dependent upon the
services of our senior management, including, without limitation: Chief
Executive Officer and President, Thomas M. Wittenschlaeger and Chief Financial
Officer and Secretary, Bob van Leyen.  The loss of the services of our
senior management or other key employees would have a material adverse effect on
our business, financial condition and results of operations.




In
addition, there are a number of other key management, sales and support
positions (including many for which individuals have not yet been hired) the
loss of which (or the inability to recruit and retain) would have a material
adverse effect on our business.  If we experience the growth we hope
to achieve, our ability to operate successfully during periods of growth (if
any) will depend on our ability to attract and retain managers and develop
adequate systems and procedures to manage such growth.  There can be
no assurance that we will be able to attract and retain additional key
management personnel with the skills and expertise necessary to manage our
business should any such period of growth occur.




Our
business could suffer if we are unable to obtain components, software and
services from outside suppliers and vendors.




Our
products are architected and manufactured through the use of third-party
electronic components, device level software and services.  We are
highly dependent on the services and products of these other
companies.  A discontinuance, disruption or other similar occurrence
to the components, software or services supplied by our vendors and suppliers
could materially diminish our ability to operate efficiently.




We
acquire components through purchase orders and have no long-term commitments
regarding supply or pricing from these suppliers.  We depend on
anticipated product orders to determine our material requirements.  If
orders for our products do not match forecasts, or if we do not manage inventory
effectively, we may have either excess or insufficient inventory of materials
and components, which could negatively affect our operating results and
financial condition.




Our
reliance on third-party manufacturing vendors to manufacture our products may
cause a delay in our ability to fill orders.




We
subcontract a significant amount of our manufacturing to Express Manufacturing,
Inc. and may, in the future, subcontract with other third-party
manufacturers.  In addition, some Company-branded products are
manufactured by third party original equipment manufacturers
(“OEMs”).  We may experience delays in product manufacturing and
shipments from our manufacturers, which in turn could delay product shipments to
our customers.  In addition, we may experience problems such as
inferior manufacturing quality or failure to manufacture products according to
specifications, any of which could have a material adverse effect on our
business and operating results.  In the event we introduce new
products or product enhancements, we may be required to rapidly achieve volume
production by coordinating our efforts with suppliers and
manufacturers.  The inability of our manufacturers or OEMs to provide
us with adequate supplies of high-quality products, the loss of any of our
third-party manufacturers or the inability to obtain components and raw
materials could cause a delay in our ability to fulfill orders.




-12-




The
average selling prices of our products, and our gross margins resulting from the
sale of such products, may decline as a result of competitive pressures,
industry trends and other factors.




The
network industry has experienced an erosion of the average product selling
prices due to a number of factors, particularly competitive and macroeconomic
pressures and rapid technological advancements.  Our competitors have
and will likely continue to lower sales prices from time to time in order to
gain market share or create more demand.  We may have to reduce the
sales prices of our products in response to such intense pricing competition,
which could cause our gross margins to decline and may adversely affect our
business, operating results or financial condition.  Our gross margins
could also be adversely affected if we are unable to reduce manufacturing costs
and effectively manage our inventory levels or by fluctuations in manufacturing
volumes, component costs, the mix of products sold and the mix of distribution
channels through which our products are sold.




If
our products contain software or hardware errors, we could incur sudden and
significant expenses and lost sales and be subject to product liability
claims.




Our
products are complex and may contain undetected defects or errors, particularly
when first introduced or as new enhancements and versions are
released.  Despite our testing procedures, these defects and errors
may be discovered after they have been shipped to customers.  Any
defects or errors in our products or failures of our customers’ networks,
regardless of whether the failure is caused by our products, could result
in:





●
              negative
      customer reactions;


●
              product
      liability claims;


●
              negative
      publicity regarding us and our
products;


●
              delays
      in or loss of market acceptance of our
products;


●
              product
      returns; and


●
              unexpected
      expenses to remedy defects or
errors.




Our
success is substantially dependent on general economic conditions and business
trends, particularly in the information technology industry, a downturn of which
could adversely affect our operations.




The
success of our operations depends to a significant extent upon a number of
factors relating to business spending.  These factors include economic
conditions such as employment rates and labor supply, general business
conditions, cost of goods and materials, inflation, interest rates and
taxation.  Our business is affected by the general condition and
economic stability of our customers as well as our vendors, suppliers and
partners and their continued willingness to work with us in the
future.  Our business is particularly sensitive to information
technology (“IT”) spending patterns and preferences.  There can be no
assurance that IT spending will not be adversely affected by general business
trends and economic conditions, thereby impacting our growth, net sales and
profitability.




Our
failure to manage growth effectively could impair our success.




In order
for us to expand successfully, management will be required to anticipate the
changing demands of a growth in operations, should such growth occur, and to
adapt systems and procedures accordingly.  There can be no assurance
that we will anticipate all of the changing demands that a potential expansion
in operations might impose.  If we were to experience growth, we might
be required to hire and train a large number of sales and support personnel, and
there can be no assurance that the training and supervision of a large number of
new employees would not adversely affect the high standards that we seek to
maintain.  Our future will depend, in part, on our ability to
integrate new individuals and capabilities into our operations, should such
operations expand in the future, and there can be no assurance that we will be
able to achieve such integration.  We will also need to continually
evaluate the adequacy of our management information systems, including our web
site.  Failure to upgrade our information systems or unexpected
difficulties encountered with these systems during an expansion in our
operations (should such an expansion occur) could adversely affect our business,
financial condition and results of operations.




-13-




Changes
in generally accepted accounting principles could have an adverse effect on our
business, financial condition, cash flows, revenue and results of
operations.




We are
subject to changes in and interpretations of financial accounting matters that
govern the measurement of our performance.  Based on our reading and
interpretations of relevant guidance, principles or concepts issued by, among
other authorities, the American Institute of Certified Public Accountants, the
Financial Accounting Standards Board and the United States Securities and
Exchange Commission, our management believes that our current contract terms and
business arrangements have been properly reported.  However, there
continue to be issued interpretations and guidance for applying the relevant
standards to a wide range of contract terms and business arrangements that are
prevalent in the industries in which we operate.  Future
interpretations or changes by the regulators of existing accounting standards or
changes in our business practices could result in future changes in our revenue
recognition and/or other accounting policies and practices that could have a
material adverse effect on our business, financial condition, cash flows,
revenue and results of operations.




Our
common stock price has been volatile, which could result in substantial losses
for investors purchasing shares of our common stock.




The
market prices of securities of technology-based companies (such as us) currently
are highly volatile.  The market price of our common stock has
fluctuated significantly in the past.  During 2009, the high and low
closing sale prices of a share of our common stock were $0.45 and $0.09,
respectively.  On March 22, 2010, the last reported sale price of a
share of our common stock was $0.19.  The market price of our common
stock may continue to fluctuate in response to the following factors, in
addition to others, many of which are beyond our control:





●
              conversion
      of our convertible notes and exercise of our warrants and the sale of
      their underlying common
stock;


●
              changes
      in market valuations of similar companies and stock market price and
      volume fluctuations
generally;


●
              economic
      conditions specific to the network switching or related information
      technology industries;


●
              announcements
      by us or our competitors of new or enhanced products, technologies or
      services or significant contracts, acquisitions, strategic relationships,
      joint ventures or capital
commitments;


●
              delays
      in our introduction of new products or technological innovations or
      problems in the functioning of our current or new products or
      innovations;


●
              third
      parties’ infringement of our intellectual property
  rights;


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


●
              regulatory
      developments;


●
              fluctuations
      in our quarterly or annual operating
results;


●
              additions
      or departures of key personnel;
and


●
              future
      sales of our common stock or other
securities.




The price
at which you purchase shares of common stock may not be indicative of the price
of our stock that will prevail in the trading market.  You may be
unable to sell your shares of common stock at or above your purchase price,
which may result in substantial losses to you.  Moreover, in the past,
securities class action litigation has often been brought 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 divert our management’s attention and resources.




Shares
of our common stock eligible, or to become eligible, for public sale could
adversely affect our stock price and make it difficult for us to raise
additional capital through sales of equity securities.




We cannot
predict the effect, if any, that market sales of shares of our common stock or
the availability of shares of common stock for sale will have on the market
price prevailing from time to time.  As of December 31, 2009, we had
outstanding 85,922,744 shares of common stock, of which 9,029,437 shares were
restricted under the Securities Act of 1933, as amended (the “Securities
Act”).  As of December 31, 2009, we also had outstanding options,
warrants, and convertible promissory notes that were exercisable for or
convertible into approximately 130,212,842 shares of common
stock.  Sales of shares of our common stock in the public market, or
the perception that sales could occur, could adversely affect the market price
of our common stock.  Any adverse effect on the market price of our
common stock could make it difficult for us to raise additional capital through
sales of equity securities at a time and at a price that we deem
appropriate.




-14-




The
conversion of convertible securities and the exercise of outstanding options and
warrants to purchase our common stock could substantially dilute your
investment, impede our ability to obtain additional financing and cause us to
incur additional expenses.




Under the
terms of existing notes convertible into our common stock, warrants to purchase
our common stock, non-compensatory options to acquire our common stock and other
outstanding options to acquire our common stock issued to employees and others,
the holders thereof are given an opportunity to profit from a rise in the market
price of our common stock that, upon the exercise of such warrants and/or
options or conversion of such notes, could result in dilution in the interests
of our other shareholders.  The terms on which we may obtain
additional financing may be adversely affected by the existence and potentially
dilutive impact of such convertible notes, options and warrants.  In
addition, holders of certain convertible notes, options and warrants have
registration rights with respect to the common stock underlying such convertible
notes, options and warrants, the registration of which will cause us to incur a
substantial expense.




The
voting power and value of your investment could decline if our senior
convertible notes and warrants are converted at a reduced price due to our
issuance of lower-priced shares or market declines which trigger rights of the
holders of our convertible notes and warrants to receive additional shares of
our stock.




As part
of our 2006, 2007 and 2008 senior convertible note financings, we issued a
significant additional amount of convertible notes and warrants, the exercise or
conversion of which could have a substantial negative impact on the price of our
common stock and could result in a dramatic decrease in the value of your
investment.  The initial conversion price of our senior convertible
notes is subject to market-price protection that will cause the conversion price
of our senior convertible notes to be reduced in the event of a downward
fluctuation in the market price of our common stock.  In addition, the
initial conversion price of our senior convertible notes and the initial
exercise price of a majority of our warrants will be subject to downward
anti-dilution adjustments in most cases, from time to time, where we issue
securities at a purchase, exercise or conversion price that is less than the
then-applicable conversion price of our senior convertible notes or exercise
price of our warrants.  Consequently, the voting power and value of
your investment in each such event would decline if our senior convertible notes
or warrants are converted or exercised for shares of our common stock at the new
lower price as a result of such declining market-price or sales of our
securities are made below the conversion price of the notes and/or the exercise
price of the warrants.




The
market-price protection feature of our senior convertible notes could also allow
those notes to become convertible into a greatly increased number of additional
shares of our common stock, particularly if a holder of our senior convertible
notes sequentially converts portions of the note into shares of our common stock
at alternate conversion prices and resells those shares into the
market.  If a holder of our senior convertible notes sequentially
converts portions of the notes into shares of our common stock at alternate
conversion prices and resells those shares into the market, then the market
price of our common stock could decline due to the additional shares available
in the market, particularly in light of the relatively thin trading volume of
our common stock.  Consequently, if a holder of our senior convertible
notes repeatedly converts portions of the notes at alternate conversion prices
and then resells those underlying shares into the market, a continuous downward
spiral of the market price of our common stock could occur that would benefit a
holder of our senior convertible notes at the expense of other existing or
potential holders of our common stock, potentially creating a divergence of
interests between a holder of our senior convertible notes and investors who
purchase the shares of common stock resold by a holder of the notes following
conversion of the notes.




The
market price of our common stock and the value of your investment could
substantially decline if our convertible notes, warrants or options continue to
be converted into shares of our common stock and resold into the market, or if a
perception exists that a substantial number of shares will be issued upon
conversion or exercise of our convertible notes, warrants or options and then
resold into the market.




If the
conversion prices at which the balances of our convertible notes, warrants and
options are converted are lower than the price at which you made your
investment, immediate dilution of the value of your investment will
occur.  In addition, sales of a substantial number of shares of common
stock issued upon conversion of our convertible notes, warrants and options, or
even the perception that such sales could occur, could adversely affect the
market price of our common stock, which would mean that certain convertible
notes and warrants would be convertible into an increased number of shares of
our common stock in cases where, as described elsewhere in these risk factors,
the conversion price is based upon a discount from the market price of our
common stock.  You could, therefore, experience a substantial decline
in the value of your investment as a result of both the actual and potential
conversion of our outstanding convertible notes, warrants or
options.




-15-




The
issuance of shares upon the conversion of convertible notes and the exercise of
outstanding options and warrants could result in a change of control of our
Company.




As of
December 31, 2009, we had outstanding options, warrants, and convertible
promissory notes that were exercisable for or convertible into approximately
130,200,000 shares of common stock.  In addition, as discussed
elsewhere in these Risk Factors, the number of shares exercisable under
outstanding warrants and convertible under outstanding notes may be subject to
increase in the event of our future issuance of securities or a downward
fluctuation in the market price of our common stock.  A change of
control of our Company could occur if a significant number of shares are issued
to the holders of our outstanding warrants or convertible notes.  If a
change of control occurs, then the stockholders who historically have controlled
our Company would no longer have the ability to exert significant control over
matters that could include the election of our directors, changes in the size
and composition of our Board of Directors and mergers and other business
combinations involving our Company.  Instead, one or more other
stockholders could gain the ability to exert this type of control and may also,
through control of our Board of Directors and voting power, be able to control
certain decisions, including decisions regarding the qualification and
appointment of officers, dividend policy, access to capital (including borrowing
from third-party lenders and the issuance of additional equity securities) and
the acquisition or disposition of our assets.




The
voting power of your investment and our earnings per share would be
substantially diluted if all or a significant portion of our convertible notes,
warrants or options were converted into shares of our common stock.




If the
aggregate number of shares of common stock underlying our convertible notes,
warrants or options had been issued and outstanding as of this date, substantial
dilution of the voting power of your investment and of our earnings per share
would occur.




Because
we are subject to “Penny Stock” rules, the level of trading activity in our
common stock may be reduced.




Our stock
is listed on the Over-the-Counter (“OTC”) Bulletin Board and constitutes “Penny
Stock.”  Broker-dealer practices in connection with transactions in
Penny Stocks are regulated by rules adopted by the SEC.  Penny Stocks
are generally equity securities with a price per share of less than $5.00 (other
than securities registered on certain national exchanges or quoted on the NASDAQ
system).  The Penny Stock rules require a broker-dealer, prior to a
transaction in Penny Stocks not exempt from the rules, to deliver a standardized
risk disclosure document that provides information about Penny Stocks and the
nature and level of risks in the Penny Stock Market.  The
broker-dealer must also provide the customer with current bid and offer
quotations for the Penny Stock, the compensation of the broker-dealer and the
salesperson in the transaction and monthly accounting statements showing the
market value of each Penny Stock held in the customer’s account.  In
addition, the broker-dealer must make a special written determination that the
Penny Stock is a suitable investment for the purchaser and receive the
purchaser’s written agreement to the transaction.  These requirements
may have the effect of reducing the level of trading activity in a Penny Stock,
such as our common stock, and investors in our common stock may find it
difficult to sell their shares.




Because
our common stock is not listed on a national securities exchange, you may find
it difficult to dispose of or obtain quotations for our common
stock.




Our
common stock trades under the symbol “RPTN” on the OTC Bulletin
Board.  Because our stock trades on the OTC Bulletin Board rather than
on a national securities exchange, you may find it difficult to either dispose
of, or to obtain quotations as to the price of, our common stock.




Item
      1B.
            Unresolved
      Staff Comments




Not
applicable




Item
      2.
            Properties




In
October 2008 we relocated to a smaller facility in the Federal Empowerment Zone
of Santa Ana, California, which reduced our overhead expenses and created a more
appropriate facility for our activities.  The address of our leased
facilities is 1508 S. Grand Ave. Santa Ana, California 92705.  This
facility, consisting of 2,400 square feet, includes our executive offices and
research and development laboratory.  The initial lease agreement was
effective September 22, 2008 for a period of six months. Thereafter the lease
was extended for periods of six months and the current extension which was
signed on December 16, 2009 expires on September 30, 2010.  The
monthly base rent amounts to $1,560.00.




-16-




We
believe that the monthly rental rates are comparable to rents charged for
comparable properties in the market area.  We require full compliance
by the lessor with applicable state and EPA environmental standards at our
facility.  We believe that the current facilities are adequate for our
expected needs through at least the end of 2010.




In
October 2008, we rendered possession of our prior operating facility to the
landlord and charged $241,261 to other expense in connection with rent due for
the remainder of the lease (October 1, 2008 – July 31, 2009).  In
November 2009, we settled the matter for $216,000, plus simple interest at 10
percent per annum until such amount is paid in full.  We paid $7,000
on the date of the agreement.  Beginning January 15, 2010 and
continuing through January 15, 2012, we will make monthly payments of
$9,000.  A final payment of $6,106 is due by February 15,
2012.  As a result of the settlement, we recorded an additional
expense of $21,435 for the year ended December 31, 2009.




Item
      3.
            Legal
      Proceedings




From time
to time, we may be involved in various claims, lawsuits, disputes with third
parties, actions involving allegations of discrimination or breach of contract
actions incidental to the operation of our business.  However, we are
not currently involved in any litigation which we believe could have a
materially adverse effect on our financial condition or results of
operations.




Item
      4.
            (Removed
      and Reserved)
















-17-





PART
II




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




Our
$0.001 par value common stock trades under the symbol “RPTN” on the OTC Bulletin
Board.  The following table sets forth, for the quarters indicated,
the high and low bid information for our common stock as reported by Pink
Sheets, LLC, a research service that compiles quote information reported on the
National Association of Securities Dealers composite feed or other qualified
inter-dealer quotation medium.  The quotations reflect inter-dealer
prices, without retail markup, markdown or commissions, and may not necessarily
represent actual transactions.




Fiscal
      2009Fiscal
      Quarter Ended:
              
              High
              
              
              LowDecember 31
              
              $
              0.25
              
              
              $
              0.16September 30
              
              $
              0.36
              
              
              $
              0.18June 30
              
              $
              0.45
              
              
              $
              0.09March 31
              
              $
              0.21
              
              
              $
              0.11
  Fiscal
      2008Fiscal
      Quarter Ended:
              
              High
              
              
              LowDecember 31
              
              $
              0.68
              
              
              $
              0.18September 30
              
              $
              0.32
              
              
              $
              0.12June 30
              
              $
              0.90
              
              
              $
              0.64March 31
              
              $
              0.95
              
              
              $
              0.68




On March
22, 2010 the high and low sale prices for a share of our common stock as
reported by Pink Sheets, LLC, were $0.20 and $0.19, respectively.




Holders




On March
22, 2010, we had 85,922,744 shares of our common stock outstanding held by 966
record shareholders.  This number of shareholders does not include
beneficial owners, including holders whose shares are held in nominee or
“street” name.




Dividends




We have
never paid a cash dividend with respect to our common stock, and do not expect
to be able to pay cash dividends in the foreseeable future as the terms of our
senior convertible notes prohibit us from paying cash dividends for the term of
the loan arrangement.




Recent
Sales of Unregistered Securities




On
November 17, 2009, we issued 1,155,255 shares of common stock for the conversion
of $171,070 of the principal balance due on the April 2008 Notes.




On
November 17, 2009, we issued 1,209,623 shares of common stock for the conversion
of $176,000 of the principal balance due on the July 2008 Notes.




On
December 9, 2009, we issued 200,000 shares of common stock for services
provided.




On
December 17, 2009, we issued 1,707,448 shares of common stock for the conversion
of $224,000 of the principal balance due on the July 2008 Notes.




These
issuances were made in reliance upon the exemption from registration available
under Section 4(2) of the Securities Act, among others, as transactions not
involving a public offering.  This exemption was claimed on the basis
that these transactions did not involve any public offering and the purchasers
in each offering were accredited or sophisticated and had sufficient access to
the kind of information registration would provide.  In each case,
appropriate investment representations were obtained and certificates
representing the securities were issued with restrictive legends.




-18-




Item
      6.
            Selected
      Financial Data




Not
applicable.




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




The
following discussion and analysis provides information that our management
believes is relevant to an assessment and understanding of our results of
operations and financial condition for the fiscal years ended December 31, 2009
and 2008.  This discussion should be read in conjunction with our
consolidated financial statements and related notes thereto beginning on page
F-1 of this Report.  This Report contains trend analysis and other
forward-looking statements that involve risks and uncertainties, such as
statements concerning future operating results; developments in markets and
strategic focus; and future economic, business and regulatory
conditions.  Such forward-looking statements are generally accompanied
by words such as “plan,” “estimate,” “expect,” “believe,” “should,” “would,”
“could,” “anticipate,” “may,” “forecast,” “project,” “pro forma,” “goal,”
“continues,” “intend,” “seek” and other words that convey uncertainty of future
events or outcomes.The cautionary statements
included in the “Risk Factors” section under Item 1A above or elsewhere in this
Report should be read as being applicable to all forward-looking statements
wherever they may appear.  Our actual future results could differ
materially from those discussed herein.  We disclaim any obligations
subsequently to revise any forward-looking statements to reflect events or
circumstances after the date of such statement or to reflect the occurrence of
anticipated or unanticipated events.




CRITICAL
ACCOUNTING POLICIES




Critical
Accounting Estimates and Judgments




Our
consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America
(“GAAP”).  The preparation of our financial statements requires our
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, expenses and related disclosures.  We
base our estimates on historical experience and various other assumptions that
are believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources.  Actual
results may differ from these estimates under different assumptions or
conditions.  The significant accounting policies that are believed to
be the most critical to aid in fully understanding and evaluating the reported
financial results include the valuation of inventories, derivative financial
instruments, and stock-based compensation and the recoverability of deferred
income tax assets.




Inventories




We determine our inventory value at the
lower of average cost or market.  When required, a provision is made
to reduce excess and obsolete inventories to estimated net realizable
value.  Our provision for excess and obsolete inventories increased
from $141,530 at December 31, 2008 to $201,694 at December 31, 2009 due to an
additional charge of $60,164 related to slow-moving parts and finished
products.




Derivative Financial
Instruments




Our
senior convertible notes are classified as non-conventional convertible
debt.  In the case of non-conventional convertible debt, we bifurcate
our embedded derivative instruments and record them at their fair value as of
the inception date of the agreement and at fair value as of each subsequent
balance sheet date.  Any change in fair value will be recorded as
non-operating, non-cash income or expense at each reporting date.  If
the fair value of the derivatives is higher at the subsequent balance sheet
date, we will record a non-operating, non-cash charge.  If the fair
value of the derivative is lower at the subsequent balance sheet date, we will
record non-operating, non-cash income.




-19-




To determine the fair value of the
derivative instruments, we make certain assumptions regarding the expected term
of exercise.  Because the expected term of the warrants impacts the
volatility and risk-free interest rates used in the Black-Scholes calculations,
these must be selected for the same time period as the expected term of the
warrants.




Stock-based
Compensation




The
Company calculates stock-based compensation by estimating the fair value of each
option using the Black-Scholes option pricing model. The Company's determination
of fair value of share-based payment awards are made as of their respective
dates of grant using that option pricing model and is affected by the Company's
stock price as well as assumptions regarding a number of subjective
variables.  These variables include, but are not limited to, the
Company's expected stock price volatility over the term of the awards and actual
and projected employee stock option exercise behavior.  The
Black-Scholes option pricing model was developed for use in estimating the value
of traded options that have no vesting or hedging restrictions and are fully
transferable.  Because the Company's employee stock options have
certain characteristics that are significantly different from traded options,
the existing valuation models may not provide an accurate measure of the fair
value of the Company's employee stock options.  Although the fair
value of employee stock options is determined in accordance with applicable
accounting standards using an option-pricing model, that value may not be
indicative of the fair value observed in a willing buyer/willing seller market
transaction.  The calculated compensation cost is recognized on a
straight-line basis over the vesting period of the option.




Deferred Income
Taxes




We record
a valuation allowance to reduce the deferred tax assets to the amount that is
more likely than not to be realized. We have considered estimated future taxable
income an ongoing tax planning strategies in assessing the amount needed for the
valuation allowance.




