##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended: December 31, 2010
 or
 o
    
    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: 000-53235
 DIGITILITI,
INC.
 (Exact Name of Registrant as specified in its Charter)
 Delaware
    
    26-1408538(State or other Jurisdiction of
Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)
 th th   (Address of Principal Executive Offices)
 (Registrants Telephone Number, including area code)
   Yes
o No
þ
 Yes
o No
þ
 þ o
 o o
 o
  Large accelerated filer o
    
    Accelerated filed o
    
    Non-accelerated filer o
    
    Smaller reporting company þ
 o þ
 Market Value of Non-Affiliate Holdings
   Outstanding Shares
  Class
    
    Outstanding at March 30, 2011Common Stock, $.001 par value per share
    
    65,599,753 shares
 Documents Incorporated by Reference




---



##### 



TABLE OF CONTENTS
 PART I
    
    
    3ITEM 1. BUSINESS
    
    
    3ITEM 1A. RISK FACTORS
    
    
    11ITEM 2: PROPERTIES
    
    
    18ITEM 3: LEGAL PROCEEDINGS
    
    
    18PART II
    
    
    19ITEM 5: MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
    
    
    19ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
    
    
    20ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    
    27ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
    
    
    54ITEM 9A: CONTROLS AND PROCEDURES
    
    
    54ITEM 9B: OTHER INFORMATION
    
    
    55PART III
    
    
    55ITEM 10: DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
    
    
    55ITEM 11: EXECUTIVE COMPENSATION
    
    
    64ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
    
    
    65ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
    
    
    67ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
    
    
    69PART IV
    
    
    55ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES
    
    
    55SIGNATURES
    
    
    57EX-10.10EX-31.1EX-31.2EX-32
   2




---



##### Table of Contents



PART I
 FORWARD-LOOKING STATEMENTS
   
 ITEM 1.
    
    BUSINESS
    th th
     www.Digitiliti.com
  3




---



##### Table of Contents



The DigiBAK business
   
  The Emerging New Universal Archive Platform (DigiLIBE) Product
  Growing both Business Segments:
  (i)
    
    solving a major industry and customer problem of managing continually growing
information volume and associated cost of storage and retrieval;
 (ii)
    
    ability to access a larger share of opportunity in the information management storage
business;
 (iii)
    
    offering significant technological advantages in control of information at the
corporate policy level and ability to leverage knowledge from the information it creates;
and
 (iv)
    
    optimization of the synergistic allocation of capital and resources between both
business.
  4




---



##### Table of Contents



5




---



##### Table of Contents



Products, Software, Services and Related Technologies Utilized
  Storage Technologies:
   6




---



##### Table of Contents



Archiving & Information Technologies:
  Principal Products or Services and their Markets
 Markets
     7




---



##### Table of Contents



Products
   Objectives
   Targets
  digitiliti Product Operational Methodology
  
    
    Develop simple and robust technologies. Mask technical complexity from IT and from the
users.
 
    
    Develop technologies and process to scale sales through VARs
 
    
    Reduce total cost of ownership (TCO) of managing information and archiving for IT and
organizations.
 
    
    Provide customers with the business knowledge of the content they create and store, to
improve their efficiency and effectiveness.
  8




---



##### Table of Contents



Distribution Methods of the Products or Services
   Status of any Publicly Announced New Product or Service
   Competitive Business Conditions, Competitive Position in the Industry and Methods of Competition
   Competitive landscape for DigiLIBE:
    9




---



##### Table of Contents



Sources and Availability of Raw Materials and Names of Principal Suppliers
    Dependence on One or a Few Major Customers
   Patents, Trademarks, Licenses, Franchises, Concessions, Royalty Agreements or Labor Contracts,
including Duration
      10




---



##### Table of Contents



StorageSwitch, LLC
  Vision to Practice, Inc.
   Research and Development Costs during the Last two Fiscal Years
  Number of Total Employees and Number of Full Time Employees
  Reports to Security Holders
   
 ITEM 1A.
    
    RISK FACTORS
 Risks Related to Our Business
 We have not recorded annual profitable operations since our inception, and continued losses may
require us to curtail or terminate our business operations.
   11




---



##### Table of Contents



Our substantial short term debt could adversely affect our financial condition and our ability to
continue our present and planned business operations.
      Our substantial indebtedness could have important adverse consequences on our ability to carry on
our present and planned business operations.
  
    
    make it more difficult for us to satisfy our obligations with respect to the current or
new debt financing, if any is offered in the future;
 
    
    fund the selling and marketing expenses that support the national roll-out of DigiLIBE;
 
    
    make us more sensitive to adverse economic conditions than some of our competitors with
less debt;
 
    
    limit our ability to fund future working capital, acquisitions, capital expenditures and
other general corporate requirements;
 
    
    limit our flexibility in planning for, or reacting to, changes in our business and the
records and information management services industry;
 
    
    make it more difficult for us to obtain additional equity or debt financing for future;
and
 
    
    limit our working capital requirements for future acquisitions or other reasons
important to our business strategy.
 Despite our current debt position, we may still need to incur substantial additional debt or we
will be unable to continue our planned operations.
  We have deficiencies in our internal controls that could adversely affect our financial statements
reporting, which could cause our financial statements to be inaccurate or un-auditable.
   12




---



##### Table of Contents



We have material weaknesses in our internal controls over financial reporting that could
adversely affect our financial statements.
   If we fail to develop new products, or if we incur unexpected expenses or delays in product
development, we may lose our competitive position and incur substantial additional losses on our
operations or may be required to curtail or terminate our present and planned business operations.
  Our business may be adversely affected by downturns in the economy that may limit the sale of
storage and universal archiving solutions and our present and planned business operations may fail
as a result.
  We depend on our key personnel, and the loss of any would impair our ability to compete and gain
any market share in the storage solutions industry that we presently serve and intend to serve.
  Our intellectual property rights or contractual provisions may not protect us and our products and
as a result, our business may fail.
    13




---



##### Table of Contents



We need additional capital to continue or expand our current business operations, and our business
operations may prove unsuccessful without additional funding.
    14




---



##### Table of Contents



We face a higher risk of failure and loss of our entire business because we cannot accurately
forecast our future revenues and operating results.
  
    
    The timing of sales of our products and services;
 
    
    The timing of product implementation;
 
    
    Unexpected delays in introducing new products and services;
 
    
    increased expenses, whether related to sales and marketing, product development or
administration;
 
    
    The mix of product license and services revenue; and
 
    
    Costs related to possible acquisitions of technology or businesses.
 Our limited resources may make it harder for us to manage growth, and the future of our business
model maybe adversely harmed if we are unable to adequately manage this growth.
  If we do not respond effectively to technological change, our products and services could become
obsolete and our business may fail.
   
    
    Rapid technological change;
 
    
    Changes in user and customer requirements and preferences;
 
    
    Frequent new product and services introductions embodying new technologies; and
 
    
    The emergence of new industry standards and practices.
  
    
    license or acquire leading technologies useful in our business;
 
    
    develop new services and technologies that address our users increasingly sophisticated
and varied needs; and
 
    
    Respond to technological advances and emerging industry and regulatory standards and
practices in a cost effective and timely way.
  We face competition for customers that could effectively keep us from being successful in our
planned business operations.
   15




---



##### Table of Contents



Our storage systems may fail, and we may be subject to substantial liabilities and could lose a
substantial portion of our customer base.
  Our operating results could be impaired if we become subject to burdensome government regulation
and legal uncertainties, all of which would increase our cash requirements and may cause our
business to fail.
  
    
    User privacy;
 
    
    pricing;
 
    
    Content;
 
    
    Copyrights;
 
    
    Distribution; and
 
    
    Characteristics and quality of products and services.
    The Internet may fail or providers of these services may increase their costs for these and related
services, which could increase our costs and make our services less attractive to customers.
   16




---



##### Table of Contents



Our auditors Going Concern qualification in our consolidated financial statements might create
additional doubt about our ability to stay in business, potentially resulting in total stockholder
loss on investment.
   Multiple acts of God could result in data loss and subject us to substantial liabilities and the
loss of our business and customers.
  Risks Related to Our Common Stock
 Our common stock is penny stock under Securities and Exchange Commission Rules and Regulations,
which means there is a very limited trading market for our shares.
   Due to the substantial instability in our common stock price, you may not be able to sell your
shares at a profit or at all, and as a result, any investment in our shares could be totally lost.
  
    
    Our competitors announcements and successes or failures;
 
    
    Other evidence about the safety or efficacy of our products;
  17




---



##### Table of Contents




    
    Announcements of new competitive products or successes by our competitors;
 
    
    Increased or new governmental regulation of our products;
 
    
    Our competitors developments of competing patents or proprietary rights or other
technology; and
 
    
    Fluctuations in our operating results.
 Our common stock has a limited trading history, and it will be difficult to determine any market
trends or prices for our shares where this present limited market is believed to be based primarily
on supply and demand.
  The sale or potential sale of shares of our common stock that may become publicly tradable under
Rule 144 in the future will have a severe adverse impact on any market that develops for our common
stock, and you may lose your entire investment or be unable to resell any shares in us that you
purchase.
  
 ITEM 2:
    
    PROPERTIES
   th
 
 ITEM 3:
    
    LEGAL PROCEEDINGS
    18




---



##### Table of Contents



PART II
 
 ITEM 5:
    
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
 Market Information
  Closing BidQuarter Ended
    
    High
    
    
    LowMarch 31, 2009*
    
    $
    .15
    
    
    $
    .12June 30, 2009*
    
    $
    .35
    
    
    $
    .35September 30, 2009*
    
    $
    .20
    
    
    $
    .20December 31, 2009*
    
    $
    .18
    
    
    $
    .17March 31, 2010*
    
    $
    .28
    
    
    $
    .28June 30, 2010*
    
    $
    .19
    
    
    $
    .18September 30, 2010*
    
    $
    .24
    
    
    $
    .20December 31, 2010*
    
    $
    .21
    
    
    $
    .21
 Holders
  Dividends
  Securities Authorized for Issuance under Equity Compensation Plans
 Number of securitiesremaining available forNumber of Securities to be
    
    
    Weighted-average exercise
    
    
    future issuance underissued upon exercise of
    
    
    price of outstanding
    
    
    equity compensation plansoutstanding options,
    
    
    options, warrants and
    
    
    excluding securitieswarrants and rights
    
    
    rights
    
    
    reflected in column (a)Plan Category
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved by
security holders
    
    
    2,990,000
    *
    
    $
    0.34
    
    
    
    0 4,380,000
    (2)(3)Equity compensation
plans not approved
by security holders
    
    None
    
    
    None
    
    
    NoneTotal
    
    
    2,990,000
    (1)
    
    $
    0.34
    
    
    
    04,380,000
    (2)(3)
 (1)
    
    Reflects the overall grant of five year options totaling 9,661,000 that vest
over various periods, less (1) the cancellation, effective April 17, 2008, of an option
to purchase 525,000 shares granted to an employee who are no longer employed by us and
(2) the forfeiture of options totaling 6,146,000 pertaining to employees who are no
longer employed by us.(2)
    
    Reflects the approval by the Companys Board of Directors on July 15, 2010 to
terminate the existing 2007 Stock Option Plan in favor of the 2010 Long Term Incentive
Plan approved on July 15, 2010, subject to approval by the shareholders at the
Companys next annual meeting.(3)
    
    Reflects the approval by the Companys Board of Directors on July 15, 2010,
and the subsequent approval by the Companys stockholders at the Companys Annual
Meeting on October 14, 2010, to enact the 2010
Long Term Incentive Plan. A narrative description of the material terms of the equity
compensation plans is set forth in Note 11 to our Consolidated Financial Statements.  19




---



##### Table of Contents



Exemptions from Registration for Sales of Restricted Securities.
  Purchases of Equity Securities by Us and Affiliated Purchasers
  
 ITEM 7:
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
    20




---



##### Table of Contents



Executive Summary
 The Business
    The DigiBak business
   
  The Emerging New DigiLIBE Product
   21




---



##### Table of Contents



Growing both Business Segments:
  (i)
    
    solving a major industry and customer problem of managing continually growing
information volume and associated cost of storage and retrieval;
 (ii)
    
    being able to access a larger share of opportunity in the information management
storage business;
 (iii)
    
    offering significant technological advantages in corporate policy level control of
information and ability to leverage knowledge from the information it creates; and
 (iv)
    
    optimizing how we synergistically allocate capital and resources between both business.
    Joseph Martins, Managing Director, Data Mobility Group LLC
  Intellectual Property Protection
  The Market and Resellers
  Company Funding
   22




---



##### Table of Contents



1.
    
    A $2,000,000 equity offering initiated in October 2009 and closed in May 2010.
This equity offering originally reflected a maximum offering of $1,000,000, but was
increased to $1,500,000 during the first quarter of 2010 and increased again to
$2,000,000 in April 2010. This equity round of financing offered shares of our common
stock at $0.20 per share and was closed in May 2010 resulting in $1,715,550 in equity
proceeds through the issuance of 9,290,000 common shares.
 2.
    
    The Company conducted an equity offering of Series B Convertible Preferred
Stock reflecting a $1.00 par value that is convertible into 5 shares of the Companys
common stock. As of December 31, 2010, the Company closed on the sale of $420,000 worth
of Series B Convertible Preferred Stock.
    1.
    
    $2,537,300 of unsecured debt plus accrued interest of $728,673 associated with the $5.5
million offering was converted into 16,329,869 common shares, and
 2.
    
    2,549,500 warrants were exercised into an equal number of common shares providing for
$509,900 of additional equity proceeds, and
 3.
    
    $650,000 of secured debt plus accrued interest of $74,187 were converted into 724,187
Series A convertible preferred shares.
   23




---



##### Table of Contents



Liquidity and Capital Resources
      Results of Operations
 Year Ended December 31, 2010 as compared to the Year Ended December 31, 2009
    24




---



##### Table of Contents



Recent and other Significant Events affecting our results of Operations and Financial Condition
     25




---



##### Table of Contents



Critical Accounting Policies and Estimates
 Software Revenue Recognition
      Share-Based Payment
  New Accounting Pronouncements
  (i)
    
    provide updated guidance on whether multiple deliverables exist, how
the deliverables in an arrangement should be separated, and how the
consideration should be allocated;(ii)
    
    require an entity to allocate revenue in an arrangement using
estimated selling prices (ESP) of deliverables if a vendor does not
have vendor-specific objective evidence of selling price (VSOE) or
third-party evidence of selling price (TPE);(iii)
    
    eliminate the use of the residual method and require an entity to
allocate revenue using the relative selling price method; and(iv)
    
    expand the disclosure requirements to require an entity to provide
both qualitative and quantitative information about the significant
judgments made in applying the revised guidance and subsequent
changes in those judgments that may significantly affect the timing
or amount of revenue recognition.
   26




---



##### Table of Contents



Off-Balance Sheet Arrangements
  ITEM 7A:
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 8:
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  27




---



##### Table of Contents



28




---



##### Table of Contents



Page(s)REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
    
    
    30CONSOLIDATED FINANCIAL STATEMENTSConsolidated Balance Sheets
    
    
    31Consolidated Statements of Operations
    
    
    32Consolidated Statements of Stockholders Deficit
    
    
    33Consolidated Statements of Cash Flows
    
    
    34Notes to Consolidated Financial Statements
    
    
    36  53
  29




---



##### Table of Contents



30




---



##### Table of Contents



December 31,2010
    
    
    2009ASSETSCURRENT ASSETSCash
    
    $
    27,557
    
    
    $
    141,086Accounts receivable, net
    
    
    333,687
    
    
    
    484,203Other current assets
    
    
    247,970
    
    
    
    220,304Total current assets
    
    
    609,214
    
    
    
    845,593Property and equipment, net
    
    
    158,105
    
    
    
    444,675Software license, net
    
    
    436,608
    
    
    
    713,199Deferred financing costs
    
    
    4,466
    
    
    
    113,334Other assets
    
    
    6,322
    
    
    
    7,322Total assets
    
    $
    1,214,715
    
    
    $
    2,124,123LIABILITIES AND STOCKHOLDERS DEFICITCURRENT LIABILITIESAccounts payable
    
    $
    692,923
    
    
    $
    361,194Accounts payable  related parties
    
    
    
    
    
    
    7,861Accrued expenses
    
    
    554,978
    
    
    
    1,222,143Due to related parties
    
    
    
    
    
    
    75,195Deferred income
    
    
    9,989
    
    
    
    Notes payable
    
    
    231,540
    
    
    
    518,371Current maturities of convertible debt
    
    
    782,941
    
    
    
    2,032,771Current maturities of capital lease obligations
    
    
    23,308
    
    
    
    45,819Total current liabilities
    
    
    2,295,679
    
    
    
    4,263,354Convertible debt, non-current
    
    
    250,000
    
    
    
    1,646,502Capital lease obligations, non-current
    
    
    
    
    
    
    24,043Other liabilities
    
    
    3,607
    
    
    
    15,159Total liabilities
    
    
    2,549,286
    
    
    
    5,949,058STOCKHOLDERS DEFICITSeries A Convertible Preferred Stock, $0.001 par value;
1,200,000 shares authorized for Series A, 724,187 outstanding
shares issued and outstanding
    
    
    724
    
    
    
    Series B Convertible Preferred Stock, $1.00 par value; 2,000,000 shares authorized for Series B, 420,000 shares issued and outstanding
    
    
    420,000
    
    
    
    Common stock, $.001 par value; 125,000,000 shares authorized,
65,699,753 and 38,808,736 shares issued and outstanding
    
    
    65,700
    
    
    
    38,809Additional paid-in capital
    
    
    24,409,477
    
    
    
    15,952,089Accumulated deficit
    
    
    (26,230,472
    )
    
    
    (19,815,833
    )Total stockholders deficit
    
    
    (1,334,571
    )
    
    
    (3,824,935
    )Total liabilities and stockholders deficit
    
    $
    1,214,715
    
    
    $
    2,124,123
   31




---



##### Table of Contents



Years Ended December 31,2010
    
    
    2009REVENUES
    
    $
    2,143,882
    
    
    $
    3,192,463COST OF REVENUES
    
    
    1,509,125
    
    
    
    2,122,633GROSS PROFIT
    
    
    634,757
    
    
    
    1,069,830OPERATING EXPENSESSelling and marketing
    
    
    849,337
    
    
    
    337,048General and administrative
    
    
    2,700,782
    
    
    
    2,220,811Research and development
    
    
    967,591
    
    
    
    830,247Total operating expenses
    
    
    4,517,710
    
    
    
    3,388,106LOSS FROM OPERATIONS
    
    
    (3,882,953
    )
    
    
    (2,318,276
    )OTHER INCOME (EXPENSE)Gain (loss) on extinguishment of debt
    
    
    (306,428
    )
    
    
    87,656Interest expense
    
    
    (2,225,258
    )
    
    
    (2,939,097
    )Total other expense
    
    
    (2,531,686
    )
    
    
    (2,851,441
    )NET LOSS
    
    $
    (6,414,639
    )
    
    $
    (5,169,717
    )NET LOSS PER COMMON SHARE  BASIC AND DILUTED
    
    $
    (0.12
    )
    
    $
    (0.15
    )WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING  BASIC AND DILUTED
    
    
    54,284,942
    
    
    
    34,572,856
   32




---



##### Table of Contents



AdditionalSeries A Preferred Stock
    
    
    Series B Preferred Stock
    
    
    Common Stock
    
    
    Paid-In
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    DeficitBALANCE, DECEMBER 31, 2008
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    26,665,020
    
    
    $
    26,665
    
    
    $
    10,364,357
    
    
    $
    (14,646,116
    )
    
    $
    (4,255,094
    )Stock issued for convertible debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,656,606
    
    
    
    7,657
    
    
    
    2,695,928
    
    
    
    
    
    
    
    2,703,585Stock issued
for cash
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,725,000
    
    
    
    2,725
    
    
    
    498,775
    
    
    
    
    
    
    
    501,500Stock issued for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    656,249
    
    
    
    656
    
    
    
    123,667
    
    
    
    
    
    
    
    124,323Stock issued as payment of payables
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,105,861
    
    
    
    1,106
    
    
    
    245,316
    
    
    
    
    
    
    
    246,422Beneficial conversion feature on converted notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    977,029
    
    
    
    
    
    
    
    977,029Warrants expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    389,818
    
    
    
    
    
    
    
    389,818Discount on convertible debt relating to warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    123,618
    
    
    
    
    
    
    
    123,618Warrants issued as settlement of liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    109,161
    
    
    
    
    
    
    
    109,161Warrants issued for debt financing costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74,424
    
    
    
    
    
    
    
    74,424Employee stock option expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    349,996
    
    
    
    
    
    
    
    349,996Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,169,717
    )
    
    
    (5,169,717
    )BALANCE, DECEMBER 31, 2009
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,808,736
    
    
    
    38,809
    
    
    
    15,952,089
    
    
    
    (19,815,833
    )
    
    
    (3,824,935
    )Stock issued for convertible debt and interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,329,869
    
    
    
    16,330
    
    
    
    3,249,643
    
    
    
    
    
    
    
    3,265,973Stock issued for cash, net of issuance costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,565,000
    
    
    
    6,565
    
    
    
    1,192,485
    
    
    
    
    
    
    
    1,199,050Stock issued for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,082,253
    
    
    
    1,082
    
    
    
    234,038
    
    
    
    
    
    
    
    235,120Stock issued as payment of payables
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    364,395
    
    
    
    364
    
    
    
    66,735
    
    
    
    
    
    
    
    67,099Warrants exercised for cash
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,549,500
    
    
    
    2,550
    
    
    
    507,350
    
    
    
    
    
    
    
    509,900Preferred stock issued for debt and interest
    
    
    724,187
    
    
    
    724
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    648,208
    
    
    
    
    
    
    
    648,932Preferred stock issued for cash
    
    
    
    
    
    
    
    
    
    
    420,000
    
    
    
    420,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    420,000Beneficial
conversion feature and incremental increase in fair value of
conversion options and warrants on converted notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,522,950
    
    
    
    
    
    
    
    1,522,950Beneficial
conversion feature on extinguished debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    259,683
    
    
    
    
    
    
    
    259,683Warrants expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    456,329
    
    
    
    
    
    
    
    456,329Warrants issued as settlement of liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,000
    
    
    
    
    
    
    
    9,000Employee stock option expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    310,967
    
    
    
    
    
    
    
    310,967Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,414,639
    )
    
    
    (6,414,639
    )BALANCE, DECEMBER 31, 2010
    
    
    724,187
    
    
    $
    724
    
    
    
    420,000
    
    
    $
    420,000
    
    
    
    65,699,753
    
    
    $
    65,700
    
    
    $
    24,409,477
    
    
    $
    (26,230,472
    )
    