Selected
Financial Data




The
following table sets forth selected financial data regarding our financial
position and operating results. This data should be read in conjunction with our
consolidated financial statements and related notes thereto beginning on page
F-1 of this Report.
















-20-




Results
of Operations for the Fiscal Year Ended December 31, 2009


Compared
to Fiscal Year Ended December 31, 2008




2009
              
              
              2008
              
              
              Change
      ($)
              
              
              Change
      (%)REVENUE,
      NET
              
              $
              1,601,906
              
              
              $
              710,330
              
              
              $
              891,576
              
              
              125.5%COST
      OF SALES
              
              
              842,485
              
              
              
              344,952
              
              
              
              497,533
              
              
              144.2%GROSS
      PROFIT
              
              
              759,421
              
              
              
              365,378
              
              
              
              394,043
              
              
              107.8%OPERATING
      EXPENSESSalary
      expense and salary related costs
              
              
              656,813
              
              
              
              1,807,752
              
              
              
              (1,150,939
              )
              
              -63.7%Marketing
      expense
              
              
              -
              
              
              
              73,121
              
              
              
              (73,121
              )
              
              -100.0%Research
      and development
              
              
              114,387
              
              
              
              983,546
              
              
              
              (869,159
              )
              
              -88.4%Selling,
      general and administrative
              
              
              472,472
              
              
              
              2,300,546
              
              
              
              (1,828,074
              )
              
              -79.5%Total
      operating expenses
              
              
              1,243,672
              
              
              
              5,164,965
              
              
              
              (3,921,293
              )
              
              -75.9%Income
      (loss) from operations
              
              
              (484,251
              )
              
              
              (4,799,587
              )
              
              
              4,315,336
              
              
              -89.9%OTHER
      INCOME (EXPENSE)Interest
      income
              
              
              23
              
              
              
              11,175
              
              
              
              (11,152
              )
              
              -99.8%Change
      in fair value of conversion option andwarrant
      liabilities
              
              
              (7,018,882
              )
              
              
              21,622,243
              
              
              
              (28,641,125
              )
              
              -132.5%Loss
      on extinguishment of debt
              
              
              -
              
              
              
              (5,182,474
              )
              
              
              5,182,474
              
              
              -100.0%Cost
      of financing senior convertible notes
              
              
              -
              
              
              
              (4,973,096
              )
              
              
              4,973,096
              
              
              -100.0%Amortization
      of discount on convertible debt
              
              
              (3,963,457
              )
              
              
              (6,127,968
              )
              
              
              2,164,511
              
              
              -35.3%Interest
      expense
              
              
              (1,206,995
              )
              
              
              (1,273,790
              )
              
              
              66,795
              
              
              -5.2%Loss
      on sale of property and equipment
              
              
              -
              
              
              
              (65,101
              )
              
              
              65,101
              
              
              -100.0%Loss
      on lease settlement
              
              
              (21,435
              )
              
              
              (241,261
              )
              
              
              219,826
              
              
              -91.1%Total
      other income (expense)
              
              
              (12,210,746
              )
              
              
              3,769,728
              
              
              
              (15,980,474
              )
              
              -423.9%Loss
      before income taxes
              
              
              (12,694,997
              )
              
              
              (1,029,859
              )
              
              
              (11,665,138
              )
              
              1132.7%Income
      tax benefit
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              0.0%NET
      LOSS
              
              $
              (12,694,997
              )
              
              $
              (1,029,859
              )
              
              $
              (11,665,138
              )
              
              1132.7%




Net
Revenues




In 2009,
total revenues amounted to $1,601,906 compared to $710,330 in 2008, an increase
of 126%.  Main contributors to this increase were the government
business in both product sales as well as services, the improvement of economic
conditions in 2009 over 2008 and the addition of a part-time salesman to the
team in April 2009 paying off in the fourth quarter of 2009.  In total
we sold 51 ER1010 core systems in 2009 compared to 11 ER1010 systems in
2008.




Gross
Profit




In 2009
gross profit amounted to $759,421 compared to $365,378 in 2008.  This
increase in gross profit of $394,043 or 108% is mainly due to the increase of
revenues as mentioned above, partially offset by increased charges for license
fees.  Due to a decrease in estimate of the total systems to be sold
over the lives of the products, we increased the amortization per system sold to
$2,160 in 2009 as compared to $548 per system in 2008.  This resulted
in an additional charge in 2009 of $82,212 as compared to 2008.  Gross
profit as a percentage of sales decreased from 51% in 2008 to 47% in 2009 which
was mainly due to additional license charges as mentioned before.




Operating
Expenses




The
decrease in operating expenses in 2009 resulted primarily because the Company
changed from a product development to a licensing model in September 2008,
enabling a reduction in headcount, footprint and infrastructure to reduce
costs.  This change of model resulted in substantial decreases of
salary expenses, professional fees and G&A, as further explained
below.




-21-




Salary
Expense




Employee
costs amounted to $656,813 in 2009 compared to $1,807,752 in total 2008, a
decrease of $1,150,939 or 64%.  The main reason for this decrease is
the decrease in headcount by 10 employees in July and August 2008 and the
decrease of pay for management  level employees in the period January
– September 2009 as compared to the same period in 2008, offset by the increase
of salaries for our management team effective September 15, 2009.




Marketing
Expenses




Marketing
expenses decreased in 2009 to zero from $73,121 in 2008 in connection with a
decrease of marketing activities.




Research
and Development (“R&D”)




Research
and development expenses decreased from $983,546 in 2008 to $114,387 in 2009, a
decline of $869,159 or 88%.  Due to a substantial reduction in design
activities effective September 30, 2008, the Company reduced its engineering
headcount by 7 persons in August and September 2008, resulting in a decrease of
salary expense in 2009 as compared to 2008 of approximately
$696,000.  Additionally, the Company reduced equipment rental and
licensing expenses by approximately $93,000, parts consumption by approximately
$46,000 and engineering labor support by $35,000.




Selling,
General and Administrative (“SG&A”)




The
decrease in SG&A expenses in 2009 resulted from the following: a decrease in
finder’s fees paid in connection with funds raised in 2008 of $187,500 (no
financings took place in 2009); a decrease of bad debt charges incurred in 2008
of $52,136 (no bad debt charges incurred in 2009); employee recruitment and
relocation decreased by $50,173 due to reduced level of recruitment; investor
relations expenses decreased by $41,465 as we terminated all investor relations
support during 2008; office related expenses decreased by $81,340 due to
headcount decreases; rent decreased by $202,914 due to the move to a smaller and
lower cost building in September 2008; consulting expenses decreased by $232,938
in connection with the termination of all business development agreements
requiring upfront payments (these agreements  were replaced by
commission only agreements in July 2008); legal fees decreased by $596,991 due
to lower legal costs for financings (no financings in 2009), lower fees for
corporate legal support and lower fees for patent filings; a decrease of audit
fees of $57,480 due to lower activity levels and the reduction of the number of
financings from 2 in 2008 to zero in 2009; expenses for accounting support
decreased by $25,959 in connection with reduced expenses incurred for SOX
support in 2009 and the fact that there were no financings in 2009; reduced
travel expenses of $135,106 due to reduced headcount; a decrease of depreciation
expense by $35,517 due to a substantial amount of furniture and equipment being
written off and sold in September 2008 because of reduced headcount thereby
decreasing the base amount to be depreciated; business insurance expenses
decreased by $29,448 due to cancellation of some insurance coverage considered
no longer required; reduced insurance premiums (lower coverage due to lower
activity levels) and reduced brokerage fees; inventory variance related expenses
decreased by $68,137, reflecting improved inventory controls due to reduction of
transactions and decrease of personnel moving inventory




-22-




Other
Income (Expense)




The
variance in other income (expense) resulted primarily from senior convertible
note financings of $4,375,000 in 2008 as compared to no financings in 2009 and
the continued decrease of our stock price.   Additionally,
modifications to the terms of our senior convertible notes resulted in losses in
2008.  Additional detail regarding other income/expense
follows:




●
              Due
      to a large decline in our stock price in 2008, we experienced a large
      decrease in the fair value of our conversion option and warrant
      liabilities in 2008.  The fair value of the conversion feature
      and warrants is dependent on several factors, including our stock price
      and the expected term of the conversion feature and
      options.  The fair value of the conversion feature moves in the
      same direction as the stock price and the expected term.  Our
      stock price decreased from $0.68 at January 2, 2008 to $0.14 at December
      31, 2008, which resulted in recognizing non-cash income of
      $21,622,243.  In 2009, our stock price increased from $0.14 at
      December 31, 2008 to $0.17 at December 31, 2009, which caused the
      conversion option and warrant liabilities to increase. Also during 2009,
      the noteholders elected to begin making conversions at the variable
      conversion prices. Therefore, we valued the conversion option liabilities
      related to the 2006 Notes, the April 2008 Notes and the July 2008 Notes at
      the variable conversion rate.  The variable conversion rate of
      the 2006 Notes is 90% of the market price.  The variable
      conversion rate of the April 2008 and July 2008 Notes is 85% of the market
      price.  The 2007 Notes are not convertible at the variable rate
      until August 1, 2010 and were valued at the fixed conversion
      rate.  The lower conversion rate of the notes caused a dramatic
      increase in the number of shares into which the notes are
      convertible.  The above factors resulted in an increase in the
      fair value of the conversion option liabilities in of $7,018,882 in
      2009.




●
              During
      the year ended December 31, 2008, we modified our July 2007 financing to
      reduce both the conversion price on the notes and the exercise price of
      the warrants from $1.21 to $0.50 and we amended the Series Q warrants to
      reduce the exercise price from $1.00 to $0.50.  The decrease in
      the exercise prices, along with the write-off of the carrying value of
      debt issuance costs of $53,905 resulted in a loss on extinguishment of
      debt of $5,182,474 for the year ended December 31, 2008.  We had
      no modifications to our debt in
2009.




●
              During
      2008, we entered into two financing transactions for an aggregate purchase
      price of $4,375,000.  Additionally, we recognized $1,146,033
      related to the contingency option of the Series M warrants in
      2008.  We had no new financings in
  2009.




●
              The
      decrease in amortization of discount on convertible debt resulted from the
      notes we entered into in 2006 being completely amortized, offset by an
      increase in amortization on the notes we entered into in 2007 and 2008 and
      an increase in the debt discount after accounting for the modifications of
      the 2007 and April 2008
financings.




●
                The
      decrease in interest expense is primarily attributable to a lower
      outstanding principal balance due to conversions of the
    notes.




●
              Loss
      on lease settlement is attributable to rendering possession of our prior
      operating facility to the landlord in October 2008.  For the
      year ended December 31, 2008, we accrued $241,261 related to the future
      rentals due under the lease through the remaining contractual
      term.  In 2009, we settled with the former
      landlord.  As a result of the settlement, an additional $21,435
      was charged to expense for the year ended December 31,
    2009.




●
              After
      reducing headcount and relocation to a much smaller facility, we faced
      substantial space constraints.  In 2008, we sold certain
      property and equipment for cash proceeds of $2,750 and wrote off the
      remaining tenant improvements at the old facility, resulting in a loss of
      $65,101.  We had no such sales or write-offs in
      2009.




Liquidity
and Capital Resources




Our
independent registered public accounting firm has qualified their opinion with
respect to our consolidated financial statements to include an explanatory
paragraph related to our ability to continue as a going concern in their reports
for each of our fiscal years ended December 31, 2009 and
2008.  Reports of independent registered public accounting firms
questioning a company's ability to continue as a going concern generally are
viewed very unfavorably by analysts and investors.  There are a number
of risks and challenges associated with such a qualified report including, but
not limited to, a significant impediment to our ability to raise additional
capital or seek financing from entities that will not conduct such transactions
in the face of such increased level of risk of insolvency and loss, increased
difficulty in attracting talent and the diversion of the attention of executive
officers and other key employees to raising capital or financing rather than
devoting time to the day-to-day operations of our business.  We urge
potential investors to review the report of our independent registered public
accounting firm and our consolidated financial statements and related notes
beginning on page F-1 of this Report, the cautionary statements included in the
“Risk Factors” section under Item 1A of this Report and to seek independent
advice concerning the substantial risks related thereto before making a decision
to invest in us, or to maintain an investment in us.




-23-




For the
years ended December 31, 2009 and 2008, we incurred net losses of $12,694,997
and $1,029,859, respectively.  Since our inception, including the year
ended December 31, 2008 we have realized negligible revenues and have financed
our operations almost exclusively from cash on hand raised through the sale of
our securities and borrowings.  As of December 31, 2009, we had a
deficit in working capital of $17,891,538, of which $9,448,534 relates to the
fair value of derivative financial instruments.




As
announced in previous filings, because Raptor's sales efforts had not produced
revenues to date sufficient to support its operating strategy and the Company
did not believe it advisable to seek additional outside financing in support of
that model, the Company shifted its primary operating model to licensing and
technology transfer in order to reduce expenses and conserve cash.




The
conversion to a licensing model as a primary but not exclusive business focus
enabled a reduction in costs of operations including headcount reductions,
salary reductions, benefit plan reductions and a facilities move aimed at
reducing both footprint as well as per square foot cost.  The Company
plans to attempt to address its working capital deficiency by increasing its
sales, maintaining strict expense controls and seeking strategic alliances,
including a merger or other corporate finance transaction with a better
capitalized entity.  While the Company will continue to rigorously
pursue new product opportunities, there can be no assurance that our new model
will generate sufficient revenues to support even our reduced SG&A
expense.  In the event that we are unable to generate sufficient
revenue, Raptor may be forced to sell its assets, cease its operations or file a
bankruptcy petition under the U.S. Bankruptcy Code.




July 2006 Senior Convertible
Note Financing




On July
30, 2006, we entered into a Securities Purchase Agreement with three accredited
investors in connection with a private placement transaction providing for,
among other things, our issuance of senior convertible notes in the aggregate
principal amount of $5 million, Series L warrants to purchase up to an aggregate
of 17,065,623 shares of our common stock and Series M warrants to purchase up to
an aggregate of 7,395,103 shares of our common stock.  We received
aggregate gross proceeds of $5 million from the investors for our issuance of
these notes and warrants.




We
subsequently entered into Amendment and Exchange Agreements, dated January 18,
2007 and amended and restated on January 22, 2007, with the investors from the
July 30, 2006 private placement providing for certain amendments to the senior
convertible notes, Series L warrants, Series M warrants and registration rights
agreement.




These
amendments include, but are not limited to, an increase in the principal amount
of the notes from an aggregate of $5 million to an aggregate of approximately
$7.2 million, an increase in the aggregate number of shares of common stock
issuable upon exercise of the Series L warrants by 5,688,540 (from an aggregate
of 17,065,623 shares to an aggregate of 22,754,163 shares) and a reduction in
the exercise price of the Series L warrants and the Series M warrants from
$0.5054 per share to $0.43948 per share.  We did not receive any
additional cash consideration for these amendments.




In
addition, the Amendment and Exchange Agreements provided for an additional
private placement transaction with one of the investors, which resulted in our
issuance of an additional senior convertible note in the principal amount of
$1.6 million, Series L-2 warrants to purchase an aggregate of 7,281,332 shares
of our common stock and Series M-2 warrants to purchase an aggregate of
2,366,433 shares of our common stock.  We received aggregate gross
proceeds of $1.6 million from the investor for our issuance of these additional
notes and warrants.





-24-





July 2007 Senior Secured
Convertible Note Financing




On July
31, 2007, we entered into a securities purchase agreement with the same
investors for total gross proceeds of $3.5 million for the issuance of senior
secured convertible notes in the aggregate principal amount of $3.5 million,
Series N warrants, Series O warrants and Series P warrants in a private
placement transaction.  The agreement also granted the investors a
first priority perfected security interest in all of our assets and requires our
subsidiary to guaranty our obligations under the secured notes.




The
secured notes bear interest at 9.25% per annum, which may be increased to 15%
upon the occurrence of an event of default, and mature on August 1,
2010.  This date may be extended, at the option of the investors, by
up to two years.  Interest is payable quarterly, starting October 1,
2007.  The secured notes were initially immediately convertible at a
conversion price of $1.2029 per share.  The conversion price was
reduced to $0.50 per share as a result of the April 2008
financing.  The entire outstanding principal balance and any
outstanding fees or interest are due and payable in full on the maturity
date.  Under certain conditions, we may require investors to convert
up to either 50% or 100% of the outstanding balances of the secured notes at any
time shares of our common stock are trading at or above $1.80 or $2.11,
respectively.




The N and
P warrants initially carried a strike price of $1.2029 for each share and were
immediately exercisable.  The O warrants will only become exercisable
by an investor if we conduct mandatory conversions, and then only to the extent
of 65% of the number of shares issued to such investor upon each mandatory
conversion.  The strike price was reduced to $0.50 per share as a
result of the April 2008 financing.




The N and
O warrants expire on the earlier of August 1, 2016 or seven years after the date
all of the shares issuable upon conversion of the secured notes have been
included on an effective registration statement.  The P warrants
expire on the earlier of the maturity date of the secured notes of August 1,
2010, which date may be extended by up to two years at the option of the
investors, and the date we have satisfied our payment obligations under the
warrant holder’s secured note.




In the
event of a default or upon the occurrence of certain fundamental transactions as
defined in the secured notes, the investors will have the right to require us to
redeem the secured notes at a premium.  In addition, at any time on or
after August 1, 2010, the investors may accelerate the partial payment of the
secured notes by requiring that we convert at the lower of the then conversion
price or a 7.5% or 10.0% discount to the recent volume weighted average price of
our common stock, or at our option, redeem in cash, up to an amount equal to 20%
of the aggregate dollar trading volume of our common stock over the prior
20-trading day period.




The
conversion price of the secured notes and the exercise price of the N warrants,
O warrants and P warrants are subject to customary anti-dilution provisions for
stock splits and the like, and are also subject to full-ratchet anti-dilution
protection such that if we issue or are deemed to have issued certain securities
at a price lower than the then applicable conversion or exercise price, then the
conversion or exercise price will immediately be reduced to such lower
price.




The
secured notes and the N warrants, O warrants and P warrants contain certain
limitations on conversion or exercise, including that a holder of those
securities cannot convert or exercise those securities to the extent that upon
such conversion or exercise, that holder, together with the holder’s affiliates,
would own in excess of 4.99% of our outstanding shares of common stock (subject
to an increase, upon at least 61-days’ notice, by the investor to us, of up to
9.99%).





April 2008 Senior Secured
Convertible Note Financing




On April
1, 2008, pursuant to the terms of a securities purchase agreement with our
investors involved in the July 2006, January 2007, and July 2007 financings, for
total gross proceeds of $3.125 million we issued senior secured convertible
notes in the aggregate principal amount of $3.125 million, Series Q warrants and
3,125,000 shares of our common stock in a private placement
transaction.  The agreement grants the investors a first priority
perfected security interest in all of the Company’s assets, requires the Company
to pledge the stock of the Company’s subsidiary and requires the Company’s
subsidiary to guaranty the Company’s obligations under the secured
notes.




The
secured notes bear interest at 10% per annum, which may be increased to 15% upon
the occurrence of an event of default, and mature on March 31,
2010.  This date may be extended, at the option of the investors, by
up to two years.  Interest on the secured notes in the amount of
$625,000, representing two years of interest, was prepaid to the investors at
the closing.  The secured notes were immediately convertible at a
conversion price of $1.00 per share.  The entire outstanding principal
balance and any outstanding fees or interest (if any) are due and payable in
full on the maturity date.  The Q Warrants initially carried a strike
price of $1.00 for each share and are immediately exercisable.  The
strike price was reduced to $0.50 as a result of an amendment included in the
July 2008 financing.  The Q warrants expire on March 31,
2017.




-25-




In the
event of a default or upon the occurrence of certain fundamental transactions as
defined in the secured notes, the investors will have the right to require the
Company to redeem the secured notes at a premium.  In addition, at any
time on or after September 30 2008, the investors may accelerate the partial
payment of the secured notes by requiring that the Company convert at the lower
of the then conversion price or 15% discount to the recent volume weighted
average price of the Company’s common stock, or at the option of the Company,
redeem in cash, up to an amount equal to 100% of the aggregate dollar trading
volume of the Company’s common stock over the prior 20-trading day
period.




The
conversion price of the secured notes and the exercise price of the Q warrants
are subject to customary anti-dilution provisions for stock splits and the like,
and are also subject to full-ratchet anti-dilution protection such that if the
Company issues or is deemed to have issued certain securities at a price lower
than the then applicable conversion or exercise price, then the conversion or
exercise price will immediately be reduced to such lower price.




The
anti-dilution provisions in this financing impacted the strike price of the 2007
Notes and the N, O and P warrants, which resulted in the issuance of 8,502,114
additional N, O and P warrants.  Additionally, the 2007 Notes may be
converted into 4,090,364 additional shares.  The strike price for the
note and warrant shares was reduced to $0.50 from $1.2029, the strike price
applicable for the July 2007 financing.




The
secured notes warrants contain certain limitations on conversion or exercise,
including that a holder of those securities cannot convert or exercise those
securities to the extent that upon such conversion or exercise, that holder,
together with the holder’s affiliates, would own in excess of 4.99% of the
Company’s outstanding shares of common stock (subject to an increase, upon at
least 61-days’ notice, by the investor to the Company, of up to
9.99%).





July 2008 Senior Secured
Convertible Note Financing




On July
28, 2008, pursuant to the terms of a securities purchase agreement with our
investors involved in the July 2006, January 2007, July 2007 and April 2008
financings, for total gross proceeds of $1.25 million we issued senior secured
convertible notes in the aggregate principal amount of $1.25 million, Series R
warrants to purchase up to an aggregate of 2,500,000 shares of the Company’s
common stock and 1,250,000 shares of the Company’s common stock in a private
placement transaction.  In addition, in exchange for the issuance of
replacement warrants (the "Replacement Warrants") and amending certain terms and
conditions of the Company's Series Q warrants (the "Amended and Restated Q
Warrants"), the investors agreed to exercise the Company's Series Q warrants
under certain circumstances.  The agreement also requires the Company
to enter into a security agreement granting the investors a first priority
perfected security interest in all of the Company’s assets, requires the Company
to pledge the stock of the Company’s subsidiary, and requires the Company’s
subsidiary to guaranty the Company’s obligations under the secured
notes.




The notes
bear interest at 10% per annum, which may be increased to 15% upon the
occurrence of an event of default, and mature on July 28, 2010.  This
date may be extended, at the option of the investors, by up to two
years.  Interest on the notes of $250,000, representing two years of
interest, was prepaid to the investors at the closing.  The notes are
immediately convertible at a conversion price of $1.00 per share.  The
entire outstanding principal balance and any outstanding fees or interest (if
any) are due and payable in full on the maturity date.  The Series R
warrants carry a strike price of $1.00 for each share and are immediately
exercisable.  The Series R warrants expire on July 28,
2017.




In the
event of a default or upon the occurrence of certain fundamental transactions as
defined in the notes, the investors will have the right to require the Company
to redeem the notes at a premium.  In addition, at any time on or
after January 28, 2009, the investors may accelerate the partial payment of the
secured notes by requiring that the Company convert at the lower of the then
conversion price or a 15% discount to the recent volume weighted average price
of the Company’s common stock, or at the option of the Company, redeem in cash,
up to an amount equal to 100% of the aggregate dollar trading volume of the
Company’s common stock over the prior 20-trading day period.





-26-




The
conversion price of the notes and the exercise price of the warrants are subject
to customary anti-dilution provisions for stock splits and the like, and are
also subject to full-ratchet anti-dilution protection such that if the Company
issues or is deemed to have issued certain securities at a price lower than the
then applicable conversion or exercise price, then the conversion or exercise
price will immediately be reduced to such lower price.




The notes
and the warrants contain certain limitations on conversion or exercise,
including that a holders of those securities cannot convert or exercise those
securities to the extent that upon such conversion or exercise, that holder,
together with the holder’s affiliates, would own in excess of 4.99% of the
Company’s outstanding shares of common stock (subject to an increase, upon at
least 61-days’ notice, by the investor to the Company, of up to
9.99%).




The notes
prohibit the Company from entering into certain transactions involving a change
of control, unless the successor entity is a public company and it assumes in
writing all of the obligations of the Company under the notes and the other
transaction documents.  In the event of such a transaction, the
investors have the right to force redemption of the notes, at the greater of (i)
200% of the sum of the principal and interest and late fees, and (ii) the
product of (x) 200% of the sum of the amount of principal, interest and late
fees to be redeemed and (y) the quotient determined by dividing (A) the
aggregate cash consideration and the aggregate cash value of any non-cash
consideration per share of common stock paid to the holders of common stock upon
consummation of such transaction (B) the conversion price.




The
holders of the notes are entitled to receive any dividends paid or distributions
made to the holders of the Company's common stock on an "as if converted"
basis.




The
Series R warrants provide for the purchase of up to 2,500,000 shares of the
Company's common stock. The Series R warrants are immediately exercisable, have
an initial exercise price of $0.50 per share and expire on July 28,
2015.




The
Amended and Restated Q warrants reduced the exercise price to the lower of (i)
$0.50 or (ii) 75% of the lesser of (w) the 15-day weighted average price of the
Company's common stock, (x) the lowest 30-day weighted average price of the
Company's common stock, (y) the weighted average price of the Company's common
stock during the first three consecutive day period thirty days prior to the
date of exercise, and (z) the weighted average price of the Company's common
stock during the last three consecutive day period thirty days prior to the date
of exercise.  The variable exercise price is only in effect if there
is an effective registration statement covering the Q warrants.  At
this time, these shares were not registered.




At any
time after the a registration statement filed covering the Amended and Restated
Q warrants is declared effective by the SEC, the Company may elect, no more than
once during any 30 day period, to require the investors to exercise the Amended
and Restated Q warrants, provided that the number of shares of the Company's
common stock into which such warrants are forced to be exercised do not exceed
15% of the 20-day trading volume in number of shares of the Company's common
stock.




The
Replacement Warrants provide for the purchase of up to 6,250,000 shares of the
Company's common stock, upon the satisfaction of certain conditions with respect
to the Amended and Restated Q warrants.  The Replacement Warrants
become exercisable, on a one-for-one basis, for every Amended and Restated Q
warrant that the investors exercise.  The Replacement Warrants expire
on July 28, 2015, and have an exercise price equal to the lower of (i) $0.50 or
(ii) 75% of number equal to the lesser of (w) the 15-day weighted average price
of the Company's common stock, (x) the lowest 30-day weighted average price of
the Company's common stock, (y) the weighted average price of the Company's
common stock during the first 3 consecutive day period 30 days prior to the date
of exercise, and (z) the weighted average price of the Company's common stock
during the last 3 consecutive day period 30 days prior to the date of
exercise.




Item
      8.
            Financial
      Statements




The
financial statements and corresponding notes to the financial statements called
for by this item appear under the caption “Index to Financial Statements”
beginning on Page F-1 of this Report.




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




There
have been no events required to be reported by this Item 8.




-27-




Item
      9A(T).
            Controls
      and Procedures




Evaluation of Disclosure Controls and
Procedures




Our Chief
Executive Officer and Chief Financial Officer (our principal executive officer
and principal financial officer, respectively) have concluded, based on their
evaluation as of December 31, 2009, that the design and operation of our
“disclosure controls and procedures” (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended (“Exchange Act”)) are effective 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 SEC’s rules and forms,
including to ensure that information required to be disclosed by us in the
reports we file or submit under the Exchange Act is accumulated and communicated
to our management, including our principal executive officer and principal
financial officer, or persons performing similar functions, as appropriate to
allow timely decisions regarding whether or not disclosure is
required.




Management’s Report on Internal Control over Financial
Reporting




Our management is responsible for establishing and
maintaining adequate “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Exchange
Act).  Under the supervision and
with the participation of our management, including our principal executive
officer and principal financial officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
framework set forth inInternal Control — Integrated
Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission.  Based on this
evaluation, our management concluded that our internal control over financial
reporting was effective as of December 31, 2009.




Our internal control over financial reporting is
supported by written policies and procedures, that:




(1)
            pertain to the maintenance of records that, in
      reasonable detail, accurately and fairly reflect the transactions and
      dispositions of our assets;


(2)
            provide reasonable assurance that transactions are
      recorded as necessary to permit preparation of financial statements in
      accordance with generally accepted accounting principles, and that
      receipts and expenditures of our company are being made only in accordance
      with authorizations of our management and directors;
      and


(3)
            provide reasonable assurance regarding prevention
      or timely detection of unauthorized acquisition, use or disposition of our
      assets that could have a material effect on the financial
      statements.




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




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




Changes in Internal Control over
Financial Reporting




During
the quarter ended December 31, 2009, there were no changes in our internal
controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.




Item
      9B.
            Other
      Information




None.




-28-




PART
III




Item
      10.
            Directors,
      Executive Officers and Corporate
Governance




Directors
and Executive Officers




Set forth
below is certain information with respect to our directors and executive
officers.





Name
            Age
            Position with
      CompanyThomas
      M. Wittenschlaeger
            52
            Chief
      Executive Officer, President, Director and Chairman of the
      BoardBob
      van Leyen
            66
            Chief
      Financial Officer and SecretaryKen
      Bramlett
            50
            Director
      (1) (2)
      (4)Larry
      L. Enterline
            57
            Director
      (1)
      (3)






(1)
            Member
      of the Audit, Nominating and Governance, and Compensation
      Committees.


(2)
            Chairperson
      of the Nominating and Governance
Committee.


(3)
            Chairperson
      of the Audit Committee.


(4)
            Chairperson
      of the Compensation Committee.




Thomas M. Wittenschlaeger,
(age 52), is our Chief Executive Officer, President, a director and Chairman of
the Board.  Mr. Wittenschlaeger has accumulated more than twenty-five
years of experience in the high technology products and services area, much of
it in general management with leadership positions in operating units ranging in
size from $3 million to $500 million in annual revenues.  From 2002 to
2004, he was Senior Vice President of Corporate Development and Chief Technical
Officer at Venturi Partners, Inc., a leading provider of information technology
and professional staffing services nationwide.  From 2000 to 2002, he
was Senior Vice President and General Manager of ViaSat Satellite Networks, the
commercial arm of ViaSat, Inc.  He is a 1979 graduate of the U.S.
Naval Academy in Annapolis, Maryland with a B.S. in electrical engineering and
post-graduate work in nuclear engineering.  He is also a graduate of
the UCLA Executive Program in Business and co-founder of UCLA's Executive
Program in Marketing.  Mr. Wittenschlaeger has  authored and
has been granted 4 core patents and is pending on 8 additional Raptor patents
related to hybrid fabric  transport, communications, computing and
security architectures.  Mr. Wittenschlaeger serves on the board of
directors of Lantronix, Inc. as Chairman of the Nominating and Governance
Committee.  Mr. Wittenschlaeger has been our Chairman of the Board,
President and Chief Executive Officer since March 15, 2004.  Mr.
Wittenschlaeger’s (CEO) qualifications to serve on the Board include more than
twenty-eight years of experience in the high technology products and services
arena, much of it in general management with leadership positions in operating
units ranging in size from $3 million to $500 million in annual revenues.
Earlier positions, in roles ranging from senior systems engineer to chief
corporate strategist at the Hughes Aircraft Company are relevant towards
providing entrepreneurial vision to this emerging technologies company. He is a
1979 graduate of the U.S. Naval Academy in Annapolis, Maryland with a B.S. in
electrical engineering and post-graduate work in nuclear engineering. He is also
a graduate of UCLA Executive Program in Business and co-founder of UCLA’s
Executive Program in Marketing. These roles offer the Company necessary
expertise in addressing the governmental marketplace with a particular focus on
the Department of Defense.




Larry L. Enterline, (age 57),
is one of our directors and Chairperson of the Audit Committee.  In
February 2006, Mr. Enterline was reappointed as the Chief Executive Officer of
COMSYS IT Partners, Inc., a leading provider of information technology services,
having previously served from December 2000 to September 2004 as the Chief
Executive Officer of Venturi Partners, Inc. (the predecessor to COMSYS IT
Partners prior to the September 2004 merger between Venturi Partners and COMSYS
Holding, Inc.).  Mr. Enterline has also served as a director of COMSYS
IT Partners since the 2004 merger, previously having served as a director of
Venturi Partners from December 2000 to March 2003 and as chairman of the board
of Venturi Partners from April 2003 until the date of the
merger.  From 1989 to November 2000, Mr. Enterline served in various
management roles with Scientific Atlanta, Inc., a leading national global
manufacturer and supplier of cable network products, the last of which was
Corporate Senior Vice President for Worldwide Sales and Service.  He
also held management positions in the marketing, sales, engineering and products
areas with Bailey Controls Company and Reliance Electric Company from 1974 to
1989.  Mr. Enterline is also a member of the board of directors
of Concurrent Computer Corp.  Mr. Enterline has been one of our
directors since October 18, 2004.  Mr. Enterline has served as a
Director and Chairman of the Audit Committee, since October 18, 2004. In
February 2006, he was appointed as the CEO of COMSYS IT Partners, Inc. From
September 2004 to February 2006, he acted as a private investor. From 2000 to
September 2004, he served as CEO and Director of Venturi Partners, Inc., a
leading provider of information technology and professional staffing services.
From 1989 to 2000, he served in various management roles with Scientific
Atlanta, Inc. He brings decades of market-defining successes in publicly traded,
technology-centric companies to our Board, as well as demonstrated expertise in
corporate restructurings, repositioning, and mergers and acquisitions. He is
also a member of the Board of Directors of COMSYS IT Partners, Inc. and
Concurrent Computers Corporation.




-29-




Ken Bramlett, (age 50), is one
of our directors and Chairperson of the Nominating and Governance Committee and
the Compensation Committee.  Mr. Bramlett has served as Senior Vice
President and General Counsel of COMSYS IT Partners, Inc., since January
2006.  Prior to that he served as a partner with the Charlotte, North
Carolina law firm of Kennedy Covington Lobdell & Hickman, L.L.P. from March
2005 to December 2005.  Mr. Bramlett is also a director of World
Acceptance Corporation, where he has served on the board of directors since
1994.  From 1996 to 2004, Mr. Bramlett served as Senior Vice President
and General Counsel of Venturi Partners, Inc., a leading national provider of
information technology and professional staffing services and from 1990 to 1996
as a partner with the law firm of Robinson, Bradshaw and Hinson,
P.A.  Mr. Bramlett has been one of our directors since December 2,
2004.  Mr. Bramlett has served as one of our Directors and Chairman of
the Nominating and Governance Committee since December 2, 2004.  He
has served as Senior Vice President and General Counsel of COMSYS IT Partners,
Inc. since January 2006.  Prior to that he served as a partner with
the Charlotte, North Carolina law firm of Kennedy Covington Lobdell &
Hickman, L.L.P. from March 2005 to December 2005.  He is a member on
the Board of Directors of World Acceptance Corporation since 1994. From 1996 to
2004, he served as a Senior Vice President and General Counsel of Venturi
Partners, Inc., a leading national provider of information technology and
professional staffing services.  From 1990 to 1996 he has been a
partner with the law firm of Robinson Bradshaw and Hinson, P.A.  He
brings 20 years of experience in corporate law and governance, public and
private equity, and mergers and acquistions to our Board.




Bob Van Leyen, (age 66), is
our Chief Financial Officer and Secretary.  Mr. Van Leyen has more
than twenty-five years of experience working in the high-tech industry, holding
various executive positions in finance, operations and general
management.  From 2002 to 2003, Mr. Van Leyen served as a partner with
Tatum CFO, L.L.C. where he provided financial and operational support to
start-up companies in the high-tech industry.  From 1999 to 2001, he
was a divisional Chief Financial Officer at Wyle Electronics.  During
his twenty-four years of employment, Mr. Van Leyen has managed extensive
financial operations organizations in Europe, Asia and the United States,
providing financial support to operations.  Mr. Van Leyen attended the
Dutch Institute of Chartered Auditors and holds a Dutch degree equivalent to a
U.S. Bachelor's degree in Business Administration.  Mr. Van Leyen has
served as our Chief Financial Officer and Secretary since September 29,
2003.




Term
of Office and Family Relationships




All
directors hold office until the next annual meeting of shareholders or until
their respective successors are elected or until their earlier death,
resignation or removal.  Executive officers are appointed by and serve
at the discretion of our Board of Directors.  There are no family
relationships among our executive officers and directors.




Board
Leadership Structure




The Board
believes that the Company’s Chief Executive Officer is best situated to serve as
Chairman because he is the director most familiar with the Company’s business
and industry, and most capable of effectively identifying strategic priorities
and leading the discussion and execution of strategy. Independent directors and
management have different perspectives and roles in strategy development. The
Company’s independent directors bring experience, oversight and expertise from
outside the company and industry, while the Chief Executive Officer brings
company-specific experience and segment-specific expertise. The Board believes
that the combined role of Chairman and Chief Executive Officer promotes strategy
development and execution, and facilitates information flow between management
and the Board, which are essential to effective governance.




Board’s
Role in Risk Oversight




The Board
has an active role, as a whole and also at the committee level, in overseeing
management of the Company’s risks. The Board regularly reviews information
regarding the Company’s credit, liquidity and operations, as well as the risks
associated with each. The Company’s Compensation Committee is responsible for
overseeing the management of risks relating to the Company’s executive
compensation plans and arrangements. The Audit Committee oversees management of
financial risks. The Nominating and Corporate Governance Committee manages risks
associated with the independence of the Board of Directors and potential
conflicts of interest. While each committee is responsible for evaluating
certain risks and overseeing the management of such risks, the entire Board of
Directors is regularly informed through committee reports about such
risks.




-30-




Board
Committees




Our Board
of Directors currently has an Audit Committee, a Nominating and Governance
Committee and a Compensation Committee.  Our Board of Directors has
determined that Larry L. Enterline and Ken Bramlett each qualify as an
“independent director” as defined in Rule 5605(a)(2) of the NASDAQ Listing Rules
and that Messrs. Enterline and Bramlett meet the applicable NASDAQ listing
standards for designation as an “Audit Committee Financial Expert.”




Audit
Committee




The Audit
Committee consists of two Board members, Larry L. Enterline, and Ken
Bramlett.  Mr. Enterline is the chairperson of the Audit
Committee.  The duties of the Audit Committee include meeting with our
independent registered public accounting firm to review the scope of the annual
audit and to review our quarterly and annual financial statements before the
statements are released to our shareholders.  The Audit Committee also
evaluates the independent registered public accounting firm’s performance and
has sole authority to appoint or replace the independent registered public
accounting firm (subject, if applicable, to shareholder ratification) and to
determine whether the independent registered public accounting firm should be
retained for the ensuing fiscal year.  In addition, the Audit
Committee reviews our internal accounting and financial controls and reporting
systems practices.  A copy of the Audit Committee’s current charter
may be found at our website at www.raptor-networks.com.




Nominating
and Governance Committee




The
Nominating and Governance Committee consists of two Board members, Larry L.
Enterline and Ken Bramlett. Mr. Bramlett is the chairperson of the Nominating
and Governance Committee.  The Nominating and Governance Committee
identifies and reviews the qualifications of candidate nominees to the Board of
Directors.  The Nominating and Governance Committee utilizes a variety
of methods for identifying and evaluating nominees for director, including
candidates that may be referred by stockholders.  Stockholders that
desire to recommend candidates for the board for evaluation may do so by
contacting our Secretary in writing, including the candidate’s name and
qualifications and a statement from the candidate that he or she consents to
being named in our proxy statement and will serve as a director if
elected.  Candidates may also come to the attention of the Nominating
and Governance Committee through current board members, professional search
firms and other persons.  A copy of the Nominating and Governance
Committee’s current charter may be found at our website at www.raptor-networks.com.  The
Governance Committee follows the guidelines of the Company and examines, among
other things, the following qualifications and skills of director
candidates—their business or professional experience, their integrity and
judgment, their records of public service, their ability to devote sufficient
time to the affairs of the Company, the diversity of backgrounds and experience
they will bring to the Board, and the needs of the Company. The Governance
Committee also believes that all nominees should be individuals of substantial
accomplishment with demonstrated leadership capabilities. The Governance
Committee does not have a formal policy with regard to the consideration of
diversity in indentifying nominees for Director.




Compensation
Committee




The
Compensation Committee consists of two Board members, Larry L. Enterline and Ken
Bramlett.  Mr. Bramlett is the chairperson of the Compensation
Committee.  The Compensation Committee is responsible for advising the
Board of Directors regarding our responsibilities relating to compensation of
our executive officers and Board members.  The Compensation Committee
is also responsible for evaluating and recommending to the Board of Directors
our executive compensation plans, policies and programs.  A copy of
the Compensation Committee’s current charter may be found at our website at
www.raptor-networks.com.




-31-




Code
of Ethics




Our board
of directors has adopted a Code of Business Conduct and Ethics that applies to
all of our directors, officers and employees and an additional Code of Ethics
that applies to our Chief Executive Officer and our senior financial
officers.




We intend
to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to
amendments to or waivers from provisions of these codes that relate to one or
more of the items set forth in Item 406(b) of Regulation S-B by describing on
our Internet website, located at www.raptor-networks.com,
within four business days following the date of a waiver or a substantive
amendment, the date of the waiver or amendment, the nature of the amendment or
waiver and the name of the person to whom the waiver was granted.




Section
16(a) Beneficial Ownership Reporting Compliance




Section
16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”),
requires our executive officers and directors, and persons who beneficially own
more than 10% of our common stock, to file initial reports of ownership and
reports of changes in ownership with the SEC.  These officers,
directors and shareholders are required by SEC regulations to furnish us with
copies of all such reports that they file.




Based
solely upon a review of copies of these reports furnished to us during 2009 and
thereafter, or written representations received by us from reporting persons
that no other reports were required, we believe that all Section 16(a) filing
requirements applicable to our reporting persons during 2009 were complied
with.




Item
      11.
            Executive
      Compensation




Compensation
of Executive Officers




The
following section contains information about the compensation paid to our
executive officers and directors during the years ended December 31, 2009 and
2008.




Summary
Compensation Table




The
following table provides information concerning the compensation for the years
ended December 31, 2009 and 2008 for our principal executive officer and our
principal financial officer, who were the only persons that served as executive
officers during 2009 (collectively, the “named executive
officers”).




Summary
Compensation Table





Name
      and
                Principal
      Position
            
            Year
            
            Salary
                ($)
            
            Bonus
                ($)
            
            
            Stock
                Awards
                ($)
            
            
            Option
      Awards
                ($)(1)
            
            
            Non-Equity
                Incentive
                Plan
      Compensation
                ($)
            
            
            Nonqualified
      Deferred Compensation Earnings
                ($)
            
            
            All
      Other Compensation
                ($)
            
            Total
                ($)Thomas
      M. Wittenschlaeger,
            
            2009
            
            145,679(2)
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            11,862(3)
            
            173,523Chief
      Executive Officer and President
            
            2008
            
            185,333(2)
            
            -
            
            
            -
            
            
            47,988
            
            
            -
            
            
            -
            
            
            42,798(4)
            
            244,070Bob
      van Leyen,
            
            2009
            
            128,711(5)
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            12,060(6)
            
            153,202Chief
      Financial Officer
            
            2008
            
            153,000(5)
            
            -
            
            
            -
            
            
            37,324
            
            
            -
            
            
            -
            
            
            19,183(6)
            
            184,580






(1)
              These
      amounts are equal to the aggregate grant date fair value, computed in
      accordance with ASC 718, but without giving effect to estimated
      forfeitures related to service-based vesting conditions.  For
      additional information on the valuation assumptions with respect to these
      option grants, refer to Note 1 of our financial statements and related
      notes beginning on page F-1 of this Report.  See our “Outstanding
      Equity Awards at December 31, 2009” table below for more information on
      options held by the named executive
officers.
  -32-


(2)
              Effective
      January 1, 2008, our compensation committee approved an increase to Mr.
      Wittenschlaeger’s annual salary from $180,000 to $192,000.  Effective
      November 1, 2008 Mr. Wittenschlaeger’s annual salary was, on a temporary
      basis, decreased from $192,000 to $152,000 in connection with the cash
      flow constraints of the Company.  Effective September 15, 2009, Mr.
      Wittenschlaeger’s annual salary was reinstated at
  $192,000.


(3)
              Consists
      of  health and life insurance
premiums.


(4)
              Consists
      of $18,000 in reimbursement of living expenses for an apartment in
      Southern California, $11,617 in relocation expenses and $13,181 in health
      and life insurance premiums.


(5)
              Effective
      January 1, 2008, our compensation committee approved an increase to Mr.
      van Leyen’s annual salary from $150,000 to $160,000.  Effective
      November 1, 2008, Mr. van Leyen’s annual salary was on a temporary basis
      decreased from $160,000 to $120,000 in connection with the cash flow
      constraints of the Company.  Effective September 15, 2009, Mr. van
      Leyen’s  annual salary was reinstated at
  $160,000.


(6)
              Consists
      of health and life insurance
premiums.




Employment
Agreements and Executive Compensation




There are
no employment contracts, termination agreements or change-in-control
arrangements between us and any of our named executive officers.  The
Compensation Committee reviews and, if deemed appropriate, adjusts the annual
salaries of our named executive officers on at least an annual
basis.  The Compensation Committee may from time to time grant
performance or similar cash bonuses to our named executive officers at its
discretion.  The Compensation Committee may also periodically award
options or warrants to our named executive officers under our existing option
and incentive plans at its discretion.




Outstanding
Equity Awards At Fiscal Year End




The
following table sets forth information about outstanding equity awards held by
our named executive officers as of December 31, 2009.




Outstanding
Equity Awards at December 31, 2009





Stock
      AwardsName
            
            Option
      Awards
            
            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:Number
              of
              Securities
            
            
            Number
              of
              Securities
            
            
            Equity
              Incentive
              Plan
              Awards:
              Number
      of
              Securities
            
            
            
            
            
            
            
            Market
      or
              Payout
              Value
      of
              Unearned
              Shares,
              Units
      orUnderlying
                Unexercised
                Options
                (#)
                Exercisable
            
            
            Underlying
                Unexercised
                Options
                (#)
                Unexercisable
            
            
            Underlying
                Unexercised
                Unearned
                Options
                (#)
            
            
            Option
                Exercise
                Price
                ($)
            
            
            Option
                Expiration
                Date
            
            Other
                Rights
      That
                Have
      Not
                Vested
                ($)Thomas
      M. Wittenschlaeger
            
            
            350,000
            
            
            
            -
            
            
            -
            
            
            1.00
            
            
            7/15/2012
            
            -
            
            
            -
            
            
            -
            
            
            -Thomas
      M. Wittenschlaeger
            
            
            30,000
            
            
            
            60,000
            
            
            -
            
            
            0.67
            
            
            1/02/2016
            
            -
            
            
            -
            
            
            -
            
            
            -Bob
      van Leyen
            
            
            300,000
            
            
            
            -
            
            
            -
            
            
            1.00
            
            
            9/29/2011Bob
      van Leyen
            
            
            23,333
            
            
            
            46,667
            
            
            -
            
            
            0.67
            
            
            1/02/2016
            
            -
            
            
            -
            
            
            -
            
            
            -




Compensation
of Directors




Through
June 30, 2008, each of our non-employee directors was
entitled to receive cash compensation in the amount of $15,000 per year for
service on our board of directors.  Effective July 1, 2008, the Board
waived payment of Director’s Fees in connection with the current cash flow
constraints the Company is experiencing.  This situation will continue
until the Company is able to improve its cash flow position. We reimburse all
directors for out-of-pocket expenses incurred in connection with attendance at
board and committee meetings.  We currently have a policy in place to
grant each non-employee director an option to purchase shares of our common
stock on the date of his or her commencement of service as a
director.  We may also periodically award options or warrants to our
directors under our existing option and incentive plans.




-33-




The
following table provides information concerning the compensation of our
directors for the year ended December 31, 2009.




Director
Compensation





Name
            
            Fees
      Earned
                or
      Paid
                in
      Cash
                ($)
            
            
            Stock
                Awards
                ($)
            
            
            Option
                Awards
                ($)(1)
            
            
            Non-Equity
      Incentive Plan Compensation ($)
            
            
            Change
                in
      Pension
                Value
      and Nonqualified Deferred Compensation Earnings
                ($)
            
            
            All
      Other Compensation
                ($)
            
            
            Total
                ($)Larry
      L. Enterline
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Ken
      Bramlett
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -






(1)
              These
      amounts are equal to the aggregate grant date fair value, computed in
      accordance with ASC 718, but without giving effect to estimated
      forfeitures related to service−based vesting conditions. For additional
      information on the valuation assumptions with respect to these option
      grants, refer to Note 1 of our financial statements and related notes
      beginning on page F-1 of this
Report.