    $
    (1,334,571
    )
   33




---



##### Table of Contents



Years Ended December 31,2010
    
    
    2009OPERATING ACTIVITIESNet loss
    
    $
    (6,414,639
    )
    
    $
    (5,169,717
    )Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:Depreciation expense
    
    
    336,797
    
    
    
    714,370Amortization of software licenses
    
    
    295,873
    
    
    
    510,824Amortization of deferred financing costs
    
    
    41,252
    
    
    
    230,074Amortization and write of discount on convertible debt
    
    
    331,584
    
    
    
    1,709,873(Gain) loss on extinguishment of debt
    
    
    306,428
    
    
    
    (87,656
    )Bad debt expense
    
    
    40,893
    
    
    
    81,787Shares issued for interest expense
    
    
    
    
    
    
    62,029Common stock issued for services
    
    
    238,340
    
    
    
    124,323Employee stock option expense
    
    
    310,967
    
    
    
    349,996Additional beneficial conversion feature on
converted debt
    
    
    1,522,950
    
    
    
    200,304Warrants expense
    
    
    456,329
    
    
    
    389,818Changes in operating assets and liabilities:Accounts receivable
    
    
    109,623
    
    
    
    (16,863
    )Other current assets
    
    
    (27,666
    )
    
    
    (18,816
    )Other assets
    
    
    1,000
    
    
    
    (1,000
    )Accounts payable  trade
    
    
    384,595
    
    
    
    355,382Accounts payable  related parties
    
    
    (7,861
    )
    
    
    (97,008
    )Accrued expenses
    
    
    155,198
    
    
    
    700,594Deferred income
    
    
    9,989
    
    
    
    Deferred rent
    
    
    (8,496
    )
    
    
    (6,578
    )Net cash provided by (used in) operating activities
    
    
    (1,916,844
    )
    
    
    31,736INVESTING ACTIVITIESPurchases of property and equipment
    
    
    (50,227
    )
    
    
    (45,702
    )Purchases of software licenses
    
    
    (19,282
    )
    
    
    Net cash used in investing activities
    
    
    (69,509
    )
    
    
    (45,702
    )FINANCING ACTIVITIESProceeds from issuance of convertible debt, net of financing costs
    
    
    250,000
    
    
    
    683,500Proceeds from exercise of warrants
    
    
    509,900
    
    
    
    Proceeds from issuance of preferred stock
    
    
    420,000
    
    
    
    Payments on convertible debt
    
    
    (95,000
    )
    
    
    (100,000
    )Payments on capital lease obligations
    
    
    (46,554
    )
    
    
    (442,723
    )Payments on notes payable
    
    
    (364,572
    )
    
    
    (647,042
    )Proceeds from notes payable
    
    
    
    
    
    
    75,000Proceeds from due to related parties
    
    
    
    
    
    
    70,500Payments on due to related parties
    
    
    
    
    
    
    (22,000
    )Proceeds from sale of common stock, net of issuance costs
    
    
    1,199,050
    
    
    
    501,500Net cash provided by financing activities
    
    
    1,872,824
    
    
    
    118,735NET INCREASE (DECREASE) IN CASH
    
    
    (113,529
    )
    
    
    104,769CASHBeginning of year
    
    
    141,086
    
    
    
    36,317End of year
    
    $
    27,557
    
    
    $
    141,086
  34




---



##### Table of Contents



Years Ended December 31,2010
    
    
    2009Cash paid for interest
    
    $
    77,710
    
    
    $
    54,736Cash paid for income tax
    
    
    
    
    
    
    Non-Cash Financing and Investing Activities:Conversion of debt and accrued interest to equity
    
    $
    3,265,973
    
    
    $
    2,641,556Preferred stock issued for debt and accrued interest
    
    
    724,187
    
    
    
    Stock issued to settle liabilities
    
    
    72,879
    
    
    
    Addition to property and equipment and maintenance fees paid
through issuance of note
    
    
    56,634
    
    
    
    406,613Accrued interest converted to debt principal
    
    
    21,107
    
    
    
    99,411Warrants issued for debt financing costs
    
    
    
    
    
    
    74,424Equipment acquired under capital lease, including issuance
of warrants for capital lease
    
    
    
    
    
    
    8,230Discount due to warrants granted with convertible notes
    
    
    
    
    
    
    123,618
   35




---



##### Table of Contents



The Company and Nature of Operations
 Digitiliti, Inc. (we, our, the Company or Digitiliti) provides back up archiving and information
management and methodologies enabling our customer to manage, control, protect and access
their information data simply and cost effectively through our products and services.
 Principles of Consolidation
 The consolidated financial statements included the accounts of Digitiliti, a Delaware
corporation and its wholly owned subsidiary, Cyclone Acquisition Corp., a Minnesota
corporation. All significant intercompany balances and transactions were eliminated.
 Correction of a Prior Period
 During the year, the Company discovered and corrected an error related to options granted to
an employee that were inadvertently omitted from the Companys employee stock option expense
from April 2008 through December 31, 2009. The error resulted to an understatement in stock
compensation expense and additional paid in capital. In accordance with the SECs Staff
Accounting Bulletin Nos. 99 and 108 (SAB 99 and SAB 108), the Company evaluated this error
and, based on an analysis of quantitative and qualitative factors and determined that the
error was immaterial to each of the prior reporting periods affected. However, if the
adjustments to correct the cumulative effect of the above error had been recorded in the year
ended December 31, 2010, the Company believes the impact would have been significant and would
impact comparisons to prior periods. Therefore, as permitted by SAB 108, the Company
corrected, in the current filing, previously reported results for the year ended December 31,
2010.
 The Consolidated Balance Sheet as of December 31, 2009 was also revised to reflect the
cumulative effect of the error described above. The error resulted to an increase in
accumulated deficit and additional paid in capital of $503,697. There was no impact to the
total consolidated stockholders deficit as of December 31, 2009.
 The following table shows the impact of the error to the Consolidated Statements of Operations
for the year ended December 31, 2009:
 Year ended December 31, 2009As PreviouslyReported
    
    
    Adjustments
    
    
    As RevisedGeneral & administrative
    
    $
    (1,989,177
    )
    
    $
    (231,634
    )
    
    $
    (2,220,811
    )Total operating expenses
    
    $
    (3,156,472
    )
    
    $
    (231,634
    )
    
    $
    (3,388,106
    )Net loss from operations
    
    $
    (2,086,642
    )
    
    $
    (231,634
    )
    
    $
    (2,318,276
    )Net loss
    
    $
    (4,938,083
    )
    
    $
    (231,634
    )
    
    $
    (5,169,717
    )Net loss per common share  Basic and
Diluted
    
    $
    (0.14
    )
    
    
    
    
    
    $
    (0.15
    )Weighted-Average common shares
outstanding  Basic and Diluted
    
    
    34,572,856
    
    
    
    
    
    
    
    34,572,856
  36




---



##### Table of Contents



The adjustments to the Consolidated Statements of Cash Flows for the year ended December 31,
2009 did not result in any changes to the amounts previously reported for net cash from
operating activities, investing activities or financing activities.
 Use of Estimates
 The preparation of these consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make
estimates and assumptions that may affect certain reported amounts and disclosures in the
consolidated financial statements and accompanying notes. The significant estimates relate to
the collectability of accounts receivable, useful lives of software licenses, valuation of
beneficial conversion feature on convertible debts, valuation of warrants and stock options,
and valuation allowance for deferred income taxes. Actual results could differ from those
estimates.
 Credit risk
 Cash is maintained in bank accounts which, at times, may exceed federally insured limits. The
Company has not experienced any losses in such accounts and does not believe it is exposed to
any significant credit risk on cash.
 Allowance for Doubtful Accounts
 The allowance for doubtful accounts is based on the aging, historical experience and
managements judgment of the individual accounts receivable. Accounts receivable are written
off against the allowance when management determines a balance is uncollectible and no longer
actively pursues collection. Accounts receivable is presented net of the allowance for
doubtful accounts of $10,753 and $162,263 at December 31, 2010 and 2009, respectively.
 Property and Equipment
 Property and equipment are recorded at cost less accumulated depreciation. Depreciation is
computed using the straight-line method over the estimated useful lives of the related assets.
Computer equipment and furniture and fixtures are depreciated over three to five years.
Maintenance and repairs are charged to operations when incurred.
 Software Licenses
 Certain software is licensed from two vendors to facilitate the secure online data storage
solution. The licenses are nonexclusive. Upon full payment, the licenses are owned outright by
the Company and are amortized over five years.
 Long-Lived Assets
 All long-lived assets are reviewed when events or changes in circumstances indicate that the
carrying amounts of such assets may not be recoverable. An impairment loss is recognized when
estimated undiscounted cash flows that can be generated by those assets are less than the
carrying value of the assets. When an impairment loss is recognized, the carrying amount is
reduced to its estimated fair value based on appraisals or other reasonable methods to
estimate fair value. There was no impairment of long-lived assets as
of December 31, 2010 and 2009.
 Deferred Financing Costs
 Costs associated with the issuance of debt is capitalized as deferred financing costs and
amortized into interest expense using the effective interest method over the life of the
related debt. At December 31, 2010 and 2009, deferred financing costs incurred totaled $0 and
$715,929, respectively. Accumulated amortization for the years ended December 31, 2010 and
2009 was $41,252 and $602,595, respectively.
 Fair Value of Financial Instruments
 The carrying value of short-term financial instruments, including cash, accounts receivable,
accounts payable and accrued expenses, short-term borrowings and capital lease obligations
approximate fair value due to the relatively short period to
maturity for these instruments. The long-term borrowings approximate fair value since the
related rates of interest approximates current market rates.
  37




---



##### Table of Contents



Software Revenue Recognition
 The Company derives its revenue from sales of its products and services. Product revenue is
derived from sales of the Companys DigiBak service and new DigiLibe service.
 The DigiBak service provides an offsite storage solution through a utility based computing
philosophy where customers pay for the gigabytes of data they store in the DigiBak vault.
 The DigiLibe service is a multiple element software sales arrangement that is comprised of
three key components that act as one: Client Agent, Information Director, and Archive
Information Store.
 For multiple element software license sales arrangements that do not require significant
modification or customization of the underlying software, we recognize revenue when: (1) we
enter into a legally binding software arrangement with a customer for the license of software,
(2) we deliver the software, (3) price is deemed fixed or determinable and free of
contingencies of significant uncertainties and (4) collection is probable.
 For sales arrangements with multiple elements, we defer revenue for any undelivered elements,
and recognize revenue when the product is delivered or over the periods in which the service
is performed. If we cannot objectively determine the fair value of any undelivered element
included in bundled arrangements, we defer revenue until all elements are delivered and
services have been performed, or until fair value can objectively be determined for any
remaining undelivered elements.
 Research and Development Costs
 Research and development costs are expensed as incurred. The Company expensed third party
development costs totaling $967,591 and $830,247 in 2010 and 2009, respectively.
 Share-Based Payment
 The Company accounts for share-based awards issued to employees and non-employees in
accordance with the guidance on share-based payments. Accordingly, employee share-based
payment compensation is measured at the grant date, based on the fair value of the award, and
is recognized as an expense over the requisite service period (generally the vesting is over a
3-year period). Additionally, share-based awards to non-employees are expensed over the
period in which the related services are rendered at their fair value.
 Income Taxes
 Deferred income tax assets and liabilities are recognized for the expected future income tax
consequences of events that have been included in the consolidated financial statements or
income tax returns. Deferred income tax assets and liabilities are determined based on
differences between the financial statement and tax bases of assets and liabilities using tax
rates in effect for the years in which the differences are expected to reverse.
 In evaluating the ultimate realization of deferred income tax assets, management considers
whether it is more likely than not that the deferred income tax assets will be realized.
Management establishes a valuation allowance if it is more likely than not that all or a
portion of the deferred income tax assets will not be utilized. The ultimate realization of
deferred income tax assets is dependent on the generation of future taxable income, which must
occur prior to the expiration of the net operating loss carry forwards.
 The Company also follows the guidance related to accounting for income tax uncertainties. In
accounting for uncertainty in income taxes, the Company recognizes the financial statement
benefit of a tax position only after determining that the relevant tax authority would more
likely than not sustain the position following an audit. For tax positions meeting the more
likely than not threshold, the amount recognized in the consolidated financial statements is
the largest benefit that has a greater than 50% likelihood of being realized upon ultimate
settlement with the relevant tax authority. No liability for unrecognized tax benefits was
recorded as of December 31, 2010 and 2009.
  38