(2)
              At
      December 31, 2009, Mr. Enterline held options to purchase an aggregate of
      100,000 shares of common stock at an exercise price of $1.00 per share, of
      which 100,000 options were vested at December 31, 2009.  In addition,
      Mr. Enterline held an additional 90,000 options to purchase common stock
      at an exercise price of $0.67.  One-third of these options (30,000)
      have vested as of December 31,
2009.


(3)
              At
      December 31, 2009, Mr. Bramlett held options to purchase an aggregate of
      100,000 shares of common stock at an exercise price of $1.00 per share, of
      which all 100,000 options were vested at December 31, 2009.  In
      addition, Mr. Bramlett held an additional 90,000 options to purchase
      common stock at an exercise price of $0.67.  One third of these
      options (30,000) have vested as of December 31,
  2009.





Stock
Option Plan




General




Our 2005
Stock Plan was approved by our Board of Directors on April 7, 2005, approved by
our shareholders on June 9, 2005 and amended and restated as the First Amended
and Restated 2005 Stock Plan (“2005 Plan”) by our Board of Directors on June,
29, 2007.  We filed a registration statement on Form S-8 with the SEC
in May 2007 to cover the issuance of up to 3,000,000 shares of common stock
underlying options and stock purchase rights authorized for issuance under the
2005 Plan and qualified for issuance the underlying securities with the
California Department of Corporations in July 2007.




All
stock options issued prior to shareholder approval of our 2005 Plan were granted
outside of a formal stock option plan (“Non-Plan Options”).  As of
March 22, 2010, options to purchase a total of 850,000 shares of common
stock were outstanding under Non-Plan Options.  As of March 22,
2010, there were 617,000 outstanding options to purchase common stock under the
2005 Plan.  Excluding these 617,000 outstanding options, 2,383,000
shares will remain available for issuance under the 2005 Plan, subject to the
limitations of authorized common stock.  We anticipate that future
stock options will be issued pursuant to our 2005 Plan or other stock option
plans as may be approved by our Board and shareholders in the
future.




-34-




Shares
Subject to the Plan




A total
of 3,000,000 shares of common stock are authorized for issuance under the 2005
Plan.  Any shares of common stock that are subject to an award but are
not used because the terms and conditions of the award are not met, or any
shares that are used by participants to pay all or part of the purchase price of
any option, may again be used for awards under the 2005 Plan.




Administration




The 2005
Plan is to be administered by our Board of Directors or an appropriate committee
of our Board of Directors.  It is the intent of the 2005 Plan that it
be administered in a manner such that option grants and exercises would be
“exempt” under Rule 16b-3 of the Securities Exchange Act of 1934, as amended
(the “Exchange Act”).




Our Board
of Directors or an appropriate committee is empowered to select those eligible
persons to whom options shall be granted under the 2005 Plan, to determine the
time or times at which each option or stock purchase right shall be granted,
whether options will be incentive stock options (“ISOs”) or nonqualified stock
options (“NQOs”), the number of shares to be subject to each option, and to fix
the time and manner in which each such option may be exercised, including the
exercise price and option period, and other terms and conditions of such
options, all subject to the terms and conditions of the 2005
Plan.  Our Board of Directors or an appropriate committee has sole
discretion to interpret and administer the 2005 Plan and our decisions regarding
the 2005 Plan are final.




The 2005
Plan may be wholly or partially amended or otherwise modified, suspended or
terminated at any time and from time to time by our Board of
Directors.  Neither our Board of Directors nor any committee may
materially impair any outstanding options without the express consent of the
optionee or increase the number of shares subject to the 2005 Plan, materially
increase the benefits to optionees under the 2005 Plan, materially modify the
requirements as to eligibility to participate in the 2005 Plan or alter the
method of determining the option exercise price without shareholder
approval.  No option may be granted under the 2005 Plan after
April 7, 2015.




Option
Terms




ISOs
granted under the 2005 Plan must have an exercise price of not less than 100% of
the fair market value of the common stock on the date the ISO is granted and
must be exercised, if at all, within ten years from the date of
grant.  In the case of an ISO granted to an optionee who owns more
than 10% of our total voting securities on the date of grant, the exercise price
may not be less than 110% of the fair market value of the common stock on the
date of grant and the option period may not exceed five years.  NQOs
granted under the 2005 Plan must have an exercise price of not less than 85% of
the fair market value of the common stock on the date the NQO is
granted.




Options
may be exercised during a period of time fixed by our Board of Directors or an
appropriate committee, except that no option may be exercised more than ten
years after the date of grant.  In the discretion of our Board of
Directors or an appropriate committee, payment of the purchase price for the
shares of stock acquired through the exercise of an option may be made in the
manner and for the type of consideration determined by our Board of Directors or
an appropriate committee, which may include cash, check, one or more promissory
notes, shares of our common stock, consideration received under a cashless
exercise program implemented in connection with the 2005 Plan or any combination
of the foregoing.





Federal
Income Tax Consequences




Holders
of NQOs do not realize income as a result of a grant of the option, but normally
realize compensation income upon exercise of an NQO to the extent that the fair
market value of the shares of common stock on the date of exercise of the NQO
exceeds the exercise price paid.  We are required to withhold taxes on
ordinary income realized by an optionee upon the exercise of a
NQO.  In the case of an optionee subject to the “short-swing” profit
recapture provisions of Section 16(b) of the Exchange Act, the optionee realizes
income only upon the lapse of the six-month period under Section 16(b),
unless the optionee elects to recognize income immediately upon exercise of his
or her option.




-35-




Holders
of ISOs will not be considered to have received taxable income upon either the
grant or the exercise of the option.  Upon the sale or other taxable
disposition of the shares, long-term capital gain will normally be recognized on
the full amount of the difference between the amount realized and the option
exercise price paid if no disposition of the shares has taken place within
either two years from the date of grant of the option or one year from the date
of exercise.  If the shares are sold or otherwise disposed of before
the end of the one-year or two-year periods, the holder of the ISO must include
the gain realized as ordinary income to the extent of the lesser of the fair
market value of the option stock minus the option price, or the amount realized
minus the option price.  Any gain in excess of these amounts,
presumably, will be treated as capital gain.  We are entitled to a tax
deduction in regard to an ISO only to the extent the optionee has ordinary
income upon the sale or other disposition of the option shares.




Upon the
exercise of an ISO, the amount by which the fair market value of the purchased
shares at the time of exercise exceeds the option price will be an “item of tax
preference” for purposes of computing the optionee’s alternative minimum tax for
the year of exercise.  If the shares so acquired are disposed of prior
to the expiration of the one-year and two-year periods described above, there
should be no “item of tax preference” arising from the option
exercise.




The
tax discussion set forth above is included for general information only and is
based upon present law.  Each holder of options under the 2005 Plan
should consult his or her own tax advisor as to the specific tax consequences of
the transaction to him or her, including application and effect of federal,
state, local and other tax laws and the possible effects of changes in federal
or other laws.




Indemnification
of Directors and Officers




Section
7-109-102 of the Colorado Business Corporations Act (the “Colorado Act”)
authorizes a Colorado corporation to indemnify any director against liability
incurred in any proceeding if he or she acted in good faith and in a manner he
or she reasonably believed to be in or not opposed to the best interests of the
corporation and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his or her conduct was unlawful.




Unless
limited by a corporation’s articles of incorporation, Section 7-109-105 of the
Colorado Act authorizes a director to apply for indemnification to the court
conducting the proceeding or another court of competent
jurisdiction.  Unless limited by the articles of incorporation,
Section 7-109-107 of the Colorado Act extends this same right to officers of a
corporation as well.




Unless
limited by a corporation’s articles of incorporation, Section 7-109-103 of the
Colorado Act requires that a Colorado corporation indemnify a director who was
wholly successful in defending any proceeding to which he or she was a party
against reasonable expenses incurred in connection therewith.  Unless
limited by the articles of incorporation, Section 7-109-107 of the Colorado Act
extends this same protection to officers of a corporation as well.




Pursuant
to Section 7-109-104 of the Colorado Act, a Colorado corporation may advance a
director’s expenses incurred in defending any action or proceeding upon receipt
of an undertaking and a written affirmation of his or her good faith belief that
he or she has met the standard of conduct specified in Section 7-109-102
described above.  Unless limited by the articles of incorporation,
Section 7-109-107 of the Colorado Act extends this same protection to officers
of a corporation as well.




Regardless
of whether a director or officer has the right to indemnity, Section 7-109-108
of the Colorado Act allows a Colorado corporation to purchase and maintain
insurance on such directors or officers behalf against liability resulting from
his or her role as director or officer.




Our
Articles of Incorporation do not limit any of the rights afforded to our
directors and officers under the Colorado Act and Article VI of our Bylaws
states that any director or officer who is involved in litigation by reason of
his or her position with us as a director or officer shall be indemnified and
held harmless by us to the fullest extent authorized by law as it now exists or
may subsequently be amended (but, in the case of any such amendment, only to the
extent that such amendment permits the corporation to provide broader
indemnification rights).  Our directors and officers are also
presently covered by an insurance policy indemnifying them against certain
liabilities, including certain liabilities arising under the Securities Act,
which might be incurred by them in such capacities and against which they may
not be indemnified by us.  We believe that the indemnification and
insurance provided to our directors and officers is necessary to attract and
retain qualified persons as directors and officers.




-36-




To the
extent indemnification for liabilities arising under the Securities Act of 1933
may be permitted to our directors, officers and controlling persons under the
above provisions, or otherwise, we have been advised that in the opinion of the
SEC such indemnification is against public policy as expressed in the Securities
Act of 1933 and is, therefore, unenforceable.




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




The
following table sets forth, as of March 22, 2010, certain information with
respect to the beneficial ownership of our stock by (i) each of our named
executive officers, (ii) each of our directors, (iii) each person
known to us to be the beneficial owner of more than 5% of each class of our
outstanding voting securities, and (iv) all of our directors and executive
officers as a group.




Beneficial
ownership is determined in accordance with the rules of the SEC, and includes
voting or investment power with respect to the securities.  To our
knowledge, except as indicated by footnote, and subject to community property
laws where applicable, the persons named in the table below have sole voting and
investment power with respect to all shares of common stock shown as
beneficially owned by them.  Shares of common stock underlying
derivative securities, if any, that currently are exercisable or convertible or
are scheduled to become exercisable or convertible for or into shares of common
stock within 60 days after the date of the table are deemed to be outstanding in
calculating the percentage ownership of each listed person or group but are not
deemed to be outstanding as to any other person or group.  Percentage
of beneficial ownership is based on 85,922,743 shares of common stock
outstanding as of March 22, 2010.




Name of Beneficial Owner(1)
            
            Number
      of Shares of Common
              Stock Beneficially Owned
            
            Percent
      of Common Stock Beneficially
      OwnedThomas
      M. Wittenschlaeger
            
            
            3,410,000
            (2)
            
            
            3.97
            %Bob
      van Leyen
            
            
            746,666
            (3)
            
            
            .87
            %Ken
      Bramlett
            
            
            160,000
            (4)
            
            
            *Larry
      L. Enterline
            
            
            160,000
            (5)
            
            
            *All
      executive officers and directors as a group (4 persons)
            
            
            4,476,666
            (6)
            
            
            5.21
            %Castlerigg Master Investments
      Ltd.
              40 West 57th St
              26th Floor
              New York, NY 10019
            
            
            9,536,365
            (7)
            
            
            9.99
            %




* Less
than 0.5%.




(1)
              Unless
      otherwise indicated, the address is c/o Raptor Networks Technology, Inc.,
      1508 S. Grand Avenue, Suite 150, Santa Ana, California
      92705.


(2)
              Thomas
      M. Wittenschlaeger is our President, Chief Executive Officer and Chairman
      of the Board. Includes 410,000
      shares of common stock issuable upon the exercise of options which were
      exercisable as of March 22, 2010 or exercisable within 60 days after
      March 22, 2010.


(3)
              Bob
      Van Leyen is our Chief Financial Officer and
      Secretary.  Includes 346,666 shares of common stock issuable
      upon the exercise of options which were exercisable as of March 22,
      2010 or exercisable within 60 days after March 22,
  2010.


(4)
              Ken
      Bramlett is one of our directors.  Represents 160,000 shares of
      common stock issuable upon the exercise of options which were exercisable
      as of March 22, 2010 or exercisable within 60 days after
      March 22, 2010.


(5)
              Larry
      L. Enterline is one of our directors.  Represents 160,000 shares
      of common stock issuable upon the exercise of options which were
      exercisable as of March 22, 2010 or exercisable within 60 days after
      March 22, 2010.


(6)
              Represents
      3,000,000 shares of common stock and 410,000 shares issuable upon the
      exercise of options held by Thomas M. Wittenschlaeger; 400,000 shares of
      common stock and 346,666 shares issuable upon the exercise of options held
      by Bob van Leyen; 160,000 shares issuable upon the exercise of options
      held by Ken Bramlett; and 160,000 shares issuable upon the exercise of
      options held by Larry L. Enterline.
  -37-


(7)
              Represents9,536,365 shares of common stock underlying
      convertible notes and warrants held by Castlerigg Master Investments Ltd.
      (“Master”), which represents a portion of the number of shares of common
      stock that are issuable upon the conversion of principal
      and/orinterest, and the payment of principal and/or
      interest in shares of common stock, under convertible notes and the
      exercise of warrants held by Master.  The number of shares
      beneficially owned by Master is capped by a contractual 9.99% beneficial
      ownership limitation set forth in the convertible notes and warrants held
      by Master.  If the 9.99% beneficial ownership limitation is
      disregarded, Master would beneficially own 68,442 shares of common stock,
      approximately 50,668,221 shares underlying the convertible notes and
      48,330,183 shares underlying the warrants held by it.The actual number of shares of common stock
      issuable upon conversion of the convertible notes is subject to adjustment
      and could be materially more than 50,668,221 shares depending on a number
      of factors including, among other factors, the future market price of our
      common stock.  Sandell Asset Management Corp. (“SAMC”) is the
      investment manager of Master.  Thomas Sandell is the sole
      shareholder of SAMC and may be deemed to have voting and dispositive power
      over the shares beneficially owned by Master.  No other natural
      person has voting or dispositive power over the shares owned by Master.
      Castlerigg International Ltd. (“Castlerigg International”) is the
      controlling shareholder of Castlerigg International Holdings Limited
      (“Holdings”).  Holdings is the controlling shareholder of
      Master.  Each of Holdings and Castlerigg International may be
      deemed to share beneficial ownership of the shares beneficially owned by
      Master.  SAMC, Mr. Sandell, Holdings and Castlerigg
      International each disclaims beneficial ownership of the securities with
      respect to which indirect beneficial ownership is
      described.




Equity
Compensation Plan Information




The
following table sets forth information about our common stock that may be issued
upon the exercise of options, warrants and rights under all of our equity
compensation plans as of December 31, 2009.





Plan
      Category
            
            Number
      of Shares to be Issued Upon Exercise
            
            
            Weighted
      Average
                Exercise
      Price
            
            
            Number
      of Securities Available for IssuancePlans
      Approved by Stockholders2005
      Stock Plan(1)
            
            
            617,000
            
            
            
            $0.58
            
            
            2,383,000Plans
      Not Approved by StockholdersNon-Plan
      Stock Options(2)
            
            
            850,000
            
            
            
            $1.53
            
            
            N/AWarrants
      for Services(3)
            
            
            1,167,095
            
            
            
            $0.58
            
            
            N/ATotal
            
            
            2,634,095
            
            
            
            $0.86
            
            
            2,383,000


__________________________




(1)
            Our
      2005 Stock Plan was approved by our Board of Directors on April 7, 2005
      and approved by our shareholders on June 9, 2005 at our 2005 Annual
      Meeting of Shareholders.  Under the 2005 Stock Plan, options to
      purchase up to 3,000,000 shares of our Common Stock may be
      granted.  As of December 31, 2009, there were 617,000
      outstanding options to purchase common
stock.


(2)
            Consists
      of stock options to purchase shares of our common stock granted to our
      employees, executive officers and directors outside of a formal stock
      option plan.  These stock options vest at the rate of 331⁄3% on
      each of the first, second and third anniversaries of the date of grant and
      expire on the eight-year anniversary of the date of
  grant.


(3)
            Consists
      of warrants to purchase shares of our common stock granted in
      consideration for consulting services, advisory services, placement agent
      services and similar services rendered to us by third
    parties.




Item
      13.
              Certain
      Relationships and Related Transactions and Director
      Independence




Certain
Relationships and Related Transactions




There
were no related party transactions in 2009 that require disclosure. The Board as
a whole reviews any    transactions that would require
disclosure under this item 13.




Director
Independence




Our Board
of Directors has determined that Larry L. Enterline and Ken Bramlett each
qualify as an “independent director” as defined in Rule 5605(a)(2) of the NASDAQ
Listing Rules.




-38-




Item
      14.
              Principal
      Accounting Fees and Services




The
following table sets forth the aggregate fees billed to us for the fiscal years
ended December 31, 2009 and 2008 by our auditors, Mendoza Berger & Company,
LLP.




Fiscal
      2009
            
            
            Fiscal 2008Audit
      Fees(1)
            
            $
            58,896
            
            
            $
            103,515Audit-Related
      Fees(2)
            
            $
            -
            
            
            $
            29,505Tax
      Fees(3)
            
            $
            1,968
            
            
            $
            13,201All
      Other Fees(4)
            
            $
            -
            
            
            $
            -




(1)
            Audit Fees consist of
      fees billed for professional services rendered for the audit of our
      consolidated annual financial statements and review of the interim
      consolidated financial statements included in quarterly reports and
      services that are normally provided by our accountants in connection with
      statutory and regulatory filings or
engagements.




(2)
            Audit-Related Fees
      consist of fees billed for assurance and related services that are
      reasonably related to the performance of the audit or review of our
      consolidated financial statements and are not reported under “Audit
      Fees.”  This category includes fees related to due diligence
      services pertaining to potential business acquisitions/disposition; and
      consultation regarding accounting or disclosure treatment of transactions
      or events and/or the actual or potential impact of final or proposed
      rules, standard or interpretation by the SEC, FASB or other regulatory or
      standard-setting bodies as well as general assistance with implementation
      of the requirements of SEC rules or listing standards promulgated pursuant
      to the Sarbanes-Oxley Act of 2002.




(3)
            Tax Fees consist of
      fees billed for professional services rendered for tax compliance, tax
      advice and tax planning.  These services include assistance
      regarding federal, state and local tax compliance, planning and
      advice.




(4)
            All Other Fees consist
      of fees for products and services other than the services reported
      above.




Our Audit
Committee is responsible for approving all Audit, Audit-Related, Tax and Other
Services.  The Audit Committee pre-approves all auditing services and
permitted non-audit services, including all fees and terms to be performed for
us by our independent registered public accounting firm at the beginning of the
fiscal year.  Non-audit services are reviewed and pre-approved by
project at the beginning of the fiscal year.  Any additional non-audit
services contemplated by our company after the beginning of the fiscal year are
submitted to the Audit Committee chairman for pre-approval prior to engaging the
independent auditor for such services.  Such interim pre-approvals are
reviewed with the full Audit Committee at its next meeting for
ratification.





Part
IV




Item
      15.
            Exhibits
      and Financial Statement Schedules





Exhibit
                Number
              
              Description2.1
              
              
              Agreement
      and Plan of Merger dated August 23, 2003 between Pacific InterMedia, Inc.,
      and Raptor Networks Technology, Inc. (incorporated herein by reference to
      Exhibit 2.1 to the Company’s Form 8-K filed with the SEC on October 22,
      2003)2.2
              
              
              Amendment
      to Agreement and Plan of Merger dated October 15, 2003 between Pacific
      InterMedia, Inc., and Raptor Networks Technology, Inc. (incorporated
      herein by reference to Exhibit 2.2 to the Company’s Form 8-K filed with
      the SEC on October 22, 2003)
  -39-
  3.1
              
              
              Articles
      of Incorporation, as amended as of June 8, 2005 (incorporated herein by
      reference to Exhibit 3.1 to the Company’s Form 10-KSB for fiscal year
      ended December 31, 2004, filed with the SEC on April 15,
    2005)3.2
              
              
              Articles
      of Amendment to Articles of Incorporation increasing Company’s authorized
      common stock to 75,000,000 shares, effective June 9, 2005 (incorporated
      herein by reference to Exhibit 3.1 to the Company’s Form 8-K filed with
      the SEC on June 15, 2005)3.3
              
              
              Articles
      of Amendment to Articles of Incorporation increasing authorized common
      stock to 110,000,000 shares, effective May 31, 2006 (incorporated herein
      by reference to Exhibit 3.1 to the Company’s Form 8-K filed with the SEC
      on June 5, 2006)3.4
              
              
              Articles of Amendment to Articles of Incorporation
      (Profit) of Raptor Networks Technology, Inc. as filed with the Colorado
      Secretary of State on April 30, 2007 (incorporated herein by reference to
      Exhibit 3.1 to the Company’s Form 8-K filed May 4,
      2007)3.5
              
              
              Bylaws
      (incorporated herein by reference to Exhibit 3.2 to Registration Statement
      on Form SB-2, Registration No. 333-74846, filed with the SEC on December
      10, 2001)3.6
              
              
              Amendment
      to Bylaws – Article II, Section 1 (incorporated herein by reference to
      Exhibit 3.3 to the Company’s Form 10-KSB for fiscal year ended December
      31, 2004, filed with the SEC on April 15, 2005)3.7
              
              
              Action with Respect to Bylaws certified by the
      Secretary of Raptor Networks Technology, Inc. on May 2, 2007 (incorporated
      herein by reference to Exhibit 3.2 to the Company’s Form 8-K filed May 4,
      2007)10.1
              
              
              Full
      Service Lease dated May 3, 2004 between PS Business Parks, L.P., and
      Raptor Networks Technology, Inc. (incorporated herein by reference to
      Exhibit 10.1 to the Company’s Form 10-KSB for fiscal year ended December
      31, 2004, filed with the SEC on April 15, 2005)10.2
              
              
              (incorporated herein by reference to
      Exhibit 10.2 to the Company’s Form 10-KSB for fiscal year ended December
      31, 2007, filed with the SEC on March 31, 2008)10.3
              
              
              Facility
      lease agreement with Martin Investment dated September 22, 2008
      (incorporated herein by reference to Exhibit 10.1 to the Company’s Form
      10-QSB for fiscal quarter ended September 30, 2008, filed with the SEC on
      November 18, 2008)10.4
              
              
              Facility
      lease agreement with Martin Investment dated February 9, 2009
      (incorporated herein by reference to Exhibit 10.4 to the Company’s Form
      10-KSB for fiscal year ended December 31, 2008)10.5
              
              
              Facility
      lease agreement with Martin Investment dated June 23, 2009 (incorporated
      herein by reference to Exhibit 10.5 to the Company’s Form 10-Q for fiscal
      quarter ended September 30, 2008)10.6
              x
              
              Facility
      lease agreement with Martin Investment dated December 16,
    200910.7
              
              
              Turnkey
      Manufacturing Services Agreement dated November 7, 2003 between Express
      Manufacturing, Inc. and Raptor Networks Technology, Inc. (incorporated
      herein by reference to Exhibit 10.2 to the Company’s Form 10-KSB for
      fiscal year ended December 31, 2005, filed with the SEC on April 3,
      2006)10.8
              **
              
              First
      Amended and Restated 2005 Stock Plan (incorporated herein by reference to
      Exhibit 10.1 to the Company’s Form 10-QSB for fiscal quarter ended June
      30, 2007, filed with the SEC on August 21, 2007)10.9
              **
              
              Form
      of 2005 Stock Plan Stock Option Agreement (incorporated herein by
      reference to Exhibit 10.19 to the Company’s Form 10-KSB for fiscal year
      ended December 31, 2005, filed with the SEC on April 3,
    2006)10.10
              
              
              Securities
      Purchase Agreement dated July 30, 2006 (incorporated herein by reference
      to Exhibit 10.1 to the Company's Form 8-K filed with the SEC on July 31,
      2006)10.11
              
              
              Form
      of Amended and Restated Amendment and Exchange Agreement dated January 22,
      2007 (incorporated herein by reference to Exhibit 10.1 to the Company's
      Form 8-K filed with the SEC on January 23, 2007)10.12
              
              
              Form
      of Amended and Restated Senior Convertible Note dated July 31, 2006
      (incorporated herein by reference to Exhibit 10.3 to the Company's Form
      8-K filed with the SEC on January 22, 2007)
  -40-
  10.13
              
              
              Senior
      Convertible Note dated January 19, 2007 (incorporated herein by reference
      to Exhibit 10.4 to the Company's Form 8-K filed with the SEC on January
      22, 2007)10.14
              
              
              Amended
      and Restated Registration Rights Agreement dated January 18, 2007
      (incorporated herein by reference to Exhibit 10.9 to the Company's Form
      8-K filed with the SEC on January 22, 2007)10.15
              
              
              Securities Purchase Agreement dated July 31, 2007
      (incorporated herein by reference to Exhibit 10.1 to the Company’s Form
      8-K filed August 2, 2007)10.16
              
              
              Registration Rights Agreement dated July 31, 2007
      (incorporated herein by reference to Exhibit 10.2 to the Company’s Form
      8-K filed August 2, 2007)10.17
              
              
              Form of Senior Secured Convertible Note issued
      August 1, 2007 (incorporated herein by reference to Exhibit 10.3 to the
      Company’s Form 8-K filed August 2, 2007)10.18
              
              
              Securities Purchase Agreement, dated March 31,
      2008 (incorporated herein by reference to Exhibit 10.1 to the Company’s
      Form 8-K filed with the SEC on April 2, 2008)10.19
              
              
              Registration Rights Agreement, dated March 31,
      2008 (incorporated herein by reference to Exhibit 10.2 to the Company’s
      Form 8-K filed with the SEC on April 2, 2008)10.20
              
              
              Form of Senior Secured Convertible Note
      (incorporated herein by reference to Exhibit 10.3 to the Company’s Form
      8-K filed with the SEC on April 2, 2008)10.21
              
              
              Form of Series Q Warrants (incorporated herein by
      reference to Exhibit 10.4 to the Company’s Form 8-K filed with the SEC on
      April 2, 2008)10.22
              
              
              Security Agreement (incorporated herein by
      reference to Exhibit 10.5 to the Company’s Form 8-K filed with the SEC on
      April 2, 2008)10.23
              
              
              Pledge Agreement (incorporated herein by reference
      to Exhibit 10.6 to the Company’s Form 8-K filed with the SEC on April 2,
      2008)10.24
              
              
              Guaranty (incorporated herein by reference to
      Exhibit 10.7 to the Company’s Form 8-K filed with the SEC on April 2,
      2008)10.25
              
              
              Securities Purchase Agreement, dated July 28, 2008
      (incorporated herein by reference to Exhibit 10.1 to the Company’s Current
      Report on Form 8-K filed with the SEC on July 31,
    2008)10.26
              
              
              Registration Rights Agreement, dated July 28, 2008
      (incorporated herein by reference to Exhibit 10.2 to the Company’s Current
      Report on Form 8-K filed with the SEC on July 31,
    2008)10.27
              
              
              Form of Senior Secured Convertible Note issued
      July 28, 2008 (incorporated herein by reference to Exhibit 10.3 to the
      Company’s Current Report on Form 8-K filed with the SEC on July 31,
      2008)10.28
              
              
              Amended and Restated Security Agreement, dated
      July 28, 2008 (incorporated herein by reference to Exhibit 10.7 to the
      Company’s Current Report on Form 8-K filed with the SEC on July 31,
      2008)10.29
              
              
              Amended and Restated Pledge Agreement, dated July
      28, 2008 (incorporated herein by reference to Exhibit 10.8 to the
      Company’s Current Report on Form 8-K filed with the SEC on July 31,
      2008)10.30
              
              
              Amended and Restated Guaranty, dated July 28, 2008
      (incorporated herein by reference to Exhibit 10.9 to the Company’s Current
      Report on Form 8-K filed with the SEC on July 31,
    2008)10.31
              
              
              Letter agreements with regard to certain cash
      payments dated September 30, 2008 (incorporated herein by reference to
      Exhibits 99.1 and 99.2 to the Company’s Form 8-K filed with the SEC on
      September 30, 2008)10.32
              
              
              Letter agreements with regard to certain cash
      payments dated December 31, 2008 (incorporated herein by reference to
      Exhibits 99.1 and 99.2 to the Company’s Form 8-K filed with the SEC on
      January 6, 2009)10.33
              
              
              Settlement
      Agreement dated November 24, 2009 (incorporated herein by reference to Exhibit 10.1
      to the Company’s Current Report on Form 8-K filed with the SEC on November
      27, 2009)10.34
              
              
              Letter agreements with regard to certain cash
      payments dated March 31, 2009 (incorporated herein by reference to
      Exhibits 99.1 and 99.2 to the Company’s Form 8-K filed with the SEC on
      April 7, 2009)10.35
              
              
              Letter agreements with regard to certain cash
      payments dated June 30, 2009 (incorporated herein by reference to Exhibits
      99.1 and 99.2 to the Company’s Form 8-K filed with the SEC on July 9,
      2009)10.36
              
              
              Letter agreements with regard to certain cash
      payments dated September 30, 2009 (incorporated herein by reference to
      Exhibits 99.1 and 99.2 to the Company’s Form 8-K filed with the SEC on
      October 14, 2009)
  -41-
  10.37
              
              
              Letter agreements with regard to certain cash
      payments dated December 31, 2009 (incorporated herein by reference to
      Exhibits 99.1 and 99.2 to the Company’s Form 8-K filed with the SEC on
      January 14, 2010)21
              
              
              Subsidiaries
      of the Registrant (incorporated herein by reference to Exhibit 21 to the
      Company’s Form 10-KSB for fiscal year ended December 31, 2005, filed with
      the SEC on April 3, 2006)31.1
              x
              
              Certification
      of the Chief Executive Officer Required by Rule 13a-14(a) of the
      Securities Exchange Act of 1934, as amended, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200231.2
              x
              
              Certification
      of the Chief Financial Officer Required by Rule 13a-14(a) of the
      Securities Exchange Act of 1934, as amended, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200232.1
              x
              
              Certification
      of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      200232.2
              x
              
              Certification
      of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002


x
            Filed
      herewith.


**
            This
      exhibit is a management contract or a compensatory plan or
      arrangement.


















-42-




SIGNATURES




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




Dated:  March
      26, 2010
              RAPTOR
      NETWORKS TECHNOLOGY, INC.By:
              /s/ Thomas
      M. WittenschlaegerThomas
      M. Wittenschlaeger,Chief
      Executive Officer




Dated:  March
      26, 2010
                RAPTOR
      NETWORKS TECHNOLOGY, INC.By:
                /s/ Bob
      van LeyenBob
      van Leyen,Chief
      Financial Officer


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





Signature
            
            Capacity
            
            Date/s/ Thomas M.
      Wittenschlaeger
              Thomas M. Wittenschlaeger
            
            Director
            
            March
      26, 2010/s/ Ken
      Bramlett
              Ken Bramlett
            
            Director
            
            March
      26, 2010/s/ Larry L.
      Enterline
              Larry L. Enterline
            
            Director
            
            March
      26, 2010











-43-





Raptor
Networks Technology, Inc.




Index
to Financial Statements






Report of
      Independent Registered Public Accounting Firm
            F-2Financial
      StatementsConsolidated
      Balance Sheets
            F-3Consolidated
      Statements of Operations
            F-4Consolidated
      Statements of Stockholders’ Deficit
            F-5Consolidated
      Statements of Cash Flows
            F-6Notes
      to Consolidated Financial Statements
            F-7
















F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM







To the
Board of Directors and Stockholders


Raptor
Networks Technology, Inc. and Subsidiary





We have
audited the accompanying consolidated balance sheets of Raptor Networks
Technology, Inc. (a Colorado corporation) (the “Company”) as of December 31,
2009 and 2008, and the related consolidated statements of operations,
stockholders' deficit and cash flows for the years then ended.  These
consolidated financial statements are the responsibility of the Company's
management.  Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting.  Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements.  An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall consolidated financial
statement presentation.  We believe that our audits provide a
reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Raptor Networks Technology,
Inc. as of December 31, 2009 and 2008, and the results of its operations and its
cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.





The
accompanying consolidated financial statements are presented assuming the
Company will continue as a going concern.  As more fully described in
Note 1 to the consolidated financial statements, the Company has sustained
accumulated losses from operations totaling approximately $84,000,000 at
December 31, 2009.  This condition and the Company’s lack of
significant sales of its products to date, raise substantial doubt about its
ability to continue as a going concern.  Management's plans to address
these conditions are also set forth in Note 1 to the consolidated financial
statements.  The accompanying consolidated financial statements do not
include any adjustments which might be necessary if the Company is unable to
continue as a going concern.








/s/
Mendoza Berger & Company, LLP





Irvine,
California


March 26,
2010








F-2




RAPTOR
NETWORKS TECHNOLOGY, INC.
 CONSOLIDATED
BALANCE SHEETS




December
      31,2009
            
            
            2008ASSETSCURRENT
      ASSETSCash
      and cash equivalents
            
            $
            162,242
            
            
            $
            62,461Accounts
      receivable, net of allowance for doubtful accountsof $0 and
      $59,530 at December 31, 2009 and 2008, respectively
            
            
            52,276
            
            
            
            54,467Inventories,
      net
            
            
            671,215
            
            
            
            912,630Prepaid
      interest
            
            
            102,708
            
            
            
            437,500License
      fees
            
            
            92,770
            
            
            
            202,930Other
      current assets
            
            
            23,414
            
            
            
            57,006Total
      current assets
            
            
            1,104,625
            
            
            
            1,726,994PROPERTY
      AND EQUIPMENT, NET
            
            
            22,943
            
            
            
            39,033OTHER
      ASSETSPrepaid
      interest, net of current portion
            
            
            -
            
            
            
            151,042Debt
      issuance costs, net
            
            
            5,015
            
            
            
            25,071Deposits
            
            
            1,560
            
            
            
            2,505TOTAL
      ASSETS
            
            $
            1,134,143
            
            
            $
            1,944,645LIABILITIES
      AND STOCKHOLDERS' DEFICITCURRENT
      LIABILITIESAccounts
      payable
            
            $
            114,061
            
            
            $
            78,066Accrued
      interest payable
            
            
            253,138
            
            
            
            305,280Current
      portion of legal settlement payable
            
            
            93,113
            
            
            
            -Deferred
      revenue
            
            
            14,777
            
            
            
            2,803Accrued
      liabilities
            
            
            570,158
            
            
            
            760,711Detachable
      warrant liabilities
            
            
            4,005,935
            
            
            
            2,501,517Conversion
      option liabilities
            
            
            5,442,599
            
            
            
            903,709Senior
      convertible note payable, net of debt discountof $1,673,367 and
      $5,510,528 at December 31, 2009 and 2008,
respectively
            
            
            8,502,382
            
            
            
            8,290,694Total
      current liabilities
            
            
            18,996,163
            
            
            
            12,842,780LEGAL
      SETTLEMENT PAYABLE, NET OF CURRENT PORTION
            
            
            115,887
            
            
            
            -TOTAL
      LIABILITIES
            
            
            19,112,050
            
            
            
            12,842,780Commitments
      and contingencies
            
            
            -
            
            
            
            -STOCKHOLDERS'
      DEFICITPreferred
      stock, no par value; 5,000,000 shares authorized;no shares issued
      and outstanding
            
            
            -
            
            
            
            -Common
      stock, $.001 par; 200,000,000 shares authorized;85,922,744 and
      70,827,775 shares issued and outstanding at December 31, 2009 and 2008,
      respectively
            
            
            85,923
            
            
            
            70,828Additional
      paid-in capital
            
            
            65,859,347
            
            
            
            60,259,217Accumulated
      deficit
            
            
            (83,923,177
            )
            
            
            (71,228,180
            )Total
      stockholders' deficit
            
            
            (17,977,907
            )
            
            
            (10,898,135
            )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
            
            $
            1,134,143
            
            
            $
            1,944,645





The
accompanying notes are an integral part of these consolidated financial
statements.


F-3




RAPTOR
NETWORKS TECHNOLOGY, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 For
the Years Ended December 31




2009
              
              
              2008REVENUE,
      NET
              
              $
              1,601,906
              
              
              $
              710,330COST
      OF SALES
              
              
              842,485
              
              
              
              344,952GROSS
      PROFIT
              
              
              759,421
              
              
              
              365,378OPERATING
      EXPENSESSalary
      expense and salary related costs
              
              
              656,813
              
              
              
              1,807,752Marketing
      expense
              
              
              -
              
              
              
              73,121Research
      and development
              
              
              114,387
              
              
              
              983,546Selling,
      general and administrative
              
              
              472,472
              
              
              
              2,300,546Total
      operating expenses
              
              
              1,243,672
              
              
              
              5,164,965Loss
      from operations
              
              
              (484,251
              )
              
              
              (4,799,587
              )OTHER
      INCOME (EXPENSE)Interest
      income
              
              
              23
              
              
              
              11,175Change
      in fair value of conversion option andwarrant
      liabilities
              
              
              (7,018,882
              )
              
              
              21,622,243Loss
      on extinguishment of debt
              
              
              -
              
              
              
              (5,182,474
              )Cost
      of financing senior convertible notes
              
              
              -
              
              
              
              (4,973,096
              )Amortization
      of discount on convertible debt
              
              
              (3,963,457
              )
              
              
              (6,127,968
              )Interest
      expense
              
              
              (1,206,995
              )
              
              
              (1,273,790
              )Loss
      on sale of property and equipment
              
              
              -
              
              
              
              (65,101
              )Loss
      on lease settlement
              
              
              (21,435
              )
              
              
              (241,261
              )Total
      other income (expense)
              
              
              (12,210,746
              )
              
              
              3,769,728Loss
      before income taxes
              
              
              (12,694,997
              )
              
              
              (1,029,859
              )Income
      tax benefit
              
              
              -
              
              
              
              -NET
      LOSS
              
              $
              (12,694,997
              )
              
              $
              (1,029,859
              )Loss
      per share - basic and diluted
              
              $
              (0.16
              )
              
              $
              (0.02
              )Weighted
      average number of shares outstanding -basic and
    diluted
              
              
              77,809,027
              
              
              
              68,377,785





The
accompanying notes are an integral part of these consolidated financial
statements.


F-4




RAPTOR
NETWORKS TECHNOLOGY, INC.


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ DEFICIT





Additional
              
              
              
              
              
              TotalCommon
      Stock
              
              
              Paid-in
              
              
              Accumulated
              
              
              Stockholders'Shares
              
              
              Amount
              
              
              Capital
              
              
              Deficit
              
              
              DeficitBalance,
      January 1, 2008
              
              
              65,042,374
              
              
              $
              65,043
              
              
              $
              56,303,256
              
              
              $
              (70,198,321
              )
              
              $
              (13,830,022
              )Stock-based
      compensation
              
              
              -
              
              
              
              -
              
              
              
              216,978
              
              
              
              -
              
              
              
              216,978Common
      stock issued in privateplacements
              
              
              4,375,000
              
              
              
              4,375
              
              
              
              3,201,875
              
              
              
              -
              
              
              
              3,206,250Common
      stock issued upon conversionof senior convertible notes and
      accrued interest payable
              
              
              1,410,401
              
              
              
              1,410
              
              
              
              537,108
              
              
              
              -
              
              
              
              538,518Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (1,029,859
              )
              
              
              (1,029,859
              )Balance,
      December 31, 2008
              
              
              70,827,775
              
              
              $
              70,828
              
              
              $
              60,259,217
              
              
              $
              (71,228,180
              )
              
              $
              (10,898,135
              )Stock-based
      compensation
              
              
              -
              
              
              
              -
              
              
              
              102,551
              
              
              
              -
              
              
              
              102,551Common
      stock issued upon conversionof senior convertible
    notes
              
              
              14,894,969
              
              
              
              14,895
              
              
              
              5,463,779
              
              
              
              -
              
              
              
              5,478,674Common
      stock issued for services
              
              
              200,000
              
              
              
              200
              
              
              
              33,800
              
              
              
              -
              
              
              
              34,000Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (12,694,997
              )
              
              
              (12,694,997
              )Balance,
      December 31, 2009
              
              
              85,922,744
              
              
              $
              85,923
              
              
              $
              65,859,347
              
              
              $
              (83,923,177
              )
              
              $
              (17,977,907
              )



















The
accompanying notes are an integral part of these consolidated financial
statements.


F-5




RAPTOR
NETWORKS TECHNOLOGY, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


For
the Years Ended December 31




For
      the Year Ended December 31,2009
              
              
              2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
              
              $
              (12,694,997
              )
              
              $
              (1,029,859
              )Adjustments
      to reconcile net loss to net cash provided by(used
      in) operating activities:Depreciation
              
              
              16,090
              
              
              
              51,607Amortization
              
              
              3,983,513
              
              
              
              6,135,050Stock-based
      compensation
              
              
              102,551
              
              
              
              216,978Common
      stock issued for services
              
              
              34,000
              
              
              
              -Change
      in fair value of conversion option and warrant liabilities
              
              
              7,018,882
              
              
              
              (21,622,243
              )Loss
      on extinguishment of debt
              
              
              -
              
              
              
              5,182,474Loss
      on sale of property and equipment
              
              
              -
              
              
              
              65,101Loss
      on lease settlement
              
              
              21,435
              
              
              
              241,261Cost
      of financing senior convertible notes
              
              
              -
              
              
              
              4,973,096Change
      in inventory reserve
              
              
              60,164
              
              
              
              (63,228
              )Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              2,191
              
              
              
              408,088Inventories
              
              
              181,251
              
              
              
              91,586Prepaid
      expenses and other assets
              
              
              630,531
              
              
              
              (342,950
              )Accounts
      payable and accrued liabilities
              
              
              732,196
              
              
              
              440,049Deferred
      revenue
              
              
              11,974
              
              
              
              (10,177
              )Net
      cash provided by (used in) operating activities
              
              
              99,781
              
              
              
              (5,263,167
              )CASH
      FLOWS FROM INVESTING ACTIVITIES:Proceeds
      from the sale of property and equipment
              
              
              -
              
              
              
              2,750Purchase
      of property and equipment
              
              
              -
              
              
              
              (4,950
              )Net
      cash used in investing activities
              
              
              -
              
              
              
              (2,200
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      proceeds on convertible notes payable
              
              
              -
              
              
              
              4,375,000Net
      increase (decrease) in cash and cash equivalents
              
              
              99,781
              
              
              
              (890,367
              )CASH
      AT BEGINNING OF YEAR
              
              
              62,461
              
              
              
              952,828CASH
      AT END OF YEAR
              
              $
              162,242
              
              
              $
              62,461SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for interest
              
              $
              599
              
              
              $
              875,000Cash
      paid for income taxes
              
              $
              3,200
              
              
              $
              3,200SUPPLEMENTAL
      DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:Conversion
      of notes payable to common stock
              
              $
              4,376,804
              
              
              $
              171,212Reduction
      of the conversion option liability upon conversion
              
              $
              1,101,870
              
              
              $
              151,931Accrued
      interest payable added to principal balance
              
              $
              751,333
              
              
              $
              -Increase
      in debt discount for conversion option liabilities
    resultingfrom
      accrued interest added to principal balance
              
              $
              126,296
              
              
              $
              -Common
      stock issued for accrued interest payable
              
              $
              -
              
              
              $
              215,373Common
      stock recorded as debt discount
              
              $
              -
              
              
              $
              3,206,250Debt
      issuance costs for accounts payable
              
              $
              -
              
              
              $
              40,113




The
accompanying notes are an integral part of these consolidated financial
statements.


F-6




1.
            Summary of Significant
      Accounting Policies





Description


The
Company is a provider of integrated high-speed Ethernet switching systems which
enable new emerging high bandwidth critical applications.  The data
network market areas that the Company is targeting include video, storage,
Internet Protocol telephony and technology refresh.  The Company is
currently focusing on the United States market.  Principal operations
have commenced, although minimal revenues have been recognized to
date.





The
Company was incorporated under the laws of the state of Colorado on January 22,
2001 under the name Pacific InterMedia, Inc. (“Pacific”).  The
principal office of the corporation is 1508 South Grand Avenue, Suite 150, Santa
Ana, California  92705.





On
October 17, 2003, Pacific completed a business combination transaction with
Raptor Networks Technology, Inc. (“Raptor”), a closely-held California
corporation, through acquisition of all of the issued and outstanding common
stock of Raptor in exchange for authorized but previously unissued restricted
common stock of Pacific.  Immediately prior to completion of the
acquisition transaction, Pacific had a total of 4,034,000 shares of its common
stock issued and outstanding comprised of 1,034,000 registered shares held by
approximately 25 stockholders and 3,000,000 shares of restricted stock held by
Pacific’s founder and sole officer and director.





As a
material aspect of the acquisition, Pacific re-acquired and cancelled the
3,000,000 restricted shares as consideration for transfer of its remaining
assets consisting of cash and office equipment to the officer and director,
leaving only the registered common stock, 1,034,000 shares, as all of its issued
and outstanding capital stock prior to completion of the Raptor
acquisition.





Pursuant
to terms of the acquisition agreement, all of the issued and outstanding common
stock of Raptor, 19,161,256 shares, was acquired by Pacific, share-for-share, in
exchange for its authorized but previously unissued common
stock.  Upon completion of the acquisition, Raptor became a wholly
owned subsidiary of Pacific and the Raptor shareholders became shareholders of
Pacific.  Unless otherwise indicated, all references in these
financial statements to “the Company” include Pacific and its wholly owned
subsidiary, Raptor.  All intercompany transactions have been
eliminated in consolidation.  On December 3, 2003, Pacific changed its
name to Raptor Networks Technology, Inc.





The
acquisition transaction has been treated as a reverse merger, with Raptor
considered the accounting acquirer.  The Company’s reporting year end
was subsequently changed from August 31 to December 31.





Reclassifications


Certain
previous year amounts have been reclassified to conform to the current year
presentation.  These reclassifications had no impact on net earnings,
financial position or cash flows.





Use of
Estimates


The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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
include the collectability of accounts receivable, the realization of
inventories, the recoverability of long-lived assets, the valuation of
stock-based compensation and the valuation allowance of the deferred tax
asset.  Actual results could differ from those estimates.





Concentrations of Credit
Risk


During
2009, 70% of our revenues were generated by one customer.  This
customer owed 76% of the accounts receivable balance as of December 31,
2009.  During 2009, another 15% of revenues were generated by another
customer.





Cash and Cash
Equivalents


The
Company considers all short-term marketable securities with an original maturity
of three months or less to be cash equivalents.




F-7


Accounts Receivable and
Allowance for Doubtful Accounts


Accounts
receivable are recorded at the invoiced amount and do not bear
interest.  The allowance for doubtful accounts is the Company’s best
estimate of the amount of probable credit losses in the Company’s existing
accounts receivable.  The Company establishes provisions for losses on
accounts receivable when it is probable that all or part of the outstanding
balance will not be collected.  The Company regularly reviews
collectability and establishes or adjusts the allowance as necessary using the
specific identification method.





Inventories


Inventories
are recorded at the lower of cost or market with cost being determined on the
average cost method.  When required, a provision is made to reduce
excess and obsolete inventory to estimated net realizable
value.  Inventories consist of raw materials, work-in-process and
finished goods.





License
Fees


The
Company capitalizes software license fees of third party software which is
included in its systems.  These costs are amortized and charged to
cost of sales over the projected number of systems expected to be sold
incorporating the capitalized software.  Amortization of the license
fees included in cost of sales for the years ended December 31, 2009 and 2008
totaled $110,160 and $23,760, respectively.





Property and
Equipment


Property
and equipment are recorded at cost less accumulated
depreciation.  Depreciation is computed using the straight-line method
over the assets’ estimated useful lives as follows:  computer
equipment, furniture and fixtures and testing equipment are depreciated over
three years; office equipment is depreciated over seven years and leasehold
improvements are depreciated over the term of the lease.  Repairs and
maintenance of a routine nature are charged as incurred.  Significant
renewals and betterments are capitalized.  At the time of retirement
or other disposition of property and equipment, the cost and accumulated
depreciation are removed from the accounts and any resulting gain or loss is
reflected in the consolidated statements of operations.