---



##### Table of Contents



It is the Companys practice to recognize penalties and/or interest related to income tax
matters in interest and penalties expense.
 The Company is subject to income taxes in the U.S. federal jurisdiction and various states and
local jurisdictions. Tax regulations within each jurisdiction are subject to the
interpretation of the related tax laws and regulations and require significant judgment to
apply. The Company is not currently under examination by any taxing jurisdiction.
 Net Loss per Share
 Basic net loss per common share is computed by dividing the net loss by the weighted-average
number of common shares outstanding. Diluted net loss per common share is computed based on
the weighted-average number of common shares outstanding increased by dilutive common stock
equivalents. For the years ended December 31, 2010 and 2009, potential dilutive securities
had an anti-dilutive effect and were not included in the calculation of diluted earnings per
common share.
 Reclassifications
 Certain 2009 amounts have been reclassified to conform to 2010 presentation.
 New Accounting Pronouncements
 In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements (ASU 2009-13)
 (i)
    
    provide updated guidance on whether multiple deliverables
exist, how the deliverables in an arrangement should be
separated, and how the consideration should be allocated;(ii)
    
    require an entity to allocate revenue in an arrangement
using estimated selling prices (ESP) of deliverables if a
vendor does not have vendor-specific objective evidence of
selling price (VSOE) or third-party evidence of selling
price (TPE);(iii)
    
    eliminate the use of the residual method and require an
entity to allocate revenue using the relative selling price
method; and(iv)
    
    expand the disclosure requirements to require an entity to
provide both qualitative and quantitative information about
the significant judgments made in applying the revised
guidance and subsequent changes in those judgments that may
significantly affect the timing or amount of revenue
recognition.
 In addition, in October 2009, the FASB also issued ASU No. 2009-14, Certain Revenue
Arrangements That Include Software Elements (ASU 2009-14) to amend the accounting standards
for revenue recognition to exclude tangible products containing software components and
non-software components that function together to deliver the tangible products essential
functionality from the scope of the software revenue recognition guidance. The revised revenue
recognition accounting standards are effective for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010 and shall be applied
on a prospective basis. Earlier application is permitted. We are required to adopt this
standard at the beginning of fiscal 2011, which begins on January 1, 2011. We are assessing
the impact of the new accounting standards on our financial position and results of
operations.
 In January 2010, the FASB issued authoritative guidance that requires reporting entities to
make new disclosures about recurring or nonrecurring fair-value measurements including
significant transfers into and out of Level 1 and Level 2 fair value measurements, and
information on purchases, sales, issuances, and settlements on a gross basis in the
reconciliation of Level 3 fair value measurements. The guidance is effective for annual
reporting periods beginning after December 15, 2009, except for Level 3 reconciliation
disclosures, which are effective for annual periods beginning after December 15, 2010. The
adoption of the above guidance did not impact the Companys financial position, results of
operations or cash flows.
 No other new accounting pronouncement issued or effective has had, or is expected to have, a
material impact on the Companys consolidated financial statements.
  39




---



##### Table of Contents



2.
    
    Going Concern
 As shown in the accompanying financial statements, the Company incurred net losses of
$6,414,639 for the year ended December 31, 2010 and a negative working capital at December 31,
2010 of $1,686,465,. These conditions raise substantial doubt as to the Companys ability to
continue as a going concern.
 The Company continues to be dependent on its ability to generate future revenues, positive
cash flows and additional financing. There can be no guarantee that the Company will be
successful in generating future revenues, in obtaining additional debt or equity financing or
that such additional debt or equity financing will be available on terms acceptable to the
Company. The financial statements do not include any adjustments that might be necessary if
the Company is unable to continue as a going concern.
 3.
    
    Property and Equipment
 Property and equipment consisted of the following:
 December 31,2010
    
    
    2009Computer equipment
    
    $
    2,656,071
    
    
    $
    2,605,845Furniture and fixtures
    
    
    14,511
    
    
    
    14,5112,670,582
    
    
    
    2,620,356Less  accumulated depreciation
    
    
    (2,512,477
    )
    
    
    (2,175,681
    )$
    158,105
    
    
    $
    444,675
 Depreciation expense totaled $336,797 and $714,370 in 2010 and 2009, respectively.
 4.
    
    Software Licenses
 Software licenses consisted of the following:
 December 31,2010
    
    
    2009Software licenses
    
    $
    1,553,132
    
    
    $
    1,533,850Less  accumulated amortization
    
    
    (1,116,524
    )
    
    
    (820,651
    )$
    436,608
    
    
    $
    713,199
 Amortization expense totaled
$295,872 and $510,824 in 2010 and 2009, respectively.
 5.
    
    Related Parties TransactionsAt December 31, 2010 and 2009, balances due to the related parties consisted of the following:
 2010
    
    
    2009Note payable to a stockholder, bearing interest at 15%
per annum, payable monthly up to March 1, 2010
    
    $
    
    
    
    $
    53,475Note payable to an officer, bearing interest at 12.25%
per annum, due on demand, unsecured
    
    
    
    
    
    
    14,120Note payable to an officer, bearing interest at 12.25%
per annum, due on demand, unsecured
    
    
    
    
    
    
    7,600$
    
    
    
    $
    75,195
  40




---



##### Table of Contents



Interest expense on these payable was $0 and $12,516 for 2010 and 2009, respectively.
 Management and Founders Agreements:
 Dan Herbeck
 Our interim CEO, Dan Herbeck, who resigned in February 2009, provided consulting
services to us during 2008 through his company, Continental Technologies Solutions, LLC
(Continental). At the time of his resignation, the severance arrangement recognized
unpaid invoices owed to Continental of $105,344, payable at a discretionary rate of
$4,000 per month commencing in April, 2009. As recognition for our delay in payment, we
also granted Continental 100,000 cashless five year warrants to purchase 100,000 shares
of our common stock at $0.35 per share. On November 4, 2009, we entered into a
Settlement Agreement with Dan Herbeck, acting through his company, Continental, that
satisfied the outstanding balance owed of $120,172 (reflecting additional accrued
interest from the date of his resignation) in return for the issuance
of 600,861 shares of
Digitiliti common stock. There was no gain or loss recognized on this transaction.
 M2 Capital Advisors, Inc.
 On May 3, 2006, we executed a consulting agreement with M2. The duties of M2 include
introducing the Company to the financial community; researching and identifying potential
business partners, executives, consultants and Board of Director candidates; assisting with
securing leases or equipment financing; and other general business consulting services. The
agreement also provided for the payment of various fees for raising capital, identifying an
acquisition/reverse merger candidate, assisting with capital lease arrangements, etc. This
agreement was amended March 2007, effective May 6, 2006.
 At the time, Mark Savage, our former President and a former director, was the President and a
principal stockholder of M2. While M2 was engaged, they assisted in raising $3,504,010 of
capital from the sale of our common stock and received $350,401 in fees for these services. In
addition, M2 assisted in raising $2,035,950 in 12% convertible notes and received fees totaling
$203,595.
 On or about March 23, 2009, we agreed to pay a 10% introduction fee to M2 under their current
Letter Agreement with us that had been extended into May, 2009, on any funds raised by us in a
planned $1,500,000 financing through the sale of secured and unsecured convertible notes.
 In April 2009, we initiated a $750,000 raise through the issuance of 12% convertible notes that
were secured by a third position security lien in our DigiBAK vault system and equipment. This
offering also included the issuance of an equal number of warrants. See Note 7 for further
details. We completed this offering in October 2009. In conjunction with the offering, M2
received $66,500 reflecting the 10% introduction fee and were issued 5 year warrants totaling
375,000 with an exercise price of $0.30. The introduction fee and the fair value of the
warrants amounting to $74,424 were charged to deferred financing costs.
 Upon the closing of this convertible note offering in October 2009, we initiated an equity
offering in November 2009 of our common stock that comprised restricted securities as that
term is defined in Rule 144 of the Securities and Exchange Commission at a price of $0.20 per
share, for total aggregate proceeds up through December 31, 2009, of $545,000 to certain
accredited investors as that term is also defined in Rule 501. As of April 13, 2010, we have
received additional proceeds from this equity raise of $857,879 combining for total proceeds
received from this equity raise of $1,402,879. In conjunction with specific monies raised by M2
Capital that were associated with this equity offering, M2 received a 10% introduction fee of
$43,500 through December 31, 2009 and additional 10% introduction fees of $74,500 up through
April 13, 2010. The related fees were charged to additional paid in capital as stock issuance
costs.
 In total, M2 partners earned total fees of approximately $74,500 and $110,000 for the years
ended December 31, 2010 and 2009, respectively.
 5X Partners, LLC.
 In August 2007, we entered into a consulting arrangement with 5X Partners, LLC (5X). Under
the agreement, 5X provided services such as senior leadership, business development, sales and
marketing, product packaging, infrastructure scaling methods and other key areas of management,
business assessment and strategies. Under the arrangement, which was amended several times, we
agreed to pay 5X a fixed fee of $60,484 and monthly fees of $28,000, of which $8,000
would be deferred until reaching a financial funding goal. In addition, we agreed to issue 5X
stock options to purchase 2,850,000 shares of our common stock at $0.385 per share, which vests
over 24 months.
  41




---



##### Table of Contents



In October 2008, 5X principals resigned their executive positions with the Company, and on July
16, 2009, we agreed on a settlement agreement for amounts due under the consulting arrangement
whereby we issued 505,000 shares and 360,000 5-year warrants with an exercise price of $0.25 as
full payment of the outstanding balance of $100,227. In connection with the above
arrangement, we recognized a loss on settlement of $108,187.
 6.
    