Debt Issuance
Costs


Debt
issuance costs reflect fees incurred to obtain financing.  Debt
issuance costs are amortized to interest expense using the straight-line method
over the life of the related debt.  Amortization expense for the years
ended December 31, 2009 and 2008 was $20,056 and $7,082,
respectively.  In connection with the debt extinguishments in 2008, an
additional $53,905 of debt issuance costs were written off and are included in
loss on extinguishment of debt in the consolidated statement of operations for
the year ended December 31, 2008.





Convertible Debenture and
Beneficial Conversion Feature


If the
conversion feature of conventional convertible debt provides for a rate of
conversion that is below market value, this feature is characterized as a
beneficial conversion feature (“BCF”).  A BCF is recorded by the
Company as a debt discount.  In those circumstances, the convertible
debt will be recorded net of the discount related to the BCF.  The
Company amortizes the discount to interest expense over the life of the debt
using the straight-line method, which approximates the effective interest
method.





Derivative Financial
Instruments


In
accounting for non-conventional convertible debt, the Company bifurcates its
embedded derivative instruments.  The Company’s derivative financial
instruments consist of embedded derivatives related to non-conventional
debentures entered into with certain investors.  These embedded
instruments related to the debenture include the conversion feature, liquidated
damages related to registration rights and default provisions.  The
accounting treatment of derivative financial instruments requires that the
Company record the derivatives and related warrants at their fair value as of
the inception date of the agreement and at fair value as of each subsequent
balance sheet date.  Any change in fair value will be recorded as
non-operating, non-cash income or expense at each reporting
period.  If the fair value of the derivatives is higher at the
subsequent balance sheet date, the Company will record a non-operating, non-cash
charge.  If the fair value of the derivative is lower at the
subsequent balance sheet date, the Company will record non-operating, non-cash
income.




F-8


Extinguishment of
Debt


A
modification of debt is considered substantial if any of the following criteria
are met:





1.
            The
      present value of the cash flows under the terms of the new debt instrument
      is at least 10% different from the present value of the remaining cash
      flows under the terms of the original
  instrument;


2.
            The
      fair value of the embedded conversion option immediately before and after
      the modification is at least 10% of the carrying amount of the original
      debt instrument immediately prior to the modification;
  or


3.
            The
      modification adds a substantive conversion option or eliminates a
      conversion option that was substantive at the date of the
      modification.





Modifications
of debt that are considered substantial are accounted for as an extinguishment
of debt whereby the new debt instrument is initially recorded at fair
value. The change in the fair value plus any fees paid or received
associated with the old debt instrument are recorded as gain or loss on the
extinguishment debt and are included in other income (expense) in the statements
of operations.  If the modification is not substantial, a new
effective rate is calculated and any fees paid or received associated with the
old debt are amortized as an adjustment of interest expense over the remaining
term of the debt.





Revenue
Recognition


The
Company records revenues when the following criteria are met: (i) persuasive
evidence of an arrangement exists; (ii) delivery has occurred; (iii) the price
to the customer is fixed or determinable; and (iv) collection of the sales price
is reasonably assured.  Delivery occurs when goods are shipped and
title and risk of loss have passed to the customer.  Revenue is
deferred in all instances where the earnings process is
incomplete.  The Company recognizes revenue from distribution sales
when all contingencies are satisfied and upon persuasive evidence of a sale to
end users until such time that historical sell through ratios have been
developed.  Payments received before all of the relevant criteria for
revenue recognition are satisfied are recorded as deferred revenue in the
accompanying consolidated balance sheets.  Revenues and costs of
revenues from consulting contracts are recognized during the period in which the
service is performed.  All revenues are reported net of any sales
discounts or taxes.





The
Company has contracts with various governments and governmental
agencies.  Government contracts are subject to audit by the applicable
governmental agency. Such audits could lead to inquiries from the
government regarding the allowability of costs under applicable government
regulations and potential adjustments of contract revenues.  To date,
the Company has not been involved in any such audits.





Marketing
Costs


Marketing
costs are expensed as incurred.  For the years ended December 31, 2009
and 2008, marketing costs were $0 and $73,121, respectively.





Research and Development
Costs


Research
and development (R&D) costs consist of labor, product design costs including
rental of design tools, consumables, and costs of prototypes and are expensed as
incurred.


Compensated
Absences


The
Company maintains a personal time off policy.  Employees of the
Company are entitled to compensated absences depending on their length of
service to a maximum of 25 days per calendar year.  As of December 31,
2009 and 2008, the balance owed for compensated absences was $56,707 and
$47,403, respectively.





Impairment or Disposal of
Long-Lived Assets


The
Company reviews its long-lived assets and certain related intangibles for
impairment periodically, and whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be fully
recoverable.  When necessary, impaired assets are written down to
estimated fair value based on the best information
available.  Estimated fair value is generally based on either
appraised value or measured by discounting estimated future cash
flows.  Considerable management judgment is necessary to estimate
discounted future cash flows.  Accordingly, actual results could vary
significantly from such estimates.  The Company disposed of a
significant amount of its assets during the year ended December 31,
2008.  Consequently, there were no assets that were considered to be
impaired as of December 31, 2009.




F-9


Income
Taxes


The
Companyaccounts for
income taxes in accordance with the asset and liability method.Under the asset
and liability method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the consolidated
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases.  Deferred tax assets and liabilities are
measured using enacted tax rates for the periods in which the differences are
expected to reverse.  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.




The
Company records a valuation allowance if based on the weight of available
evidence, it is more likely than not that some or all of the deferred tax asset
will not be realized.  In determining the possible realization of
deferred tax assets, the Company considers future taxable income from the
following sources: (i) the reversal of taxable temporary differences,
(ii) taxable income from future operations and (iii) tax planning
strategies that, if necessary, would be implemented to accelerate taxable income
into periods in which net operating losses might otherwise expire.




The
Company also recognizes the income tax effect of tax positions taken or expected
to be taken in a tax return.  For those benefits to be recognized, a
tax position must be more-likely-than-not to be sustained upon examination by
taxing authorities.  The amount recognized is measured as the largest
amount of benefit that has a greater than 50 percent likelihood of being
realized upon ultimate settlement.  If recognized, the tax portion of
the adjustment would affect the effective tax rate.





Fair Value of Financial
Instruments


Unless
otherwise indicated, the fair value of all reported assets and liabilities which
represent financial instruments (none of which are held for trading purposes)
approximate the carrying values of such instruments.





Stock-Based
Compensation


The
Company accounts for stock-based compensation at fair value using the
Black-Scholes Option pricing model. All stock-based compensation cost is
measured at the grant date using the Black-Sholes Option Pricing Model, based on
the fair value of the award.  The value of the portion of the award
that is ultimately expected to vest is recognized as expense over the requisite
service periods in the Company’s consolidated statements of
operations.





No
options were granted during the year ended December 31, 2009.  The
fair value of options granted during 2008 was calculated based upon the
following weighted-average assumptions:




Dividend
      Yield
            0.0%Risk-Free
      Interest Rate
            2.84%Expected
      Life
            5.00
      yearsExpected
      Volatility
            111.57%




Stock-based
compensation expense recognized during the period is based on the value of the
portion of share-based payment awards that is ultimately expected to vest during
the period.  Forfeitures are estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates.  The forfeiture rate that the Company presently uses
is 0%.





Cash
flows resulting from the tax benefits resulting from tax deductions in excess of
the compensation cost recognized for those options are classified as financing
cash flows.  Due to the Company’s loss position, there were no such
tax benefits for the years ended December 31, 2009 and 2008.





Net Loss per Common
Share


Basic net
loss per share is computed by dividing the net loss available to common
stockholders for the period by the weighted average number of shares of common
stock outstanding during the period.  The calculation of diluted net
loss per share gives effect to common stock equivalents; however, potential
common shares are excluded if their effect is anti-dilutive.  For the
years ended December 31, 2009 and December 31, 2008, basic and diluted earnings
per share were the same.




F-10


Recent Accounting
Pronouncements


Effective
July 1, 2009, the Company adopted the Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) 105-10, Generally Accepted Accounting
Principles – Overall (“ASC 105-10”).  ASC 105-10 establishes
the FASB Accounting Standards
Codification(the “Codification”) as the source of authoritative
accounting principles recognized by the FASB to be applied by nongovernmental
entities in the preparation of financial statements in conformity with U.S.
GAAP.  Rules and interpretive releases of the SEC under authority of
federal securities laws are also sources of authoritative U.S. GAAP for SEC
registrants.  All guidance contained in the Codification carries an
equal level of authority.  The Codification superseded all existing
non-SEC accounting and reporting standards.  All other
non-grandfathered, non-SEC accounting literature not included in the
Codification is non-authoritative.  The FASB will not issue new
standards in the form of Statements, FASB Staff Positions or Emerging Issues
Task Force Abstracts.  Instead, it will issue Accounting Standards
Updates (“ASUs”).  The FASB will not consider ASUs as authoritative in
their own right.  ASUs will serve only to update the Codification,
provide background information about the guidance and provide the bases for
conclusions on the change(s) in the Codification.  References made to
FASB guidance throughout this document have been updated for the
Codification.





Effective
January 1, 2008, the Company adopted FASB ASC 820-10, Fair Value Measurements and
Disclosures – Overall(“ASC 820-10”) with respect to its financial assets
and liabilities.  In February 2008, the FASB issued updated guidance
related to fair value measurements, which is included in the Codification in ASC
820-10-55, Fair Value
Measurements and Disclosures – Overall – Implementation Guidance and
Illustrations.  The updated guidance provided a one year
deferral of the effective date of ASC 820-10 for non-financial assets and
non-financial liabilities, except those that are recognized or disclosed in the
financial statements at fair value at least annually.  The Company
adopted the provisions of ASC 820-10 for non-financial assets and non-financial
liabilities effective January 1, 2009, and such adoption did not have a
material impact on the Company’s results of operations or financial
condition.





Effective
April 1, 2009, the Company adopted FASB ASC 820-10-65, Fair Value Measurements and
Disclosures – Overall – Transition and Open Effective Date Information
(“ASC 820-10-65”).  ASC 820-10-65 provides additional guidance for
estimating fair value in accordance with ASC 820-10 when the volume and level of
activity for an asset or liability have significantly decreased.  ASC
820-10-65 also includes guidance on identifying circumstances that indicate a
transaction is not orderly.  ASC 825-10-65 also amends ASC 825-10 to
require disclosures about the fair value of financial instruments in interim
financial statements as well as in annual financial statements and also amends
ASC 270-10 to require those disclosures in all interim financial
statements.  The adoption of ASC 820-10-65 did not have an impact on
the Company’s results of operations or financial condition.





Effective
April 1, 2009, the Company adopted FASB ASC 855-10, Subsequent Events – Overall(“ASC 855-10”).  ASC 855-10 establishes general standards of
accounting for and disclosure of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. 
It requires the disclosure of the date through which an entity has evaluated
subsequent events and the basis for that date – that is, whether that date
represents the date the financial statements were issued or were available to be
issued.  This disclosure should alert all users of financial statements
that an entity has not evaluated subsequent events after that date in the set of
financial statements being presented.  Adoption of ASC 855-10 did not
have a material impact on the Company’s consolidated results of operations or
financial condition.  The Company has evaluated subsequent events from
December 31, 2009 to the date the financial statements were issued.





Effective
July 1, 2009, the Company adopted FASB ASU No. 2009-05, Fair Value Measurements and
Disclosures (Topic 820) (“ASU 2009-05”).  ASU 2009-05 provided
amendments to ASC 820-10, Fair
Value Measurements and Disclosures – Overall, for the fair value
measurement of liabilities.  ASU 2009-05 provides clarification that
in circumstances in which a quoted price in an active market for the identical
liability is not available, a reporting entity is required to measure fair value
using certain techniques.  ASU 2009-05 also clarifies that when
estimating the fair value of a liability, a reporting entity is not required to
include a separate input or adjustment to other inputs relating to the existence
of a restriction that prevents the transfer of a liability.  ASU
2009-05 also clarifies that both a quoted price in an active market for the
identical liability at the measurement date and the quoted price for the
identical liability when traded as an asset in an active market when no
adjustments to the quoted price of the asset are required are Level 1 fair value
measurements.  Adoption of ASU 2009-05 did not have a material impact
on the Company’s results of operations or financial condition.




F-11




In
October 2009, the FASB issued ASU 2009-13, Multiple-Deliverable Revenue
Arrangements, (amendments to FASB ASC Topic 605, Revenue Recognition) (“ASU
2009-13”) and ASU 2009-14, Certain Arrangements That Include
Software Elements, (amendments to FASB ASC Topic 985, Software) (“ASU
2009-14”).  ASU 2009-13 requires entities to allocate revenue in an
arrangement using estimated selling prices of the delivered goods and services
based on a selling price hierarchy.  The amendments eliminate the
residual method of revenue allocation and require revenue to be allocated using
the relative selling price method.  ASU 2009-14 removes tangible products
from the scope of software revenue guidance and provides guidance on determining
whether software deliverables in an arrangement that includes a tangible product
are covered by the scope of the software revenue guidance.  ASU 2009-13 and
ASU 2009-14 should be applied on a prospective basis for revenue arrangements
entered into or materially modified in fiscal years beginning on or after
June 15, 2010, with early adoption permitted.  The Company does
not expect adoption of ASU 2009-13 or ASU 2009-14 to have a material impact on
the Company’s results of operations or financial condition.





Presentation as a Going
Concern


The
accompanying condensed consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going
concern.  The Company has sustained net losses of $12,694,997 and
$1,029,859 for the years ended December 31, 2009 and December 31, 2008,
respectively.  The Company also has an accumulated deficit of
$83,923,177 and a working capital deficit of $17,891,538 at December 31,
2009, of which $9,448,534 relates to the fair value of derivative financial
instruments.  In September 2008, the Company shifted its principal
operating model from product development to licensing enabling a reduction in
headcount, footprint and infrastructure reducing expense run rates
substantially.  There can be no assurance that this shift in business
model will be successful.





The items
discussed above raise substantial doubts about the Company's ability to continue
as a going concern.  If the Company's financial resources are
insufficient, the Company may require additional financing in order to execute
its operating plan and continue as a going concern.  The Company
cannot predict whether this additional financing will be in the form of equity,
debt or another form.  The Company may not be able to obtain the
necessary additional capital on a timely basis, on acceptable terms, or at
all.  Should financing sources fail to materialize, management would
seek alternate funding sources such as the sale of common and/or preferred
stock, the issuance of debt or other means.  The Company plans to
attempt to address its working capital deficiency by increasing its sales,
maintaining strict expense controls and seeking strategic
alliances.





In the
event that these financing sources do not materialize, or the Company is
unsuccessful in increasing its revenues and profits, the Company will be forced
to further reduce its costs, may be unable to repay its debt obligations as they
become due or respond to competitive pressures, any of which circumstances would
have a material adverse effect on its business, prospects, financial condition
and results of operations.  Additionally, if these funding sources or
increased revenues and profits do not materialize, and the Company is unable to
secure additional financing, the Company could be forced to reduce or curtail
its business operations unless it is able to engage in a merger or other
corporate finance transaction with a better capitalized entity.





The
financial statements do not include any adjustments relating to the
recoverability and reclassification of recorded asset amounts or amounts and
reclassification of liabilities that might be necessary, should the Company be
unable to continue as a going concern.





2.
              Fair Value of
      Financial Instruments




The
Company measures fair value in accordance with a fair value hierarchy that
prioritizes the inputs to valuation techniques used to measure fair
value.  The hierarchy gives the highest priority to unadjusted quoted
prices in active markets for identical assets or liabilities (Level 1
measurements) and the lowest priority to unobservable inputs (Level 3
measurements).  The three levels of the fair value hierarchy are
described below:





Level 1
            Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or
  liabilities;  F-12
  Level 2
            Quoted
      prices in markets that are not active, or inputs that are observable,
      either directly or indirectly, for substantially the full term of the
      asset or liability; andLevel 3
            Prices
      or valuation techniques that require inputs that are both significant to
      the fair value measurement and unobservable (supported by little or no
      market activity).





The
following table sets forth the Company’s financial assets and liabilities
measured at fair value by level within the fair value
hierarchy.  Assets and liabilities are classified in their entirety
based on the lowest level of input that is significant to the fair value
measurement.





The table
below sets forth a summary of the fair values of the Company’s financial assets
and liabilities as of December 31, 2009:





Total
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3ASSETS:Cash
      equivalents
              
              $
              1,520
              
              
              $
              1,520
              
              
              $
              -
              
              
              $
              -$
              1,520
              
              
              $
              1,520
              
              
              $
              -
              
              
              $
              -LIABILITIES:Conversion
      option liabilities
              
              $
              5,442,599
              
              
              $
              -
              
              
              $
              -
              
              
              $
              5,442,599Detachable
      warrant liabilities
              
              
              4,005,935
              
              
              
              -
              
              
              
              -
              
              
              
              4,005,935$
              9,448,534
              
              
              $
              -
              
              
              $
              -
              
              
              $
              9,448,534




The
Company’s cash instrument is classified within Level 1 of the fair value
hierarchy because it is valued using quoted market prices.  The cash
instrument that is valued based on quoted market prices in active markets are
primarily money market securities and U.S. Treasury securities.




The
Company’s detachable warrant and conversion option liabilities are valued using
pricing models and the Company generally uses similar models to value similar
instruments.  Where possible, the Company verifies the values produced
by its pricing models to market prices.  Valuation models require a
variety of inputs, including contractual terms, market prices, yield curves,
credit spreads, measures of volatility and correlations of such
inputs.  These financial liabilities do not trade in liquid markets,
and as such, model inputs cannot generally be verified and do involve
significant management judgment.  Such instruments are typically
classified within Level 3 of the fair value hierarchy.  See Note 5 for
the rollforward of Level 3 liabilities.





3.
              Inventories





Inventories
consisted of the following at December 31:





2009
            
            
            2008Raw
      materials
            
            $
            492,280
            
            
            $
            631,280Work
      in process
            
            
            13,336
            
            
            
            -Finished
      goods
            
            
            367,293
            
            
            
            422,880872,909
            
            
            
            1,054,160Allowance
      for obsolescence
            
            
            201,694
            
            
            
            141,530Inventory,
      net
            
            $
            671,215
            
            
            $
            912,630







F-13





4.
              Property and
      Equipment





Property
and equipment consisted of the following at December 31:




2009
            
            
            2008Furniture
      and office equipment
            
            $
            29,666
            
            
            $
            126,962Computer
      equipment
            
            
            183,689
            
            
            
            214,773Testing
      equipment
            
            
            271,676
            
            
            
            625,395Leasehold
      improvements
            
            
            85,952
            
            
            
            113,317570,983
            
            
            
            1,080,447Less:
      Accumulated depreciation
            
            
            548,040
            
            
            
            1,041,414Property
      and equipment, net
            
            $
            22,943
            
            
            $
            39,033





Depreciation
and amortization expense related to property and equipment for the years ended
December 31, 2009 and 2008 was $16,090 and $51,607, respectively.





5.
              Securities Purchase
      Agreements





The
Company entered into four separate securities purchase agreements (the “2006
SPA,” the “2007 SPA,” the “April 2008 SPA” and the “July 2008 SPA,” collectively
the “SPAs”) with three institutional investors in connection with private
placement transactions that provided for, among other things, the issuance of
senior convertible notes (the “2006 Notes,” the “2007 Notes,” the “April 2008
Notes” and the “July 2008 Notes,” collectively the “Notes”), warrants to
purchase shares of common stock (the “2006 Warrants,” the “2007 Warrants,” “the
April 2008 Warrants,” the “July 2008 Warrants” and the “Replacement Warrants,”
collectively the “Warrants”) and the issuance of common stock (the “March 2008
Stock” and the “July 2008 Stock”).  Following is a summary of the
securities issued pursuant to the terms of the SPAs.





Transaction
                
                Date
      of
                  Financing
                
                Initial
      Principal
                  Amount
      of
                  Notes
                
                Series
      of
                  Warrants
                  Issued
                
                Initial
                  Numberof
                  Warrants
                  Issued
      to the
                  Investors
                
                
                Shares
      of
                  Common
                  Stock
      Issued2006
      SPA
                
                July
      30, 2006 (1)
                
                $
                8,804,909
                
                L
      and M
                
                
                39,797,031
                
                
                
                -2007
      SPA
                
                July
      31, 2007
                
                
                3,500,000
                
                N,
      O and P
                
                
                6,047,886
                
                
                
                -April
      2008 SPA
                
                April
      1, 2008
                
                
                3,125,000
                
                Q
                
                
                6,250,000
                
                
                
                3,125,000July
      2008 SPA
                
                July
      28, 2008
                
                
                1,250,000
                
                R
                
                
                8,750,000
                (2)
                
                
                1,250,000$
                16,679,909
                
                
                
                
                60,844,917
                
                
                
                4,375,000
  (1)
                  The
      information presented reflects the January 22, 2007
    amendment.
 (2)
                    Includes
      2,500,000 Series R warrants and 6,250,000 Replacement
      Warrants.
   F-14


The
Company allocated the proceeds of the April 2008 and July 2008 Notes to the
individual financial instruments included in the transactions based on their
estimated absolute fair values as follows:





April
      2008
              
              
              July
      2008
              
              
              TotalTotal
      proceeds
              
              $
              3,125,000
              
              
              $
              1,250,000
              
              
              $
              4,375,000Allocated
      to:Common
      stock
              
              
              2,531,250
              
              
              
              675,000
              
              
              
              3,206,250Warrants
              
              
              2,993,750
              
              
              
              856,750
              
              
              
              3,850,500Conversion
      option
              
              
              1,002,813
              
              
              
              142,500
              
              
              
              1,145,3136,527,813
              
              
              
              1,674,250
              
              
              
              8,202,063Debt
      discount
              
              
              (3,125,000
              )
              
              
              (1,250,000
              )
              
              
              (4,375,000
              )Cost
      of financing senior convertible notes
              
              $
              3,402,813
              
              
              $
              424,250
              
              
              $
              3,827,063




The fair
value of the common stock was based on the closing market price of the Company’s
common stock on the date of the transactions.  The fair values of the
warrants and conversion options were based on the Black-Scholes Option pricing
model.  All of the SPAs require the Company to maintain authorized
shares of at least 130% of the sum of the maximum number of common shares
issuable upon conversion of the Notes and upon exercise of the
Warrants.





All of
the SPAs contain registration rights agreements which require the Company to
file registration statements with the SEC for the resale of the shares of common
stock underlying all of the Notes, Warrants and common stock
issued.  The Company is required to maintain the effectiveness of the
registration statements through the latest date at which the Notes can be
converted or the Warrants can be exercised.  Notwithstanding other
remedies available under the SPAs, the Company will be required to pay
liquidated damages equal to 2% of the principal amount of the Notes on the date
of failure and 2% of the principal amount of the Notes every 30th day
thereafter (or for a pro rated period if less than 30 days) for failure to
timely file the registration statements or have them declared effective by the
SEC and failure to maintain the effectiveness of the registration statements,
subject to certain grace periods.  Any liquidated damages not paid
timely will accrue interest at the rate of 2% per month.  Registration
penalties under SPAs are capped at 12.5% of the principal amount of the
respective Notes.  The maximum registration penalties under the Notes
are as follows:




Transaction
              
              Maximum
                Registration
                Penalty2006
      SPA
              
              $
              1,100,6142007
      SPA
              
              
              437,500April
      2008 SPA
              
              
              390,625July
      2008 SPA
              
              
              156,250$
              2,084,989




The
Company is required to assess its potential liability with respect to
registration rights agreements.  On May 29, 2008, the investors agreed
to delay payments in connection with the registration rights agreement contained
in the April 2008 SPA and the registration of the shares underlying the L-1 and
L-2 warrants.  The deadline has been indefinitely extended by the
investors.  As such, no liability related to the registration rights
agreements has been recorded in the accompanying consolidated financial
statements.





Significant
events of default under the SPAs include:




●
              The
      failure of any registration statement to be declared effective by the SEC
      within 60 days after the date required by the applicable registration
      rights agreement or the lapse or unavailability of such registration
      statement for more than 10 consecutive days or more than an aggregate of
      30 days in any 365-day period (other than certain allowable grace
      periods).