    Notes Payable
 We issued a $250,000 promissory note to a stockholder dated December 15, 2005. The note
mirrors a promissory note between the stockholder and his bank, which matured on December 15,
2009 and had an interest rate 0.5% above the banks index rate
(6.00% at December 31, 2009 and 6.00% at December 31, 2010).
Subsequent to December 15, 2009, the note was renewed to February 1, 2011. The balance of the
note was $231,540 at December 31, 2010 and 2009. Interest expense was $13,478 and $15,218 for
2010 and 2009, respectively. On February 28, 2011, this note was paid in full.
 In June 2008, the Company negotiated a six-month payment plan with its primary software vendor
Asigra, Inc. Under the terms of this payment plan, the Company was granted extended payment
terms that omitted Asigras standard 20% discount for a net 30-day early payment. This payment
plan reflected monthly payments based on a percentage of outstanding invoices owed for
software licenses and maintenance, with any remaining outstanding balance payable in December
2008. In December 2008, this payment plan was extended for another 6 months with all
outstanding debt payable in May 2009. In July 2009, we executed a Payment and Security
Agreement (the Security Agreement) with Asigra that reflected an 8-month payment plan that
would satisfy the existing balance owed to Asigra along with the inclusion of amounts to be
charged over this 8-month period. This Security Agreement provided Asigra a security lien in
the Companys DigiBAK vault system. As of March 6, 2010, the Company has made all payments
called for under this Security Agreement totaling $364,572 and now owns all of Asigra licenses
outright.
 In December 2007, we entered into a Software Purchase Agreement (SPA) with Exanet, Inc. The
terms of the SPA reflect the financing of $485,000 of software over 36-months at 12% interest.
Commencing on January 15, 2008, we are obligated to make minimum monthly interest only
payments of $4,850 that increased to $20,000 effective October 15, 2008. The terms of the SPA
include a possible $2,500 increase to the minimum monthly interest only payments predicated on
performance goals. We have the right to prepay the outstanding balance without penalty
throughout the term of the agreement.
 On December 31, 2009, we entered into a settlement agreement with Exanet whereby debt balance
amounting to $405,000 was discharged in exchange for the return of excess Exanet software
license. At the same time, we paid Exanet the balance of $80,000 to reflect the purchase of
active license in use at this time. As a result of the above, we recognized a gain on the
settlement of debt of $222,840 which is the difference between the value of the discharged
debt and the net book value of the software license returned to Exanet.
 7.
    
    Convertible Debt
 A summary of the convertible debt as of December 31, 2010 and 2009 is as follows:
 2010
    
    
    2009Gross proceeds from the debts
    
    $
    7,000,000
    
    
    $
    6,750,000Less: discount on the warrants
    
    
    (2,360,593
    )
    
    
    (2,360,593
    )Less: beneficial conversion feature
    
    
    (90,130
    )
    
    
    (90,130
    )Less: principal converted to common stock
    
    
    (5,795,000
    )
    
    
    (2,607,700
    )Less: principal payments
    
    
    (195,000
    )
    
    
    (100,000
    )Add: accrued interest converted into debt
    
    
    30,000
    
    
    
    30,000Add: amortization of discount
    
    
    1,821,359
    
    
    
    1,679,106Add: unamortized discount on converted debt charged to interest
    
    
    622,305
    
    
    
    378,590Total
convertible debt, net
    
    
    1,032,941
    
    
    
    3,679,273Current
maturities of convertible debt, net
    
    
    (782,941
    )
    
    
    (2,032,771
    )Convertible
debt, non-current
    
    $
    250,000
    
    
    $
    1,646,502
  42




---



##### Table of Contents



A summary of the contingent beneficial conversion feature as of December 31, 2010 and 2009 are
as follows:
 Unrecognized beneficial conversion feature (BCF) at December 31, 2008
    
    $
    1,745,660Add: Contingent BCF for the $750,000 convertible debt, at measurement date
    
    
    127,085Less: BCF charged to interest expense on converted debt
    
    
    (776,725
    )Unrecognized BCF at December 31, 2009
    
    
    1,096,020Less: BCF
charged to interest on converted and extinguished debt
    
    
    (1,041,079
    )Unrecognized BCF at December 31, 2010
    
    $
    54,941
 12% Convertible debt  $5.5 million Private Offering
 In March 2007, we engaged M2 (see Note 5  Related Party Transactions) to raise up to $5.5
million from the sale of 12% convertible debt and warrants. This $5.5 million raise was closed
in September 2008. Under the initial conversion terms, the debt was convertible into common
stock at $0.50 per share, subject to an effective registration statement covering the
underlying common stock that has been filed with the Securities and Exchange Commission. In
addition, for each $1 invested, the investor receives one half warrant to acquire one half of
a share of common stock with a five year term at $1.50 per share (the A warrants); and one
half warrant to acquire one half share of common stock with a five year term at $2.25 per
share (the B warrants) (see inducement discussion below). Each warrant cannot be exercised
during the first 6-months and one day following issuance, unless there is an effective
registration statement covering the underlying common stock that has been filed with the
Securities and Exchange Commission. The warrants are callable at $0.01 per warrant, if the
common stock of the Company trades for 20 consecutive days on its principal market above $2.25
for the first one half warrant and $3.00 for the second one half warrant, provided there is an
effective registration statement covering the underlying common stock that has been filed with
the Securities and Exchange Commission. A total of 840,000 warrants at $1.00, 2,330,000
warrants at $1.50 and 2,330,000 warrants at $2.25 were issued.
 In conjunction with the sale of the 12% convertible debt referenced above, M2 received a 10%
introductory fee, which totaled $523,550 pursuant to a Consulting Agreement and an officer
also received a 10% introductory fee which totaled $26,450. These introductory fees were
accounted for as deferred financing cost and were amortized using the effective interest
method over the term of the convertible debt.
 We analyzed these convertible debt and the warrants issued for derivative accounting
consideration and determined that derivative accounting is not applicable for these debts.
 The convertible debt was evaluated for a beneficial conversion feature, at which time it was
concluded that a contingent beneficial conversion feature existed for a substantial portion of
the convertible debt. The beneficial conversion feature was measured using the commitment-date
stock price and will be recognized once the contingency is resolved. (see further discussion
below regarding induced conversion of debt below.)
 In addition, the relative fair value of the warrants was measured using the Black-Scholes
Option Pricing Model and recorded as a debt discount, which is being amortized over the life
of the debt using the effective interest method. The total discount recorded was $2,116,131
and the unamortized balance at December 31, 2010 and 2009 was $0 and $295,580, respectively.
 In November 2008, we initiated a request to all of these convertible debt holders to either
extend their respective convertible debt for another 18 months or to convert their principal
and accrued interest into common stock. During 2009, the Company converted $2,337,700 of its
convertible debt and $365,885 of accrued interest into 7,656,606 shares of the Companys
common stock.
 In exchange for extending their convertible debt for an additional 18 months, we agreed to
reduce the exercise price of the associated warrants from $1.50 and $2.25 per share to $1.00
per share, respectively for the A and B warrants. In addition, we agreed to extend the term of
both the A and B warrants from 5 years to 6 1/2 years. However, the requirement of an effective
registration was not removed in the case of extending the note.
 In exchange for converting their convertible debt into common stock, we agreed to reduce the
exercise price from $0.50 to $0.35 per share. We also agreed to reduce the exercise price of
the associated warrants from the $1.50 and $2.25 per share to $1.00 per share, respectively
for the A and B warrants. In addition, we agreed to extend the term of both the A and B
warrants from 5 years to 6 1/2 years. Furthermore, the requirement of an effective registration
was removed to allow
conversion, which removed the contingency associated with the beneficial conversion feature.
As a result, the measured value associated with the converted debt was recognized as interest
expense.
  43




---



##### Table of Contents



In June 2010, under the terms of our Incentive Offer, we initiated a request to the remaining
convertible debt holders to convert their convertible notes at a preferential $0.20 per share
conversion rate. In response to this offer, the Company converted $2,537,300 of its
convertible debt and $728,673 of accrued interest into 16,329,869 shares of the Companys
common stock. The debt holders who elected to convert were also allowed to exercise their
outstanding common stock warrants at a reduced exercise price of $0.20 per share. The Company
closed the Incentive Offer in July 2010.
 During 2010, the Company
entered into settlement agreements with five unsecured convertible
note holders. Pursuant to these agreements, the Company repaid an
aggregate of $95,000 of
principal and $8,933 of accrued interest to settle the outstanding convertible notes. In
connection with the settlement, the note holders surrendered all or a
portion of the warrants associated
with these notes.
 We evaluated the extension event in November 2008 under the guidance for troubled debt
restructuring and debt modification or exchange of debt instruments. Because the investors
did not grant concession on these outstanding loans, the transactions were not accounted for
as troubled debt restructuring. Consequently, we evaluated these transactions to determine if
the modification was substantial and determined they were not. As a result, no gain or loss
was recorded on the date of the extension since the modification in terms is not considered
significant. For the year ended December 31, 2009, the Company recognized warrant expense of
$73,272 associated with the modification of the exercise price of the warrants on the extended
debt and charged the unamortized discount to interest expense over the remaining life of the
convertible debt under the new terms.
 We accounted for the conversion events in June 2010 and November 2008 as induced conversions
under the guidance of FASB ASC 470-20. Under ASC 470-20, the Company recognized additional
interest expense for 2010 and 2009 totaling $608,956 and $299,693, respectively, which is
equal to the fair value of the incremental compensation cost created by the modification of
the exercise price of the warrants and the incremental increase in the fair value of the
conversion option as a result of the reduction in the conversion price. In addition, the
remaining unamortized discount on the debt converted in 2010 and 2009 of $189,331 and $378,590,
respectively, was recognized to interest expense.
 Likewise, the contingency related to the contingent beneficial conversion feature was resolved
on the respective dates of conversion. The beneficial conversion features calculated on the
respective commitment dates were fully recognized through interest expense and additional paid
in capital. During 2010 and 2009, $913,994 and $776,725, respectively, of the contingent
beneficial conversion feature was recognized into interest expense. At December 31, 2010, the
unamortized debt discount on the convertible debt and the unrecognized contingent beneficial
conversion feature amounted to $0 and $54,941, respectively.
 The Company is also in default on $190,000 of convertible debt and accrued interest of $82,863
as of December 31, 2010.
 12% Convertible Debt  $750,000 Private Offering
 In April 2009, we raised $750,000 from the sale of 12% convertible debt and warrants that are
secured against the assets associated with our Pharaoh Business Fortress Storage Center,
subject to certain other liens. Under the conversion terms, the debt is convertible into
common stock at $0.35 per share, subject to an effective registration statement covering the
underlying common stock that has been filed with the Securities and Exchange Commission. In
addition, for each $1 invested, the investor receives one warrant to acquire one share of
common stock with a five year term at $0.50 per share. The warrants are callable at $0.01 per
warrant, if the common stock of the Company trades for 20 consecutive days on its principal
market above $1.50 per share, provided there is an effective registration statement covering
the underlying common stock that has been filed with the Securities and Exchange Commission.
In conjunction with the sale of the 12% convertible debt referenced above, we paid M2 10%
introductory fee totaling $66,500 and issued 5 year warrants totaling 375,000 with an exercise
price of $0.30. The introductory fee and the fair value of the warrants amounting to $74,424
were charged to deferred financing costs and are amortized using the effective interest method
over the term of the convertible debt.
  44