●
              The
      failure to issue unlegended certificates within 3 trading days after the
      Company receives documents necessary for the removal of the
      legend.




F-15





In
January 2007, the Company amended the 2006 SPA (the “2006 Amended
SPA”).  The amendments included, but were not limited to, a waiver of
all fees, penalties and defaults as of January 19, 2007 which related to
registration statement filing failures and/or effectiveness failures, as
described in the 2006 SPA, an increase in the principal amount of the 2006 Notes
from an aggregate of $5 million to an aggregate of $7.2 million, issuance of an
additional 5,688,540 of 2006 Warrants which increased the aggregate number of
shares of common stock issuable upon exercise of the Series L-1 Warrants from an
aggregate of 17,065,623 shares to an aggregate of 22,754,163 shares, and a
reduction in the exercise price of the Series L-1 Warrants and the Series M-1
Warrants from $0.5054 per share to $0.43948 per share.  The Company
did not receive any additional cash consideration for these
amendments.





Additionally,
pursuant to the terms of the 2006 Amended SPA, the Company entered into a
Securities Purchase Agreement with one of the existing institutional investors
in a private placement transaction providing for, among other things, the
issuance of senior convertible notes (the “2006 Amended Notes) in the principal
amount of $1.6 million, Series L-2 Warrants to purchase up to 7,281,332 shares
of common stock and Series M-2 Warrants to purchase up to 2,366,433 shares of
common stock.  The Series L-2 Warrants were immediately
exercisable.  The Series M-2 warrants were to become exercisable only
upon a mandatory conversion of the 2006 Notes, as defined in the 2006
Notes.  Both the Series L-2 Warrants and Series M-2 Warrants have an
exercise price of $0.43948 per share and expire on July 31, 2011.





The April
2008 SPA amended the 2007 Notes and the 2007 Warrants.  Pursuant to
the 2008 SPA, the conversion price of the 2007 Notes and the exercise price of
the 2007 Warrants were reduced from $1.20 to $0.50.  The April 2008
SPA had no effect on the 2006 Notes.  The July 2008 SPA amended the
exercise price of the Series Q warrants from $1.00 to $0.50.




Since the
modifications of the 2006 Notes, the 2007 Notes and the Series Q warrants
resulted in terms that were substantially different from the terms of the
previous 2006 Notes, the modification was recorded as an extinguishment of
debt.  After eliminating all liabilities related to the 2006 and 2007
SPAs and adjusting the fair value of the Series Q warrants to reflect the
reduced exercise price, a loss of $5,182,474 was recorded in the consolidated
statements of operations for the year ended December 31, 2008.





The April
2008 SPA also amended the terms of the Series M-1 and M-2 warrants to eliminate
the contingency provisions and therefore, the Series M-1 and Series M-2 warrants
became immediately exercisable upon the effective date of the 2008
SPA.  The modifications to these warrants were not considered
substantial and the Company did not record any gain or loss related to the
amendments.  However, the Company recorded the portion of expense
related to the warrants that became immediately exercisable of $1,146,033 as
cost of financing for the year ended December 31, 2008.





The
conversion price of the Notes and the exercise price of the Warrants are subject
to customary anti-dilution provisions for stock splits and the like, and are
also subject to full-ratchet anti-dilution protection such that if the Company
issues or is deemed to have issued certain securities at a price lower than the
then applicable conversion or exercise price, then the conversion or exercise
price will immediately be reduced to such lower price.





The Notes
and the Warrants contain certain limitations on conversion or exercise,
including that a holder of those securities cannot convert or exercise those
securities to the extent that upon such conversion or exercise, that holder,
together with the holder’s affiliates, would own in excess of 4.99% of the
Company’s outstanding shares of common stock (subject to an increase or
decrease, upon at least 61-days’ notice, by the investor to the Company, of up
to 9.99%).




F-16


Notes





Information
relating to the Notes is as follows:




Transaction
                
                Initial
                  Principal
      Amount
                
                
                Interest
                  Rate (4),
      (5)
                
                Maturity
                  Date
                
                
                Initial
                  Fixed
      Conversion Price
                
                
                Current
                  Fixed
      Conversion Price
                
                
                Unpaid
      Principal as of December 31, 2009
                
                
                Unamortized
      Discount as of December 31, 2009
                
                
                Carrying
                  Value
      as of December 31, 20092006
      Notes(1),(7)
                
                $
                8,804,909
                
                
                
                9.25
                %
                (3)
                07/31/2008
                (7)
                
                $
                0.44
                
                
                $
                0.44
                
                
                $
                4,448,440
                
                
                $
                -
                
                
                $
                4,448,4402007
      Notes(2),(8)
                
                
                3,500,000
                
                
                
                9.25
                %
                
                08/01/2010
                
                
                $
                1.21
                
                
                $
                0.50
                
                
                
                2,752,309
                
                
                
                (877,592
                )
                
                
                1,874,717April
      2008 Notes(6),(9)
                
                
                3,125,000
                
                
                
                10.00
                %
                
                03/31/2010
                
                
                $
                1.00
                
                
                $
                1.00
                
                
                
                2,125,000
                
                
                
                (431,192
                )
                
                
                1,693,808July
      2008 Notes(6),(10)
                
                
                1,250,000
                
                
                
                10.00
                %
                
                07/28/2010
                
                
                $
                1.00
                
                
                $
                1.00
                
                
                
                850,000
                
                
                
                (364,583
                )
                
                
                485,417$
                16,679,909
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                10,175,749
                
                
                $
                (1,673,367
                )
                
                $
                8,502,382
  (1)
                  All
      information presented reflects amendments made in January
      2007.
 (2)
                  Fixed
      conversion price reflects the effect of anti-dilution provision as a
      result of the April 2008 SPA.
 (3)
                  The
      interest rate may be reduced to 7.00% at the beginning of each quarter if
      certain conditions are met.  No such conditions havebeen
      met to date.
 (4)
                    The
      interest rates increase to 15.00% upon the occurrence of an event of
      default.
 (5)
                    Interest
      is calculated on the basis of a 360 day
year.
 (6)
                    All
      interest due under the April 2008 Notes and July 2008 Notes was deducted
      from the proceeds. Prepaid interest is reflected in theaccompanying consolidated balance sheets as follows as
  of:
 December
      31, 2009
                
                
                December
      31, 2008Current
                
                
                Long-term
                
                
                Total
                
                
                Current
                
                
                Long-term
                
                
                TotalApril
      2008 Notes
                
                $
                53,125
                
                
                $
                -
                
                
                $
                53,125
                
                
                $
                312,500
                
                
                $
                78,125
                
                
                $
                390,625July
      2008 Notes
                
                
                49,583
                
                
                
                -
                
                
                
                49,583
                
                
                
                125,000
                
                
                
                72,917
                
                
                
                197,917$
                102,708
                
                
                $
                -
                
                
                $
                102,708
                
                
                $
                437,500
                
                
                $
                151,042
                
                
                $
                588,542
  (7)
                  The
      investors have not demanded repayment.  During the year ended
      December 31, 2009, the Company issued 4,391,604 shares of commonstock
      for the conversion of $1,930,020 of the balance due on the 2006
      Notes.  During the year ended December 31, 2008, the Companyissued
      1,410,401 shares of common stock for the conversion of $171,212 of the
      balance due on the 2006 Notes.  Additionally, accruedinterest
      payable of $452,238 was added to the principal balance of the 2006 Notes
      during the year ended December 31,
2009.
 (8)
                  During
      the year ended December 31, 2009, the Company issued 2,093,569 shares of
      commons stock for the conversion of $1,046,784 of thebalance
      due on the 2007 Notes.  Additionally, $299,093 of accrued interest
      payable was added to the principal balance of the 2007
    Notes.
 (9)
                  During
      the year ended December 31, 2009, the Company issued 4,337,369 shares of
      commons stock for the conversion of $1,000,000 ofthe
      balance due on the April 2008
Notes.
 (10)
                    During
      the year ended December 31, 2009, the Company issued 2,364,878 shares of
      commons stock for the conversion of $400,000 ofthe
      balance due on the July 2008
Notes.
 
 The
Company may elect to make monthly installment payments in cash or in shares of
the Company’s common stock.





The
maturity date of the Notes may be extended at the option of the investors so
long as there is not an event of default.





Despite
the maturity dates and past deferrals of required payments and/or conversions,
the Notes are classified as current liabilities in the accompanying consolidated
balance sheets because the investors have the right to accelerate conversion of
the Notes up to an amount equal to 20% of the aggregate dollar trading volume of
the Company’s common stock over the prior 20 trading day period.  In
addition, the Company has the right to call a forced conversion under certain
conditions.





The 2006
and 2007 Notes are convertible into shares of common stock at the option of the
holder at the lower of the fixed conversion price or the optional conversion
price, defined as 90% of the arithmetic average of the weighted-average price of
the common stock for the 5 consecutive trading days immediately preceding the
conversion date.  However, if the weighted average price for the 20
trading days preceding the date of conversion exceeds $1.00, the conversion
price is computed as 92.5% of the weighted average price of the common stock for
the 5 consecutive trading days immediately preceding the conversion
date.  However, the Company may, at its option, redeem in cash, up to
an amount equal to 20% of the aggregate dollar trading volume of the Company’s
common stock over the prior 20-trading day period on the 2007
Notes.




F-17




Subject
to certain conditions, the Company may require the investors to convert up to
50% of the 2006 Notes after the SEC has declared effective the initial
registration statement at any time when the shares of the Company’s common stock
are trading at or above 150% of the initial conversion price or convert up to
100% of the notes after the SEC has declared effective the initial registration
statement at any time when the shares of the Company’s common stock are trading
at or above 175% of the initial conversion price. The 2006 Notes contain certain
limitations on optional and mandatory conversion.





The
entire outstanding principal balance of the 2007 Notes and any outstanding fees
or interest shall be due and payable in full on the maturity
date.  Interest is payable quarterly, beginning October 1,
2007.  Under certain conditions, the Company may require investors to
convert up to either 50% or 100% of the outstanding balances of the 2007 Notes
at any time the Company shares are trading at or above $1.80 or $2.11,
respectively





The April
2008 Notes are convertible into shares of common stock at the lower of the fixed
conversion price or the optional conversion price, defined as 85% of the
arithmetic average of the weighted-average price of the common stock for the 5
consecutive trading days immediately preceding the conversion
date.  However, following the disclosure of an SEC event, as defined
in the April 2008 Notes, the conversion price will be computed using the lowest
of (i) 50% of arithmetic average of the weighted average price for the 30
trading days preceding the date of conversion; (ii) 50% of the closing price of
the common stock on the trading day preceding the date of conversion; or (iii)
50% of the closing price of the common stock on the date preceding the SEC
event.





The July
2008 Notes are convertible into shares of common stock at the lower of the fixed
conversion price or the optional conversion price, defined as the lesser of (i)
85% of the arithmetic average of the weighted-average price of the common stock
for the 30 consecutive trading days immediately preceding the conversion date
and (ii) 85% of the arithmetic average of the weighted-average price of the
common stock for the 3 lowest trading days during the 30 consecutive trading
days immediately preceding the conversion date.  However, following
the disclosure of an SEC event, as defined in the April 2008 Notes, the
conversion price will be computed using the lowest of (i) 50% of the amounts
determined as above; (ii) 50% of the closing price of the common stock on the
trading day preceding the date of conversion; or (iii) 50% of the closing price
of the common stock on the date preceding the SEC event.





The Notes
are secured by a first priority perfected security interest in all of the
Company's assets and the common stock of the Company’s
subsidiary.  Additionally, the Notes are guaranteed by the Company’s
subsidiary.


Significant
events of default under the Notes include:




●
              The
      failure of any registration statement to be declared effective by the SEC
      within 60 days after the date required by the applicable registration
      rights agreement or the lapse or unavailability of such registration
      statement for more than 10 consecutive days or more than an aggregate of
      30 days in any 365-day period (other than certain allowable grace
      periods).




●
              The
      suspension from trading or failure of the common stock to be listed for
      trading on the OTC Bulletin Board or another eligible market for more than
      5 consecutive trading days or more than an aggregate of 10 trading
      days in any 365-day period.




●
              The
      failure to issue shares upon conversion of the Notes or for more than 10
      business days after the relevant conversion date or a notice of the
      Company’s intention not to comply with a request for
      conversion.




●
              The
      Company’s failure to pay any amount of principal, interest, late charges
      or other amounts when due.




If there
is an event of default, the investors have the right to redeem all or any
portion of the Notes, at the greater of (i) up to 125% of the sum of the
outstanding principal, interest and late fees, depending on the nature of the
default, and (ii) the product of (a) the greater of (1) the closing
sale price for the Company’s common stock on the date immediately preceding the
event of default, (2) the closing sale price for the Company’s common stock
on the date immediately after the event of default and (3) the closing
sale price for the Company’s common stock on the date an investor delivers its
redemption notice for such event of default, multiplied by (b) 130% of the
number of shares into which the notes (including all principal, interest and
late fees) may be converted.




F-18




In the
event of a default or upon the occurrence of certain fundamental transactions as
defined in the 2007 Notes, the investors will have the right to require the
Company to redeem the 2007 Notes at a premium.  In addition, at any
time on or after August 1, 2010, the investors may accelerate the partial
payment of the 2007 Notes by requiring that the Company convert at the lower of
the then conversion price or a 7.5% or 10.0% discount to the recent volume
weighted average price of the Company’s common stock, or at the option of the
Company, redeem in cash, up to an amount equal to 20% of the aggregate dollar
trading volume of the Company’s common stock over the prior 20-trading day
period.





Warrants





In
connection with the SPAs, the Company issued detachable warrants as
follows:




Series
      of
                  Warrants
                
                Initial
      Number
                  of
      Warrants Issued
                
                
                Initial
                  Exercise
                  Price
                
                
                Current
                  Exercise
                  Price
                
                Term(4)
                
                Additional
      Warrant
                  Grants(6)
                
                
                Warrants
      Outstanding at December 31, 2009
                
                
                Fair
      Value of Warrant Liability as of December 31, 2009
                
                
                Fair
      Value of Warrant Liability as of December 31, 2008L-1(1)
                
                
                22,754,163
                
                
                $
                0.505
                
                
                $
                0.439
                
                7
      years
                
                
                -
                
                
                
                22,754,163
                
                
                $
                1,226,449
                
                
                $
                841,306L-2(1)
                
                
                7,281,332
                
                
                $
                0.505
                
                
                $
                0.439
                
                7
      years
                
                
                -
                
                
                
                7,281,332
                
                
                
                392,464
                
                
                
                269,409M-1(1),(3)
                
                
                7,395,103
                
                
                $
                0.505
                
                
                $
                0.439
                
                7
      years
                
                
                -
                
                
                
                7,395,103
                
                
                
                398,596
                
                
                
                273,619M-2(1),
      (3)
                
                
                2,366,433
                
                
                $
                0.505
                
                
                $
                0.439
                
                7
      years
                
                
                -
                
                
                
                2,366,433
                
                
                
                127,551
                
                
                
                87,558N(2)
                
                
                2,909,636
                
                
                $
                1.203
                
                
                $
                0.500
                
                7
      years
                
                
                4,090,364
                
                
                
                7,000,000
                
                
                
                660,100
                
                
                
                302,400O(2),(5)
                
                
                1,891,263
                
                
                $
                1.203
                
                
                $
                0.500
                
                7
      years
                
                
                2,658,737
                
                
                
                4,550,000
                
                
                
                N/A
                
                
                
                N/AP(2)
                
                
                1,246,987
                
                
                $
                1.203
                
                
                $
                0.500
                
                7
      years
                
                
                1,753,013
                
                
                
                3,000,000
                
                
                
                282,900
                
                
                
                129,600Q(7),(8)
                
                
                6,250,000
                
                
                $
                1.000
                
                
                $
                0.500
                
                7
      years
                
                
                -
                
                
                
                6,250,000
                
                
                
                655,625
                
                
                
                426,875R
                
                
                2,500,000
                
                
                $
                0.500
                
                
                $
                0.500
                
                7
      years
                
                
                -
                
                
                
                2,500,000
                
                
                
                262,250
                
                
                
                170,750Replacement(9)
                
                
                6,250,000
                
                
                $
                1.000
                
                
                $
                1.000
                
                7
      years
                
                
                -
                
                
                
                6,250,000
                
                
                
                N/A
                
                
                
                N/A60,844,917
                
                
                
                
                
                
                
                
                
                
                
                
                8,502,114
                
                
                
                69,347,031
                
                
                $
                4,005,935
                
                
                $
                2,501,517
  (1)
                  All
      information presented reflects amendments made in January
      2007.
 (2)
                  Current
      exercise price reflects the effect of anti-dilution provision as a result
      of the April 2008 SPA.
 (3)
                  The
      April 2008 SPA modified the warrants to eliminate the contingency
      provision.
 (4)
                  The
      term begins as of the effective date of the registration
      statement.
 (5)
                    The
      fair value of the Series O warrants has not yet been recorded since the
      contingency provisions have not been
met.
 (6)
                    Additional
      warrants were granted due to the anti-dilution provisions in the 2007
      SPA.
 (7)
                    Exercise
      price is the lesser of $0.50 or 75% of the lowest of the
      following:
 (i)
                    The
      average of the dollar volume-weighted average price of the stock for the
      15 consecutive tradingdays
      immediately following the public disclosure of an event of
      default;
 (ii)
                The
      lowest of the dollar volume-weighted average price of the stock during the
      30 consecutive tradingdays
      ending on the date of exercise;
 (iii)
                  The
      average of the dollar volume-weighted average price of the stock for the 3
      consecutive tradingdays
      immediately preceding the date of exercise;
or
 (iv)
                  The
      average of the dollar volume-weighted average price of the stock for the 3
      consecutive tradingdays
      immediately following the date of
exercise.
 (8)
                    Exercise
      price was amended by July 2008
SPA.
 (9)
                    The
      Replacement Warrants are exercisable on a one-to-one basis as the Series Q
      warrants are exercised.  Theexercise
      price is the lowest of $0.50 or 75% of the lowest of the
      following:
 (i)
                      The
      average of the dollar volume-weighted average price of the stock for the
      30 consecutive tradingdays
      immediately following the public disclosure of an event of
      default;
 (ii)
                The
      average of the dollar volume-weighted average price of the stock for the
      30 consecutive tradingdays
      immediately preceding the public disclosure of an event of
      default;
 (iii)
                The
      average of 3 lowest volume-weighted average prices of the stock during
      either (i) or (ii)
above.




The
holders’ rights to exercise the 9,761,536 Series M warrants was contingent on a
mandatory conversion of the 2006 Notes at the option of the
Company.  A mandatory conversion for a portion of the 2006 Notes took
place on July 30, 2007 entitling investors to exercise up to 7,646,361 M warrant
shares.  The 2008 SPA contained a provision which removed the
contingency on the remaining M warrants such that they are immediately
exercisable.  The Company recognized $1,146,063 of expense related to
the M warrants for the year ended December 31, 2008.  The value of the
M warrants was measured at fair value on January 18, 2007 using the
Black-Scholes option pricing model.  The Replacement Warrants are
exercisable on a one-for-one basis for every Series Q warrant
exercised.




F-19




Since
conversion of the Series O warrants is contingent on a mandatory conversion of
the 2007 Notes and since the exercise of the Replacement Warrants is contingent
on the exercise of the Series Q warrants, the total charge was measured as of
the date of issuance of the Series O warrants and the Replacement
Warrants.  This charge will not be recognized until the mandatory
conversion “contingency” has been satisfied.  The fair values of the
Series O warrants and Replacement Warrants at inception were $1,493,341 and
$2,725,625, respectively.





The fair
value of the conversion options and the detachable warrant liabilities were
calculated using the Black-Scholes Option Pricing Model with the following
assumptions for the year ended:





December
      31, 2009
                
                December
      31, 20082006
      Notes
                
                2007
      Notes
                
                April
      2008 Notes
                
                July
      2008
                  Notes
                
                2006
      Notes
                
                2007
      Notes
                
                April
      2008 Notes
                
                July
      2008
                  NotesStock
      price
                
                $
                0.17
                
                $
                0.17
                
                $
                0.17
                
                $
                0.17
                
                $
                0.14
                
                $
                0.14
                
                $
                0.14
                
                $
                0.14Exercise
      price
                
                $
                0.16
                
                $
                0.50
                
                $
                0.15
                
                $
                0.15
                
                $
                0.44
                
                $
                0.50
                
                $
                1.00
                
                $
                1.00Expected
      life (in years)
                
                
                0.75
                
                
                1.50
                
                
                1.26
                
                
                1.26
                
                
                0.75
                
                
                1.50
                
                
                1.26
                
                
                1.26Volatility
                
                
                168.86%
                
                
                176.74%
                
                
                177.93%
                
                
                177.93%
                
                
                165.61%
                
                
                131.21%
                
                
                138.78%
                
                
                138.78%Risk-free
      rate of return
                
                
                0.34%
                
                
                0.81%
                
                
                0.64%
                
                
                0.64%
                
                
                0.32%
                
                
                0.57%
                
                
                0.47%
                
                
                0.47%Expected
      dividend yield
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
  2006
                  Warrants
                
                2007
                  Warrants
                
                April
      2008 Warrants
                
                July
      2008 Warrants
                
                2006
                  Warrants
                
                2007
                  Warrants
                
                April
      2008 Warrants
                
                July
      2008 WarrantsStock
      price
                
                $
                0.17
                
                $
                0.17
                
                $
                0.17
                
                $
                0.17
                
                $
                0.14
                
                $
                0.14
                
                $
                0.14
                
                $
                0.14Exercise
      price
                
                $
                0.44
                
                $
                0.50
                
                $
                0.50
                
                $
                0.50
                
                $
                0.44
                
                $
                0.50
                
                $
                1.00
                
                $
                0.50Expected
      life (in years)
                
                
                0.75
                
                
                1.50
                
                
                2.76
                
                
                2.76
                
                
                0.75
                
                
                1.50
                
                
                2.76
                
                
                2.76Volatility
                
                
                168.86%
                
                
                176.74%
                
                
                141.04%
                
                
                141.04%
                
                
                165.61%
                
                
                131.21%
                
                
                124.11%
                
                
                124.11%Risk-free
      rate of return
                
                
                0.34%
                
                
                0.81%
                
                
                1.57%
                
                
                1.57%
                
                
                0.32%
                
                
                0.57%
                
                
                0.94%
                
                
                0.94%Expected
      dividend yield
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%
                
                
                0.00%




















F-20





Activity
in the 2006 Notes and 2006 Warrants was as follows:




Principal
                  Balance
                
                
                Discount
      on
                  Notes
      Payable
                
                
                Conversion
                  Option
                  Liability
                
                
                Detachable
                  Warrant
                  LiabilityBalance,
      January 1, 2008
                
                $
                6,097,434
                
                
                $
                (3,331,597
                )
                
                $
                3,929,462
                
                
                $
                8,696,190Amortization
      of debt discount
                
                
                -
                
                
                
                3,331,597
                
                
                
                -
                
                
                
                -Conversion
      of notes to common stock
                
                
                (171,212
                )
                
                
                -
                
                
                
                (151,932
                )
                
                
                -Recognition
      of warrant liabilities uponsatisfaction of contingency related to
      Series M-1 and M-2 warrants
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,146,033Change
      in fair value of conversionoption and detachable warrant
      liabilities
                
                
                -
                
                
                
                -
                
                
                
                (3,279,034
                )
                
                
                (8,370,331
                )Balance,
      December 31, 2008
                
                
                5,926,222
                
                
                
                -
                
                
                
                498,496
                
                
                
                1,471,892Accrued
      interest added to principal balance
                
                
                452,238
                
                
                
                (74,084
                )
                *
                
                74,084
                
                
                
                -Amortization
      of debt discount
                
                
                -
                
                
                
                74,084
                
                *
                
                -
                
                
                
                -Conversion
      of notes to common stock
                
                
                (1,930,020
                )
                
                
                -
                
                
                
                (319,559
                )
                
                
                -Change
      in fair value of conversionoption and detachable warrant
      liabilities
                
                
                -
                
                
                
                -
                
                
                
                2,331,928
                
                
                
                673,168Balance,
      December 31, 2009
                
                $
                4,448,440
                
                
                $
                -
                
                
                $
                2,584,949
                
                
                $
                2,145,060
  *
                Since
      the 2006 Notes are due on demand, the additional debt discount related to
      the accrued interest addedto
      principal was immediately
amortized.
 