---



##### Table of Contents



We analyzed the convertible debt and the warrants issued for derivative accounting
consideration and determined that derivative accounting is not applicable for these debts.
 The convertible debt was evaluated for a beneficial conversion feature at which time it was
concluded that a contingent beneficial conversion feature existed for a substantial portion of
the convertible debt. The beneficial conversion feature was measured using the commitment-date
stock price to be $127,085, which will be recorded once the contingency has been resolved. In
addition, the relative fair value of the warrants were measured using the Black-Scholes Option
Pricing Model to be $123,618 and recorded as a debt discount, which is amortized over the life
of the debt using the effective interest method. The unamortized discount as of December 31,
2010 amounted to $7,059.
 In connection with the Incentive Offer noted above, the secured convertible debt holders were
also allowed to convert their convertible notes into shares of the Companys Series A
Convertible Preferred Stock at a conversion rate of $1.00 per share (whereby each Preferred
Stock is convertible into five shares of common stock). In response, the Company converted
$650,000 of its secured convertible stock and $74,187 of accrued interest into 724,187 shares
of the Companys Series A Convertible Preferred Debt. The secured debt holders who elected to
convert were also allowed to exercise their outstanding common stock warrants at a reduced
exercise price of $0.20 per share.
 The Company accounted for the issuance of the Series A Convertible Preferred Stock for the
repayment of the secured convertible debt as a debt extinguishment under FASB ASC 470-50. As
a result, a total loss on the extinguishment of $173,830 was recognized for the year ended
December 31, 2010.
 As of December 31, 2010, the unamortized discount and the unrecognized beneficial conversion
feature on the outstanding secured convertible debt amounted to $7,059 and $0, respectively.Other Convertible Notes
 In October 2008, we issued a $250,000 12% convertible debt to an individual. The debt can be
converted into our common stock at $0.50 per share, subject to an effective registration
statement covering the underlying common stock that has been filed with the Securities and
Exchange Commission. The debt is guaranteed by a stockholder of the Company. In conjunction
with this convertible debt, we issued stock warrants to purchase 150,000 shares and 100,000
shares, respectively, of Digitiliti common stock with a five year term at $0.50 per share.
This convertible note reflected a 6-month maturity date that was later extended to October 16,
2009.
 On June 30, 2010, the Company modified the terms of this $250,000 convertible note to reflect
an extended maturity date of December 31, 2011 and a reduction in the conversion rate from
$.50 to $.20 per share. In connection with this modification, the Company granted the holder
50,000 common stock warrants exercisable at $.20 per share. The fair value of the warrants was
determined to be $9,000 (see Note 12). The incremental increase in the fair value of the
conversion option was determined to be $132,598. The Company evaluated the modification under
FASB ASC 470-50 and determined the modification was substantial and the revised terms
constituted a debt extinguishment. As a result, the total loss on extinguishment of $141,598
was recognized during the year ended December 31, 2010.
 In November 2008, we issued a $250,000 12% convertible debt to a stockholder. The debt can be
converted into our common stock at $0.35 per share, subject to an effective registration
statement covering the underlying common stock that has been filed with the Securities and
Exchange Commission. In conjunction with this convertible debt, we issued stock warrants to
purchase 250,000 shares of Digitiliti common stock with a five year term at $0.50 per share.
 Pursuant to a security agreement with the stockholder, our DigiLIBE software and our DigiBAK
vaults along with other intellectual properties serve as the collateral for the above
guarantee, convertible debt and the related note payable (see Note 6). The convertible note
matured on May 20, 2009 and became past due.
 On June 30, 2010, the Company modified the terms of the above convertible note whereby the
maturity date was extended from May 20, 2009 to August 31, 2010. The Company evaluated the
modification under FASB ASC 470-50 and determined that the modification was not substantial
and did not qualify as a debt extinguishment. Accordingly, no gain or loss was recognized from
the modification.
 We analyzed these two convertible debt and the warrants issued for derivative accounting
consideration and determined that derivative accounting is not applicable for these debts.
  45




---



##### Table of Contents



We discounted the relative fair value of warrants attached to both debts and calculated the
intrinsic value of the beneficial conversion feature of the debt. The resulting discount of
$210,974 is being amortized over the life of the debts using the effective interest method.
The discount was fully amortized in 2009.
 In December 2010, the Company issued a $250,000 12% convertible debt to a stockholder. The
debt reflects an 18-month maturity date and can be converted into common stock at $0.20 per
share. The debt is secured by a lien on all assets of the Company; provided, however, that the
stockholder agrees to be subordinate with respect to up to $100,000 of original principal
amount of other note against the vault.
 8.
    
    Capital Leases Obligations
 In August and September 2008, the Company entered into three 36-month leases for computer
equipment with two financial institutions. The present value of the monthly lease payments was
capitalized using an imputed interest rate of approximately 20% and 10%. The amount
outstanding for the capital lease obligation was $23,308 and $69,862 at December 31, 2010 and
2009, respectively.
 Amortization of capital
lease property is included in depreciation expense and was $194,250 and
$547,464 in 2010 and 2009, respectively.
 Assets under capital leases, included in property and equipment, consisted of the following:
 December 31,2010
    
    
    2009Computer equipment
    
    $
    944,545
    
    
    $
    1,944,545Less accumulated depreciation
    
    
    (921,999
    )
    
    
    (1,727,748
    )$
    22,546
    
    
    $
    217,797
 9.
    
    Income Taxes
 Income tax computed at the U.S. federal statutory rate reconciled to the effective tax rate
consisted of the following:
 Years Ended December 31,2010
    
    
    2009Federal tax benefit at statutory rate
    
    $
    (2,180,977
    )
    
    
    (34.0
    )%
    
    $
    (1,678,948
    )
    
    
    (34.0
    )%State income taxes, net of federal
tax
    
    
    (416,952
    )
    
    
    (6.5
    )
    
    
    (319,395
    )
    
    
    (6.5
    )Valuation allowance for deferred tax
    
    
    2,562,469
    
    
    
    39.9
    
    
    
    1,107,137
    
    
    
    22.4Other
    
    
    35,460
    
    
    
    .6
    
    
    
    891,206
    
    
    
    18.1Income Tax
    
    $
    
    
    
    
    
    %
    
    $
    
    
    
    
    
    %
  46




---



##### Table of Contents



The components of deferred income taxes consisted of the following:
 December 312010
    
    
    2009Current Deferred Income Tax AssetsVacation accrual
    
    $
    19,041
    
    
    $
    10,404Allowance for uncollectible accounts
    
    
    4,355
    
    
    
    65,665Accrued expense
    
    
    
    
    
    
    3,221Stock based compensation
    
    
    199,685
    
    
    
    199,528Total
    
    
    223,081
    
    
    
    278,818Noncurrent Deferred Income Tax AssetsNet operating loss carryforward
    
    
    8,749,217
    
    
    
    6,280,122Noncurrent Deferred Income Tax LiabilitiesDepreciation
    
    
    (101,676
    )
    
    
    (14,086
    )Deferred rent
    
    
    (1,238
    )
    
    
    (4,674
    )Deferred revenue
    
    
    (4,046
    )
    
    
    Total
    
    
    (106,960
    )
    
    
    (18,670
    )Valuation Allowance
    
    
    (8,865,338
    )
    
    
    (6,540,180
    )Net Deferred Income Tax
    
    $
    
    
    
    $
    
 The Company established a valuation allowance to fully offset the net deferred income tax
assets due to the uncertainty of the Companys ability to generate the future taxable income
necessary to realize those net deferred income tax assets, considering the Companys history
of significant operating losses. In addition, future utilization of the available net
operating loss carryforward may be limited under Internal Revenue Code Section 382 as a result
of changes in ownership that have or may result from the issuance of common stock, and from
options and warrants for the purchase of common stock.
 At December 31, 2010 and 2009 respectively, the Company had net operating loss carryforward of
approximately $21,603,000 and $15,518,000, respectively, which will begin to expire in 2026.
 10.
    
    Equity
 For the year ended December 31, 2009
 On various dates in 2009, sixty six convertible debt holders converted their investment in
convertible debt totaling $2,703,585, including principal and accrued interest, into common
stock. Total shares issued in exchange for the debt were 7,656,606. (See also Note 7)
 In July 2009, the Company issued 505,000 shares of common stock, valued at $126,250, in
connection with the Settlement Agreement with 5X Partners (see Note 5). The Company recognized
a loss of $108,187 on the settlement of this transaction.
 In the fourth quarter of 2009, in lieu of wages the Company issued 656,249 shares of fully
vested common stock to the CEO, valued at $124,323, in connection with his compensation
package.
 On November 4, 2009, in lieu of cash, the Company issued 600,861 shares of common stock,
valued at $120,172, as payment of prior year consulting fees.
 During the last two months of 2009, the Company sold 2,725,000 shares of common stock for cash
proceeds of $501,500, net of share issuance costs of $43,500.
  47




---



##### Table of Contents



For the year ended December 31, 2010
 During the year ended December 31, 2010, in connection with the Companys Incentive Offer, the
Company issued 16,329,869 common shares to repay $2,537,300 of principal and $728,673 of
accrued interest on the convertible debt. (See Note 7)
 During the year ended December 31, 2010, in connection with a private placement, the Company
sold 6,565,000 common shares at $0.20 per share for cash proceeds of
$1,199,050, net of
issuance costs of $112,950
 During the year ended December 31, 2010 the Company issued 1,082,253 common shares for
services valued at $235,120 based on the grant-date quoted market value of the Companys
stock.
 During the year ended December 31, 2010, the Company issued 364,395 common shares to settle
payables to an officer of the Company. The shares were valued at $67,099 based on the
grant-date quoted market value of the Companys stock. In connection with this settlement,
the Company recorded additional compensation expense of $3,220 and a gain on the
extinguishment of liability of $9,000.
 During the year ended December 31, 2010 the Company issued 2,549,500 common shares for the
exercise of 2,549,500 common stock warrants and received cash proceeds of $509,900.
 During the year ended December 31, 2010 the Company issued 724,187 shares of Series A
Convertible Preferred Stock to repay $650,000 of principal and $74,187 of accrued interest on
the secured convertible debt (see Note 7). Each share of Series A Convertible Preferred Stock
is convertible into 5 common shares at the option of the holder and is entitled to annual
cumulative dividends at the rate of 6%. The Series A Convertible Preferred Stock will be
automatically converted into common shares if any one of the following events occurs:
 a)
    
    The Companys common stock trades at $0.60 per share for more than 10
consecutive days;
 b)
    
    The Company conducts a capital raise of common stock at a price of at
least $0.50 per share and raises at least $5 million of gross proceeds; or
 c)
    
    At least 2/3 of the authorized shares of the Series A Convertible
Preferred Stock have been converted to common shares.
 During the year ended December 31, 2010, the Company issued 420,000 shares of Series B
Convertible Preferred Stock for cash. Each share of Series B Convertible Preferred Stock is
convertible into 5 common shares at the option of the holder and is entitled to annual
cumulative dividends at the rate of 5%. The Series B Convertible Preferred Stock will be
automatically converted into common shares if any one of the following events occurs:
 d)
    
    The Companys common stock trades at $1.00 per share for more than 20
consecutive days;
 e)
    
    The Company conducts a capital raise of common stock at a price of at
least $0.50 per share and raises at least $5 million of gross proceeds; or
 f)
    
    At least 2/3 of the authorized shares of the Series B Convertible
Preferred Stock have been converted to common shares.
 On October 14, 2010, the Company held its annual meeting of stockholders. At the meeting, the
stockholders approved an Amendment to the Articles of Incorporation to increase the number of
authorized shares from 110,000,000 to 135,000,000 shares and to allocate the additional shares
as common stock.
 11.
    