 Activity
in the 2007 Notes and 2007 Warrants is as follows:





Principal
                Balance
              
              
              Discount
      on
                Notes
      Payable
              
              
              Conversion
                Option
                Liability
              
              
              Detachable
                Warrant
                LiabilityBalance,
      January 1, 2008
              
              $
              3,500,000
              
              
              $
              (3,013,890
              )
              
              $
              150,428
              
              
              $
              214,896Loss
      on extinguishment of debt
              
              
              -
              
              
              
              2,722,224
              
              
              
              (372,142
              )
              
              
              (531,630
              )Fair
      value of amended notes, conversionoption liability and detachable
      warrant liabilities
              
              
              -
              
              
              
              (3,500,000
              )
              
              
              2,658,600
              
              
              
              3,798,000Amortization
      of debt discount
              
              
              -
              
              
              
              1,416,666
              
              
              
              -
              
              
              
              -Change
      in fair value of conversionoption and detachable warrant
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              (2,134,486
              )
              
              
              (3,049,266
              )Balance,
      December 31, 2008
              
              
              3,500,000
              
              
              
              (2,375,000
              )
              
              
              302,400
              
              
              
              432,000Accrued
      interest added to principal balance
              
              
              299,093
              
              
              
              (52,212
              )
              
              
              52,212
              
              
              
              -Conversion
      of notes to common stock
              
              
              (1,046,784
              )
              
              
              -
              
              
              
              (169,370
              )
              
              
              -Amortization
      of debt discount
              
              
              -
              
              
              
              1,549,620
              
              
              
              -
              
              
              
              -Change
      in fair value of conversionoption and detachable warrant
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              333,843
              
              
              
              511,000Balance,
      December 31, 2009
              
              $
              2,752,309
              
              
              $
              (877,592
              )
              
              $
              519,085
              
              
              $
              943,000





F-21




Activity
in the April 2008 Notes and 2008 Warrants is as follows:





Principal
                Balance
              
              
              Discount
      on
                Notes
      Payable
              
              
              Conversion
                Option
                Liability
              
              
              Detachable
                Warrant
                LiabilityBalance
      at April 1, 2008 (inception)
              
              $
              3,125,000
              
              
              $
              (3,125,000
              )
              
              $
              1,002,813
              
              
              $
              2,993,750Gain
      on extinguishment of debt
              
              
              -
              
              
              
              701,167
              
              
              
              -
              
              
              
              (1,590,625
              )Fair
      value of amended notes, conversionoption liability and detachable
      warrant liabilities
              
              
              -
              
              
              
              (841,400
              )
              
              
              -
              
              
              
              2,084,375Amortization
      of debt discount
              
              
              -
              
              
              
              1,119,288
              
              
              
              -
              
              
              
              -Change
      in fair value of conversionoption and detachable warrant
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              (929,375
              )
              
              
              (3,060,625
              )Balance,
      December 31, 2008
              
              
              3,125,000
              
              
              
              (2,145,945
              )
              
              
              73,438
              
              
              
              426,875Conversion
      of notes to common stock
              
              
              (1,000,000
              )
              
              
              -
              
              
              
              (231,526
              )
              
              
              -Amortization
      of debt discount
              
              
              -
              
              
              
              1,714,753
              
              
              
              -
              
              
              
              -Change
      in fair value of conversionoption and detachable warrant
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              1,828,492
              
              
              
              228,750Balance,
      December 31, 2009
              
              $
              2,125,000
              
              
              $
              (431,192
              )
              
              $
              1,670,404
              
              
              $
              655,625








Activity
in the July 2008 Notes and July 2008 Warrants is as follows:




Principal
                Balance
              
              
              Discount
      on
                Notes
      Payable
              
              
              Conversion
                Option
                Liability
              
              
              Detachable
                Warrant
                LiabilityBalance
      at July 28, 2008 (inception)
              
              $
              1,250,000
              
              
              $
              (1,250,000
              )
              
              $
              142,500
              
              
              $
              856,750Amortization
      of debt discount
              
              
              -
              
              
              
              260,417
              
              
              
              -
              
              
              
              -Change
      in fair value of conversionoption and detachable warrant
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              (113,125
              )
              
              
              (686,000
              )Balance,
      December 31, 2008
              
              
              1,250,000
              
              
              
              (989,583
              )
              
              
              29,375
              
              
              
              170,750Conversion
      of notes to common stock
              
              
              (400,000
              )
              
              
              -
              
              
              
              (381,415
              )
              
              
              -Amortization
      of debt discount
              
              
              -
              
              
              
              625,000
              
              
              
              -
              
              
              
              -Change
      in fair value of conversionoption and detachable warrant
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              1,020,201
              
              
              
              91,500Balance,
      December 31, 2009
              
              $
              850,000
              
              
              $
              (364,583
              )
              
              $
              668,161
              
              
              $
              262,250






F-22




A summary
of the balances as of December 31, 2009 and 2008 follows:




Principal
              Balance
            
            
            Discount
      on
              Notes
      Payable
            
            
            Conversion
              Option
              Liability
            
            
            Detachable
              Warrant
              Liability2006
      Notes
            
            $
            4,448,440
            
            
            $
            -
            
            
            $
            2,584,949
            
            
            $
            2,145,0602007
      Notes
            
            
            2,752,309
            
            
            
            (877,592
            )
            
            
            519,085
            
            
            
            943,000April
      2008 Notes
            
            
            2,125,000
            
            
            
            (431,192
            )
            
            
            1,670,404
            
            
            
            655,625July
      2008 Notes
            
            
            850,000
            
            
            
            (364,583
            )
            
            
            668,161
            
            
            
            262,250Balance,
      December 31, 2009
            
            $
            10,175,749
            
            
            $
            (1,673,367
            )
            
            $
            5,442,599
            
            
            $
            4,005,935




Principal
                Balance
              
              
              Discount
      on
                Notes
      Payable
              
              
              Conversion
                Option
                Liability
              
              
              Detachable
                Warrant
                Liability2006
      Notes
              
              $
              5,926,222
              
              
              $
              -
              
              
              $
              498,496
              
              
              $
              1,471,8922007
      Notes
              
              
              3,500,000
              
              
              
              (2,375,000
              )
              
              
              302,400
              
              
              
              432,000April
      2008 Notes
              
              
              3,125,000
              
              
              
              (2,145,945
              )
              
              
              73,438
              
              
              
              426,875July
      2008 Notes
              
              
              1,250,000
              
              
              
              (989,583
              )
              
              
              29,375
              
              
              
              170,750Balance,
      December 31, 2008
              
              $
              13,801,222
              
              
              $
              (5,510,528
              )
              
              $
              903,709
              
              
              $
              2,501,517




6.
              Stockholders’
      Equity





The
Company’s authorized capital consists of 200,000,000 shares of common stock, par
value $0.001 per share and 5,000,000 shares of preferred stock, no par value per
share.





During
2009, the Company issued 200,000 shares of common stock for consulting services
valued at $34,000.





During
2009, the Company issued 13,187,420 shares of common stock for the conversion of
$4,376,804 of the principal balance of notes payable and $1,101,870 related to
the reduction of the conversion option liability.





During
2008, in connection with the Company’s senior convertible notes, the Company
issued 1,410,401 shares related to $171,212 of principal, $215,373 in accrued
interest and $151,933 relating to the reduction of the conversion option
liability.





During
2008, the Company issued a total of 4,375,000 shares of common stock in
connection with 2 private placements valued at $3,206,250 (See note
5).





7.
              Stock
      Options





2005 Stock
Plan





The
Company’s 2005 Stock Plan was approved by the Company’s Board of Directors on
April 7, 2005, approved by the Company’s shareholders on June 9, 2005, and
amended and restated as the First Amended and Restated 2005 Stock Plan (“2005
Plan”) by the Company’s Board of Directors on June, 29, 2007.  The
Company filed a registration statement on Form S-8 with the Securities and
Exchange Commission (“SEC”) in May 2007 to cover the issuance of up to 3,000,000
shares of common stock underlying options and stock purchase rights authorized
for issuance under the 2005 Plan and qualified for issuance the underlying
securities with the California Department of Corporations in July,
2007.  Prior to that time, the Company issued only non-plan stock
options.  The 2005 Plan is now the Company’s only formal plan for
providing stock-based incentive compensation to the Company’s eligible
employees, non-employee directors and certain consultants.  The Board
of Directors or committee of the Board of Directors administering the 2005 Plan
has discretion to set vesting, expiration and other terms of awards under the
2005 Plan.  As of December 31, 2009, the 2005 Plan had a total of
908,667 options outstanding and 1,991,333 shares reserved for future
grants.




F-23


Non-Plan
Options





Prior to
approval of our 2005 Plan, the Company granted stock options
out-of-plan.  These non-plan options provided for the periodic
issuance of stock options to our employees and non-employee board of
directors.  The vesting period for the non-plan stock options is three
equal annual installments commencing on the first anniversary of the date of
grant.  The maximum contractual term of stock options granted under
these out-of-plan options was eight years.  As of December 31, 2009,
there were 850,000 non-plan options outstanding.





A summary
of the activity of the Company’s stock options for the years ended December 31,
2008 and 2009 is presented below:




Options
            
            Shares
            
            
            Weighted
              Average
              Exercise
      Price
            
            
            Weighted
              Average
              Remaining
              Contract
      Term
            
            
            Aggregate
              Intrinsic
      ValueOutstanding,
      January 1, 2008
            
            
            1,801,000
            
            
            $
            1.01Granted
            
            
            1,282,000
            
            
            
            0.53Forfeited
      / Expired
            
            
            (1,213,000
            )
            
            
            0.89Exercised
            
            
            -
            
            
            
            -Outstanding,
      December 31, 2008
            
            
            1,870,000
            
            
            $
            0.76
            
            
            
            5.42
            
            
            $
            -Granted
            
            
            -
            
            
            
            -Forfeited
      / Expired
            
            
            (111,333
            )
            
            
            0.42Exercised
            
            
            -
            
            
            
            -Outstanding,
      December 31, 2009
            
            
            1,758,667
            
            
            $
            0.78
            
            
            
            4.32
            
            
            
            -Exercisable,
      December 31, 2009
            
            
            1,247,333
            
            
            $
            0.88
            
            
            
            3.53
            
            
            $
            -




As of
December 31, 2009 total unrecognized stock-based compensation cost related to
unvested stock options was $95,295, which is expected to be recognized over a
weighted average period of approximately 1.24 years.





A summary
of the status of the Company’s unvested stock options as of December 31, 2009 is
presented below:




Number
      of
              Shares
            
            
            Weighted-
              Average
      Grant-
              Date
      Fair ValueNon-vested
      at January 1, 2008
            
            
            619,167Granted
            
            
            1,282,000Vested
            
            
            (221,667
            )Non-vested
      shares forfeited
            
            
            (759,667
            )
            
            $
            0.59Non-vested
      at December 31, 2008
            
            
            919,833
            
            
            $
            0.39Granted
            
            
            -Vested
            
            
            (325,666
            )
            
            $
            0.41Non-vested
      shares forfeited
            
            
            (83,333
            )
            
            $
            0.19Non-vested
      at December 31, 2009
            
            
            510,834
            
            
            $
            0.42




For the
year ended December 31, 2009 and 2008, the Company recognized $102,551 and
$216,978, respectively, in stock-based compensation costs related to the
issuance of options to employees.  These costs were calculated using
the Black-Scholes Option Pricing Model and are reflected in operating
expenses.




F-24





8.
            Warrants





Warrants
granted to investors, brokers and other service providers are summarized as
follows:





Weighted
              AverageShares
            
            
            Exercise
      PriceOutstanding
      at January 1, 2008
            
            
            55,604,444
            
            
            $
            0.76Granted
            
            
            23,868,498
            
            
            
            0.50Cancelled/Forfeited
            
            
            (400,000
            )
            
            
            1.22Exercised
            
            
            -
            
            
            
            -Outstanding
      at December 31, 2008
            
            
            79,072,942
            
            
            $
            0.63Granted
            
            
            -
            
            
            
            -Cancelled/forfeited
            
            
            (3,447,999
            )
            
            
            1.23Exercised
            
            
            -
            
            
            
            -Outstanding
      at December 31, 2009
            
            
            75,624,943
            
            
            $
            0.64





Series
              
              Issue
      Date
              
              Outstanding
      at January 1,
                2008
              
              Granted
              
              Exercised
      / Forfeited
              
              Outstanding
      at December 31,
                2008
              
              Granted
              
              Exercised
      / Forfeited
              
              
              Outstanding
      at December 31, 2009B
              
              April
      2004
              
              1,950,001
              
              
              -
              
              
              -
              
              
              1,950,001
              
              
              -
              
              
              (1,950,001
              )
              
              
              -D
              
              June
      2004
              
              972,223
              
              
              -
              
              
              -
              
              
              972,223
              
              
              -
              
              
              (972,223
              )
              
              
              -E
              
              2004-2005
              
              141,000
              
              
              -
              
              
              -
              
              
              141,000
              
              
              -
              
              
              (141,000
              )
              
              
              -F
              
              April
      2005
              
              14,385
              
              
              -
              
              
              -
              
              
              14,385
              
              
              -
              
              
              -
              
              
              
              14,385G
              
              April
      2005
              
              3,564,188
              
              
              -
              
              
              -
              
              
              3,564,188
              
              
              -
              
              
              -
              
              
              
              3,564,188G-BH
              
              April
      2005
              
              1,505,989
              
              
              -
              
              
              -
              
              
              1,505,989
              
              
              -
              
              
              -
              
              
              
              1,505,989I
              
              February
      2005
              
              10,000
              
              
              -
              
              
              -
              
              
              10,000
              
              
              -
              
              
              -
              
              
              
              10,000J
              
              August
      2005
              
              16,255
              
              
              -
              
              
              -
              
              
              16,255
              
              
              -
              
              
              -
              
              
              
              16,255L-1
              
              July
      2006 & January 2007
              
              22,754,163
              
              
              -
              
              
              -
              
              
              22,754,163
              
              
              -
              
              
              -
              
              
              
              22,754,163L-2
              
              July
      2006 & January 2007
              
              7,281,332
              
              
              -
              
              
              -
              
              
              7,281,332
              
              
              -
              
              
              -
              
              
              
              7,281,332M-1
              
              July
      2006 & January 2007
              
              7,395,103
              
              
              -
              
              
              -
              
              
              7,395,103
              
              
              -
              
              
              -
              
              
              
              7,395,103M-2
              
              July
      2006 & January 2007
              
              2,366,433
              
              
              -
              
              
              -
              
              
              2,366,433
              
              
              -
              
              
              -
              
              
              
              2,366,433N
              
              July
      2007
              
              2,909,636
              
              
              4,090,364
              
              
              -
              
              
              7,000,000
              
              
              -
              
              
              -
              
              
              
              7,000,000O
              
              July
      2007
              
              1,891,263
              
              
              2,658,737
              
              
              -
              
              
              4,550,000
              
              
              -
              
              
              -
              
              
              
              4,550,000P
              
              July
      2007
              
              1,246,987
              
              
              1,753,013
              
              
              -
              
              
              3,000,000
              
              
              -
              
              
              -
              
              
              
              3,000,000Q
              
              April
      2008
              
              -
              
              
              6,250,000
              
              
              -
              
              
              6,250,000
              
              
              -
              
              
              -
              
              
              
              6,250,000Replacement
              
              July
      2008
              
              -
              
              
              6,250,000
              
              
              -
              
              
              6,250,000
              
              
              -
              
              
              -
              
              
              
              6,250,000R
              
              July
      2008
              
              -
              
              
              2,500,000
              
              
              -
              
              
              2,500,000
              
              
              -
              
              
              -
              
              
              
              2,500,000Miscellaneous
              
              2003
      - 2007
              
              1,585,486
              
              
              366,384
              
              
              (400,000
              )
              
              1,551,870
              
              
              -
              
              
              (384,775
              )
              
              
              1,167,09555,604,444
              
              
              23,868,498
              
              
              (400,000
              )
              
              79,072,942
              
              
              -
              
              
              (3,447,999
              )
              
              
              75,624,943





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





Range
      of Exercise
              Prices
            
            Number
              Outstanding
            
            Wtd. Ave. Life
            
            Wtd. Ave. Price
            
            Number
              Exercisable$.40-2.50
            
            75,624,943
            
            3.22
            
            $0.64
            
            64,824,943




F-25




2008
Warrants





On April
1, 2008, pursuant to the terms of the securities purchase agreement the Company
issued 6,250,000 Series Q warrants. These warrants had an initial exercise
price of $1.00 and expire on March 31, 2017.  In connection with the
July 2008 financing, the exercise price of the Series Q warrants was reduced to
$0.50.  Based on this adjustment, the Company issued an additional
4,090,364, 2,658,737, and 1,753,013 Series N, Series O, and Series P warrants,
respectively.





On July
31, 2008, pursuant to the terms of the securities purchase agreement the Company
issued 2,500,000 Series R warrants. These warrants have an exercise price
of $1.00 and expire on July 31, 2016.





2007
Warrants





In
connection with securing the 2007 Notes (as described in Note 5 above), the
investors were entitled to Series N warrants to purchase up to an aggregate of
2,909,636 shares of the Company’s common stock, Series P warrants to purchase up
to an aggregate of 1,246,987 shares of the Company’s common stock and Series O
warrants to purchase up to an aggregate of 1,891,263 shares of the Company’s
common stock.  These series of N, O, and P warrants had an original
exercise price of $1.2029 per share and expire August 1, 2016.  The
Series N and P warrants are immediately exercisable.  The Series O
warrants become exercisable only upon a “mandatory conversion” of the notes,
which is callable by the Company.





2006
Warrants





In
connection with securing the 2006 Notes (as described in Note 5 above), the
investors were issued Series L-1 warrants to purchase up to an aggregate of
22,754,163 shares of the Company’s common stock, Series L-2 warrants to purchase
up to an aggregate of 7,281,332 shares of the Company’s common stock and Series
M-2 warrants to purchase up to an aggregate of 2,366,433 shares of the Company’s
common stock.  Both the Series L-1 warrants and Series M-2 warrants
have an exercise price of $0.44 per share and expire August 1,
2016.  The Series L-1 warrants are immediately
exercisable.  The Series M-2 warrants become exercisable only upon a
“mandatory conversion” of the notes, which is callable by the
Company.





In
connection with the 2006 SPA, the Company issued to the placement agent warrants
with a term of five years to purchase 600,710 shares of the Company’s common
stock at an exercise price of $0.44.  In connection with the 2007 SPA,
the Company will issue warrants to purchase 116,385 shares of the Company’s
common stock at an exercise price of $1.20.  In connection with the
2008 SPA, the Company will issue warrants to purchase 125,000 shares of the
Company’s common stock at an exercise price of $1.00.  All placement
agent warrants are immediately exercisable.





The
placement agent warrants were measured at fair value using the Black-Scholes
option pricing model.  During 2008, the Company capitalized $40,113 as
debt issuance costs.  During the years ended December 31, 2009 and
2008, the Company amortized $20,056 and $141,213, respectively, $53,905 of which
is included in loss on extinguishment of debt for the year ended December 31,
2008.





9.
            Commitments and
      Leases





The
Company leases office space under a non-cancelable operating lease expiring
March 31, 2010 for $1,560 per month.  Rent expense for the years ended
December 31, 2009 and 2008 was $18,720 and $231,304, respectively.





In
October 2008, the Company rendered possession of its prior operating facility to
the landlord and charged $241,261 to other expense in connection with rent due
for the remainder of the lease (October 1, 2008 – July 31, 2009).  In
November 2009, the Company settled the matter for $216,000 plus simple interest
at 10 percent per annum.  The Company paid $7,000 on the date of the
agreement.  Beginning January 15, 2010 and continuing through January
15, 2012, the Company will make monthly payments of $9,000.  A final
payment of $6,106 is due on February 15, 2012.  As a result of the
settlement, the Company recorded an additional expense of $21,435 for the year
ended December 31, 2009.  The Company charged $241,261 to expense for
the year ended December 31, 2008.




F-26




Future
minimum payments under the settlement agreement are as follows:




2010
              
              $
              93,1132011
              
              
              100,9552012
              
              
              14,931$
              208,999




As of
December 31, 2009, the Company has $30,178 in purchase order
commitments.





10.
            Income
      Taxes





The
Company computes and records taxes payable based upon determination of taxable
income which is different from pre-tax financial statement
income.  Such differences arise from the reporting of financial
statement amounts in different periods for tax purposes.  The timing
differences are a result of different accounting methods being used for
financial and tax reporting.





The
Company’s total deferred tax assets and deferred tax liabilities were as follows
at December 31:





2009
            
            
            2008Deferred
      tax assets:Non-cash
      compensation
            
            $
            95,000
            
            
            $
            95,000Non-benefited  tax
      losses and credits
            
            
            36,683,000
            
            
            
            29,086,000Total
      deferred tax assets
            
            
            36,778,000
            
            
            
            29,181,000Deferred
      tax liabilities
            
            
            -
            
            
            
            -Net
      book value of assets
            
            
            -
            
            
            
            (26,000
            )Total
      deferred tax liabilities
            
            
            -
            
            
            
            (26,000
            )Total
      net deferred tax assets
            
            
            36,778,000
            
            
            
            29,155,000Valuation
      allowance
            
            
            (36,778,000
            )
            
            
            (29,155,000
            )Net
      deferred tax assets
            
            $
            -
            
            
            $
            -





A
valuation allowance has been established against the realization of the deferred
tax assets since the Company has determined that the operating loss
carryforwards may not be realized.





The
Company has federal and state net operating loss carryforwards of approximately
$84,530,000 and $80,290,000, respectively expiring between 2023 and 2029. 
Should the Company move out of the enterprise zone, approximately $29,000,000 of
the state net operating loss will be suspended leaving approximately
$31,000,000 of the general state net operating loss
remaining.





Internal
Revenue Code Section 382 imposes limitation on our ability to utilize net
operating losses if we experience an ownership change and for the NOL’s acquired
in the acquisitions of subsidiaries.  An ownership change may result from
transactions increasing the ownership percentage of 5% or greater stockholders
in the stock of the corporation by more than 50 percentage points over a
three-year period.  The value of the stock at the time of an ownership
change is multiplied by the applicable long-term tax exempt interest rate to
calculate the annual limitation.  Any unused annual limitation may be
carried over to later years.





At
December 31, 2009 and 2008, the amount of gross unrecognized tax benefits
before valuation allowances and the amount that would favorably affect the
effective income tax rate in future periods after valuation allowances were
zero.




F-27




The
Company files income tax returns in U.S. federal and various state
jurisdictions.  The Company is beyond the statute of limitations subjecting
it to U.S. federal and state income tax examinations by tax authorities for
years before 2007 and 2006, respectively.  The Company is not currently
subject to any income tax examinations by any tax authority.  Should a tax
examination be opened, management does not anticipate any tax adjustments, if
accepted, that would result in a material change to its financial
position.




11.
            Subsequent
      Events





The
following subsequent events have occurred through the filing date of this
report, March 26, 2009.




In a
letter agreement dated January 12, 2010, signed by Castlerigg Master
Investments, Ltd., Cedar Hill Capital Partners Onshore, LP, Cedar Hill Capital
Partners Offshore, Ltd. (the “Investors”) and the Company, the Investors granted
the Company a limited waiver by which interest in the amount of $166,220 due
under the secured notes payable as of December 31, 2009 will be added to the
principal balance of the secured notes rather than be paid in cash or through
conversion of the notes.





On March
4, 2010 the Company renewed the lease for its current premises through September
30, 2010.  The lease has a monthly rent of $1,560.


















F-28




INDEX
TO EXHIBITS FILED WITH THIS REPORT




Exhibit
              Number
            
            Description10.6
            
            
            Facility
      lease agreement with Martin Investment dated December 16,
    200931.1
            
            
            Certification
      of the Chief Executive Officer Required by Rule 13a-14(a) of the
      Securities Exchange Act of 1934, as amended, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200231.2
            
            
            Certification
      of the Chief Financial Officer Required by Rule 13a-14(a) of the
      Securities Exchange Act of 1934, as amended, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200232.1
            
            
            Certification
      of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      200232.2
            
            
            Certification
      of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002






















44