    Stock Options
 For the year ended December 31, 2009
 Options to purchase 1,700,000 shares of common stock were granted by the Company to its
employees and consultants at exercise prices ranging from $0.35 to $0.385. These options have
a term of 5 years, and have vesting dates that vary from either full vesting at date of grant
or having a vesting period of 3 years from the date of grant. The fair value of $429,366 was
determined using the Black-Scholes option-pricing model. Variables used in the Black-Scholes
option-pricing model include (1) discount rate ranging from 1.3 to 1.4%, (2) expected life of
3.5 years (3) expected volatility ranging from 152% to 183% and (4) zero expected dividends.
 For the year ended December 31, 2010On July 15, 2010, the Companys Board of Directors approved the 2010 Long Term Incentive Plan,
subject to the approval of the Companys stockholders at the annual meeting. In conjunction
with this resolution, the Board of Directors, by subsequent written action, shall authorize
the specific number of shares of common stock of the Company for issuance under the terms of
the 2010 Long Term Incentive Plan. On October 14,2010, the stockholders approved
the 2010 Long Term Incentive Plan.
  48




---



##### Table of Contents



In connection with the Long-term Incentive Plan, a total of 20,000 common stock options were
granted to the Companys non-employee directors with an exercise price, equal to the fair
value of the share at the date of grant, of $0.22. These options vest over a period of 1
year, have a term of 5 years and a fair value of $4,400, as calculated using the Black-Scholes
option pricing model. Variables used in the Black-Scholes option-pricing model for the options
included: (1) discount rate of 0.60%, (2) expected term of 3 years, (3) expected volatility of
352% and (4) zero expected dividends.
 For the year ended December 31, 2010, in connection with the terms of his employment
agreement, the Company granted 600,000 common stock options to the CEO with an exercise price,
equal to the fair value of the share at the date of grant, of $0.21 per share. These options
have a term of 5 years, vests equally on December 31, 2010, December 31, 2011 and December 31,
2012 and have a fair value of $125,805, as calculated using the Black-Scholes option pricing
model. Variables used in the Black-Scholes option-pricing model for the options included: (1)
discount rates of 0.86% and 1.17%, (2) expected terms ranging from 2.6 to 3.6 years, (3)
expected volatility ranging from 358% to 453% and (4) zero expected dividends.
 For the year ended December 31, 2010, the Company granted 100,000 common stock options to an
employee with an exercise price of $0.35 per share. These options have a term of 7 years,
vested immediately and have a fair value of $21,991, as calculated using the Black-Scholes
option pricing model. Variables used in the Black-Scholes option-pricing model for the options
included: (1) discount rate of 1.44%, (2) expected term of 3.5 years, (3) expected volatility
of 383% and (4) zero expected dividends.
 Stock option expense for the twelve months ended December 31, 2010 totaled $310,967. As of
December 31, 2010, there was approximately $185,648 of unrecognized option expense which is
expected to be recorded through December 2012.
 A summary of option
activities for the year ended December 31, 2010 and 2009 is
reflected below:
 Weighted-
    
    
    WeightedAverage
    
    
    AverageExercise
    
    
    RemainingOptions
    
    
    Price
    
    
    Life (yrs)Outstanding at December 31, 2008
    
    
    1,655,848
    
    
    
    0.36
    
    
    
    3.4Granted
    
    
    1,700,000
    
    
    
    0.38Canceled
    
    
    
    
    
    
    Forfeited
    
    
    (985,848
    )
    
    
    0.37Outstanding at December 31, 2009
    
    
    2,370,000
    
    
    
    0.37
    
    
    
    3.2Granted
    
    
    720,000
    
    
    
    0.23Canceled
    
    
    
    
    
    
    Forfeited
    
    
    (100,000
    )-
    
    
    0.35
    -Outstanding at December 31, 2010
    
    
    2,9990,000
    
    
    
    0.34Exercisable at December 31, 2010
    
    
    2,010,971
    
    
    
    0.35
    
    
    
    3.1
 The weighted-average grant date fair value of options granted in 2010 was $0.21. The
outstanding options at December 31, 2010 have an intrinsic value of zero.
 12.
    
    Stock Warrants
 For the year ended December 31, 2009
 In connection with a private offering, the Company issued warrants to purchase 750,000 shares
of its common stock to certain institutional and accredited investors. These warrants expire
in 5 years and are exercisable at $.50 per share immediately. These warrants are classified as
equity and have a fair value of $123,618.
  49




---



##### Table of Contents



In conjunction with the private offering referenced above, the Company issued to M2 warrants
totaling 375,000 with an exercise price of $0.30. These warrants have a term of 5 years, vest
immediately and have a fair value of $74,424, as calculated using the Black-Scholes option
pricing model. Variables used in the Black-Scholes option-pricing model include (1) discount
rate of 2.19%, (2) warrant life of five years, (3) expected volatility of 176% and (4) zero
expected dividends.
 During the third quarter of 2009, warrants to purchase 100,000 shares of common stock were
granted to an individual who provided loan to the Company at an exercise price of $0.20. These
warrants have a term of five years and vest immediately. Fair value of $17,048 was calculated
using the Black-Scholes option-pricing model. Variables used in the Black-Scholes
option-pricing model include (1) discount rate of 1.79%, (2) warrant life of five years, (3)
expected volatility of 166% and (4) zero expected dividends.
 During the third quarter of 2009, in exchange for the discharge of an approximate $100,227
balance of unpaid compensation due a former vendor, 5X, we issued warrants to purchase 360,000
shares of common stock at an exercise price of $0.385. These warrants have a term of five
years and they vest immediately. Fair value of $82,164 was calculated using the Black-Scholes
option-pricing model. Variables used in the Black-Scholes option-pricing model include (1)
discount rate of 2.52%, (2) warrant life of five years, (3) expected volatility of 160% and
(4) zero expected dividends.
 During the second quarter of 2009, warrants to purchase 125,000 shares of common stock were
granted by the Company to one of its convertible note holders at an exercise price of $0.50.
These warrants have a term of three years and they vest immediately. Fair value of $26,997 was
calculated using the Black-Scholes option-pricing model. Variables used in the Black-Scholes
option-pricing model include (1) discount rate of 1.79%, (2) warrant life of three years, (3)
expected volatility of 146% and (4) zero expected dividends.
 During 2009, warrants to purchase a total of 1,700,000 shares of common stock were granted by
the Company to a former director and certain employees with exercise prices ranging from $0.20
to 0.50. These warrants have terms ranging from three to five years. Of the total, 950,000
warrants vested immediately while 750,000 warrants would have vested upon the successful
achievement of certain performance goals that were not. The fair value of these warrants
amounted to $263,733 and was calculated using the Black-Scholes option-pricing model.
Variables used in the Black-Scholes option-pricing model include (1) discount rate ranging
from 1.79% to 2.31% (2) warrant life of three to five years, (3) expected volatility ranging
from 142% to 173% and (4) zero expected dividends.
 For the year ended December 31, 2010
 In conjunction with the Companys past equity raise, the Company granted 340,000 common stock
warrants with an exercise price of $0.30 per share to a consulting group that introduced
investors to the Company. These warrants have a term of 5 years, vested immediately and have a
fair value of $77,395, as calculated using the Black-Scholes option pricing model. Variables
used in the Black-Scholes option-pricing model for the warrants included: (1) discount rate of
2.37%, (2) expected life of five years, (3) expected volatility of 181% and (4) zero expected
dividends. The above warrants were accounted for against the Companys additional paid-in
capital account as share issuance costs.
 Pursuant to final terms of a former executive officers severance agreement confirmed on April
15, 2010, the Company granted 1,500,000 common stock warrants with an exercise price of $0.385
per share. These warrants have a term of 5 years, vested immediately and have a fair value of
$374,995, as calculated using the Black-Scholes option pricing model. Variables used in the
Black-Scholes option-pricing model for the warrants included: (1) discount rate of 1.79%, (2)
expected life of five years, (3) expected volatility of 393% and (4) zero expected dividends.
The fair value of the above warrants were recognized as warrant expense for the year ended
December 31, 2010.
  50




---



##### Table of Contents



As compensation for computer software programming services provided, the Company granted
50,000 common stock warrants with an exercise price of $0.35 per share. These warrants have a
term of 5 years, vested immediately and have a fair value of $12,500, as calculated using the
Black-Scholes option pricing model. Variables used in the Black-Scholes option-pricing model
for the warrants included: (1) discount rate of 1.79%, (2) expected life of five years, (3)
expected volatility of 393% and (4) zero expected dividends. The fair value of the above
warrants were recognized as warrant expense for the year ended December 31, 2010.
 In return for extending the maturity date of a convertible note (see Note 7), the Company
granted 50,000 common stock warrants with an exercise price of $0.20 per share. These warrants
have a term of 5 years, vested immediately and have a fair value of $9,000, as calculated
using the Black-Scholes option pricing model. Variables used in the Black-Scholes
option-pricing model for the warrants included: (1) discount rate of 1.79%, (2) expected life
of five years, (3) expected volatility of 377% and (4) zero expected dividends. The value of
the above warrants were included in the loss on extinguishment of debt.
 In conjunction with the sale of the Series B Convertible Preferred Stock, the Company granted
100,000 common stock warrants with an exercise price of $0.30 to a consultant. These warrants
have a term of 5 years, vested immediately and have a fair value of $23,998, as calculated
using the Black-Scholes option pricing model. Variables used in the Black-Scholes
option-pricing model for the warrants included: (1) discount rate of 1.79%, (2) expected life
of five years, (3) expected volatility of 356% and (4) zero expected dividends.
 On October 14, 2010, the Companys Board of Directors approved the issuance of warrants to the
Chairman of the Board as follows:
 1.
    
    250,000 warrants with a five-year life and a $0.35 per share exercise price as a
result of the successful launch of the Companys DigiLIBE product prior to March 31,
2010. These warrants will vest on January 14, 2011, and have a fair value of $55,000, as
calculated using the Black-Scholes option pricing model. Variables used in the
Black-Scholes option-pricing model for the warrants included: (1) discount rate of 1.18%,
(2) expected life of five years, (3) expected volatility of 443% and (4) zero expected
dividends.
 2.
    
    250,000 warrants with a five-year life and an exercise price of $0.22 for raising
$2.35M of capital prior to June 30, 2010. These warrants will vest on December 1, 2010,
if the Company raises $1.3 million in additional capital as of November 30, 2010, and
have a fair value of $55,000, as calculated using the Black-Scholes option pricing model.
Variables used in the Black-Scholes option-pricing model for the warrants included: (1)
discount rate of 1.18%, (2) expected life of five years, (3) expected volatility of 443%
and (4) zero expected dividends. The performance condition was not met and the warrants
were forfeited.
 3.
    
    250,000 warrants with a five-year life and an exercise price of $0.22 for his
assistance in facilitating a new CEO transition, along with his continued assistance in
providing technical advice and investor relations expertise. These warrants will vest on
January 14, 2011, and have a fair value of $55,000, as calculated using the Black-Scholes
option pricing model. Variables used in the Black-Scholes option-pricing model for the
warrants included: (1) discount rate of 1.18%, (2) expected life of five years, (3)
expected volatility of 443% and (4) zero expected dividends.
 During the year, the Company reached settlement agreements with three convertible note holders
that included the surrender and forfeiture of an aggregate of 30,000 associated common stock
warrants.
 During the year, the Company reached partial settlement agreements that were entered into in
conjunction with the Incentive Offer (see Note 7) involving two convertible note holders that
resulted in the surrender and forfeiture of 37,500 common stock warrants.
 During the year, 750,000 contingent warrants granted to the Companys former President/CEO
were forfeited since the related performance conditions were not met.
  51




---



##### Table of Contents



A summary of warrant activities for the years ended December 31, 2010 and 2009 are as follows:
 Weighted-AverageWarrants
    
    
    Exercise PriceOutstanding at December 31, 2008
    
    
    6,200,348
    
    
    $
    1.03Granted
    
    
    3,410,000
    
    
    
    0.39Exercised
    
    
    (100,000
    )
    
    
    1.88Outstanding at December 31, 2009
    
    
    9,510,348
    
    
    
    0.79Granted
    
    
    2,790,000
    
    
    
    0.35Exercised
    
    
    (2,549,500
    )
    
    
    0.92Forfeited
    
    
    (1,067,500
    )
    
    
    0.52Outstanding at December 31, 2010
    
    
    8,683,348
    
    
    
    0.65
 Except for 500,000 warrants
that will vest in January 14, 2011, all warrants are fully vested
and exercisable at December 31, 2010.
 The weighted-average grant date fair value of warrants granted in 2010 and 2009 was $0.24
and $0.20, respectively. The outstanding warrants at December 31, 2010 have an intrinsic value
of $3,250.
 13.
    
    Commitments and Contingencies
 Because some of our convertible note holders have not accepted our offers to convert their
notes under the terms of the Modification Proposal and Incentive Offer, we are presently in
arrears in principal and accrued interest payments in an aggregate total of $272,863 as of
December 31, 2010. Although we are continuing to discuss payment and/or conversion or
extension of these notes with note holders, these outstanding obligations pose a risk to our
ongoing operations.
 On July 13, 2009, the Company was made a party to a complaint by nuArch, LLC, alleging breach
of contract and sought recovery of unpaid compensation of approximately $140,000 for alleged
services rendered during 2008 and 2009. On February 4, 2010, the Company entered into a
Settlement Agreement with nuArch that reflected an agreed upon payment of $75,000 to be paid
over a 9-month period commencing on March 22, 2010. Accordingly, the Company reduced the
related payable based on the agreed settlement amount. As of December 31, 2010, all payments
have been made in compliance with the terms of this Settlement Agreement.
 From time to time, Digitiliti may be subject to routine litigation, claims, or disputes in the
ordinary course of business. In the opinion of management; no pending or known threatened
claims, actions or proceedings against Digitiliti are expected to have a material adverse
effect on Digitilitis consolidated financial position, results of operations or cash flows.
Digitiliti cannot predict with certainty, however, the outcome or effect of any of the
litigation or investigatory matters specifically described above or any other pending
litigation or claims. There can be no assurance as to the ultimate outcome of these lawsuits
and investigations.
 Operating leases
 The Company leases its office space for a period of 4.6 years through December 2011. In The
lease requires monthly rental payments that range from $4,450 to $6,450 through December 2008.
Thereafter, the rent will be consistent with other similar commercial properties. The Company
is recording deferred rent to equalize the monthly payments during the lease term. To date,
our base rent of $6,450 has not changed.
 The Companys previous office space lease expired in October 2010. This lease required the
Company to make rental payments in 2009 and 2010 ranging from $3,092 to $3,350. The Company
subleased this previous office space through the end of the lease term. Monthly sublease
payment amounted to $3,239.
 For 2010, rent expense was
$140,264, net of $32,398 of sublease rental income. For 2009, rent
expense was $123,160, net of $45,349 sublease rental income.
 The table below reflects the Companys commitments as they come due over the next five years.
 Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year2011
    
    
    2012
    
    
    2013
    
    
    2014
    
    
    2015Capital leases (includes interest)
    
    $
    31,280
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0Operating leases
    
    
    77,400
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Convertible debt and accrued
interest
    
    
    1,417,231
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0$
    1,525,911
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
  52




---



##### Table of Contents



14.
    
    Major Customers and Vendors
 The Company earned 21% percent of its revenues from one customer for the year ended December
31, 2010.
 The Company primarily deals with four major vendors which account for approximately 52% of the
cost of revenues for the year ended December 31, 2010.
 15.
    
    Subsequent Events
 On January 24, 2011 the Board of Directors approved the grant of 1,200,000 options to
employees and independent contractors working for the Corporation. These options vest over a
period of 3 years and have a term of 5 years. The Board of
Directors approved the Compensation
Committees recommendation to grant options to certain employees and other Company personnel
so as to bring their respective option total into parity with other employees that have the
same management level and length of duration of service with the Company. The options were
priced at the closing price on the day of grant ($0.19) and are in some cases performance
based and in other cases based on service.
 On January 24, 2011, the Board of Directors approved a cash reduction of 20% in salaries to
certain members of senior management, effective December 15, 2010 and continuing through June
15, 2011. The 20% cash reduction is to be paid in stock options, with the calculation of the
number of options earned reflecting the equivalent of the salary reduction accepted by members
of senior management up through June 30, 2011, based on the closing price of the Companys
common stock on January 24, 2011. Once the total options have been calculated for each member
of Senior Management, the Company shall on the last day of each month vest that portion of
these total options that reflect that months portion of these total options. The amount of
salary forgone is $49,432. The terms of the related stock options will reflect a 3-year
vesting schedule and have a 5-year term and an exercise price equal to $0.19 per share based
on on the closing price on January 24, 2011.
 Effective March 17, 2011, the Companys CEO offered to receive his salary in stock in lieu of
cash for the six month period beginning February 15, 2011 and ending July 15, 2011. The Board
accepted Mr. Taghizadehs offer and agreed that on the last day of each month, cash
compensation due to Mr. Taghizadeh will be paid in common stock based on the amount due at the
end of each month divided by the closing price of the stock on that date. The amount of cash
compensation Mr. Tagizadeh has agreed to forgo is, $15,417 per month, or $92,500 for the six
month period, which includes the 20% cash previously forgone.
 On February 28, 2011, the Company completed the placement of $1,182,844 Secured Convertible
Promissory Note and Warrants (the Secured Convertible Debt Offering).
 The Lenders in the Secured Convertible Debt Offering paid a 10% discount for their investment,
resulting in a stepped-up basis in their individual Secured Convertible Promissory Notes.
The Secured Convertible Promissory Notes bear interest at the rate of 12% per annum, have an
18-month maturity date and a $0.20 per share conversion rate in the Companys common stock.
The Secured Convertible Promissory Notes are secured by a first lien on all assets of the
Company; provided, however, that the Lenders agreed to subordinate to a lien with respect to
up to $100,000 of original principal amount of other notes against the Companys vault.
 The Lenders received Warrants to purchase an aggregate of 3,252,821 shares of Company Common
Stock. The Warrants have a five year term, $0.30 exercise price and include a cashless
exercise provision and a put right in the event of an acquisition of the Company valued at the
Black Scholes Value of the unexercised portion of the Warrant obtained from the OV function
on Bloomberg determined as of the day prior to announcement of the transaction. The Warrants
include antidilution provisions for stock splits, stock dividends and recapitalization only.
 The Secured Convertible Debt Offering was conducted in order to implement a previously
approved repayment of debt obligations (see Notes 6 and 7) owed to two stockholders (the
Miners), as well as provide additional working capital for the Company. Contemporaneously
with the closing of the Secured Convertible Debt Offering, the Company and the Miners executed
a Repayment of Note Obligations and Release of Security Interest Agreement that provided for
the repayment of $431,540 of debt principal with the remaining principal balance owed of
$100,000 being rolled into a secured promissory note under the Secured Convertible Debt
Offering. Correspondingly, all outstanding accrued interest owed on the debt was paid to the
Miners in the form of the Companys common stock based on a rate of $0.15 per share, along
with a modification in terms on 350,000 common stock purchase warrants previously issued to
the Miners and the issuance of an additional 200,000 warrants reflecting a five year term and
a $0.20 per share exercise price. After
completion of all documentation reflecting the repayment of the debt, the Miners released
their first lien in the Companys assets in preference to those Lenders associated with the
Secured Convertible Debt Offering.
  53




---



##### Table of Contents



On March 2, 2011, the Company entered into a twenty-four month operating lease for equipment
to upgrade its vault. The lease expense for the years ended December 31, 2011, 2012 and 2013,
respectively will be $26,280., $63,072, and $21,024. A payment of $20,958, approximating
four months lease expense has been made.
 Effective March 17, 2011, the Company retained an individual to provide various services to
the Company. The retainer for these services is 10,000 common stock warrants per month from
March to August 2011, reflecting a five year term and a $0.20 per share exercise price.
 On March 24, 2011, the Company entered into a short term loan totaling $16,000 with a related
party that reflected a 12% annual rate of interest and a 3-month maturity. This debt
obligation was secured against first security lien in the Company accounts receivable.
 
 ITEM 9:
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
  
 ITEM 9A:
    
    CONTROLS AND PROCEDURES THIS ENTIRE SECTION NEED TO BE REVIEWED
 Evaluation of Disclosure Controls and Procedures
    Managements Report on Internal Control over Financial Reporting
   54




---



##### Table of Contents



Internal
ControlIntegrated Framework
    Changes in internal control over financial reporting
  
 ITEM 9B:
    
    OTHER INFORMATION
 
 PART III
 
 ITEM 10:
    
    DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
  
 PART IV
 
 ITEM 15:
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 See the Exhibit Index
  55




---



##### Table of Contents



No.

    
    Description3.1
    
    
    Amended and Restated Certificate of Incorporation filed
May 13, 2008.
    
    Exhibit to our Form
10-K for the year
ended December 31,
20083.2
    
    
    Bylaws.
    
    Exhibit to our Form
10-K for the year
ended December 31,
200810.1
    
    
    XO Communications Contract.
    
    Exhibit to our Form 1010.2
    
    
    FRM Associates Lease, as amended.
    
    Exhibit to our Form 1010.3
    
    
    EBC Minneapolis, Inc. Sublease Agreement.
    
    Exhibit to our Form 1010.4
    
    
    Upper Corner Venture, LLC Lease Agreement.
    
    Exhibit to our Form 1010.5
    
    
    5X Partners Corporate Development Services Agreement
with Addendums.
    
    Exhibit to our Form 1010.6
    
    
    StorageSwitch Consulting Services Agreement.
    
    Exhibit to our Form 1010.7
    
    
    StorageSwitch Non-Compete Agreement.
    
    Exhibit to our Form 1010.8
    
    
    StorageSwitch Technology Purchase Agreement.
    
    Exhibit to our Form 1010.9
    
    
    Vision to Practice, Inc. Development Services Agreement.
    
    Exhibit to our Form 1010.10
    
    
    Sub-Lease Agreement14
    
    
    Code of Ethics
    
    Exhibit to our Form
10-K for the year
ended December 31,
200821
    
    
    Subsidiaries.
    
    Exhibit to our Form 1031.1
    *
    
    302 Certification of CEO, Roy A. Bauer31.2
    *
    
    302 Certification of CFO, William McDonald32
    *
    
    906 Certification99.1
    
    
    Digitiliti, Inc. Stock Option Plan.
    
    Exhibit to our Form 1099.2
    
    
    Charter of the Audit and Finance Committee of the Board
of Directors
    
    Exhibit to our 8-K
Current Report dated
December 16, 2008 and
filed December 22,
200899.3
    
    
    Charter of the Corporate Governance and Nomination
Committee of the Board of Directors
    
    Exhibit to our 8-K
Current Report dated
December 16, 2008 and
filed December 22,
200899.4
    
    
    Charter of the Compensation Committee of the Board of
Directors
    
    Exhibit to our 8-K
Current Report dated
December 16, 2008 and
filed December 22,
2008
    
    
    Filed with this Annual report.
  56




---



##### Table of Contents



SIGNATURES
  DIGITILITI, INC.Date: April 14, 2011
    
    By:
    
    /s/ Eshhan Taghizadeh

Esshan TaghizadehChief Executive Officer/President
  DIGITILITI, INC.Date: April 14, 2011
    
    By:
    
    /s/ Esshan Taghizadeh

Eshhan TaghizadehChief executive Officer/PresidentDate: April 14, 2011
    
    By:
    
    /s/  William McDonald

William McDonaldChief Financial Officer
  57