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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark  One)** | ** ** | ** **                                                                                                                                                                                                                                                                                                                  |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **x**           | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| ** **      | ** ** | **For  the quarterly period ended June 30, 2008**                                                                                                                                                                                                                                                                      |
| ** **      | ** ** | ** **                                                                                                                                                                                                                                                                                                                  |
| **o**           | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| ** **      | ** ** | **For  the transition period from                         to                       ** |

 

**Commissionfile number 000-31081**

 

**ETELOS,INC.**

(Exact name ofsmall business issuer as specified in its charter)

 

| **Delaware**                     | ** ** | **77-0407364**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (IRS Employer        |
| incorporation or  organization)  |       | Identification  No.) |

 

**1900O’Farrell St., Suite 320, San Mateo, CA 94403**

(Address ofprincipal executive offices)

 

**(425)458-4510**

(Issuer’stelephone number)

 

 

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or For such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.
|   |   | YES o   NO x |
|--------|--------|---------------------------------------|

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definition of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 
| Large accelerated  filer   o    |   | Accelerated  Filer   o         |
|------------------------------------------------|--------|-----------------------------------------------|
|                                           |   |                                          |
| Non-accelerated  filer   o      |   | Smaller reporting  company   x |
|                                           |
| (Do  not check if a smaller reporting company) |

 
| Indicated by check mark  whether the registrant is a shell company (as defined in Rule 12b-2 of  the Exchange Act). | YES o   NO x |
|--------------------------------------------------------------------------------------------------------------------------|---------------------------------------|

 

On June 30, 2008,the registrant had outstanding 23,052,624 shares of $0.01 par value commonstock, its only class of common equity.

 

 

 

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EXPLANATORY NOTE

 

On February 8, 2007,Tripath Technology Inc., a Delaware corporation (“Tripath”) filed a voluntarypetition for relief under Chapter 11 of the Bankruptcy Code. On February 1,2008, the bankruptcy court issued an order confirming approval of the Plan ofReorganization, including the merger and the transfer of all of Tripath’sexisting assets into a separate bankruptcy estate and the discharge of all ofTripath’s liabilities.  The Plan ofReorganization also contemplated the merger of Etelos, Incorporated, aWashington corporation (“Etelos-WA”) with Tripath.   The overallimpact of the confirmed Plan of Reorganization was for Tripath to emerge fromthe bankruptcy proceeding with no assets and no liabilities as a shellcorporation and for all issued and outstanding securities of and interests inTripath, including debentures, stock options (including, but not limited to,all stock options granted to employees), warrants, and other shares of commonstock to be canceled and extinguished.

 

On April 23, 2008,Tripath  filed a Current Report on Form 8-Kannouncing, among other things, that Etelos-WA, merged with and into Tripath(the “Merger”), and that the surviving corporation changed its name to Etelos, Inc.and its fiscal year end  to December 31. The effective date of the Merger was April 22,2008, and Etelos, Inc., as the surviving corporation, will conduct thebusiness and operations previously conducted by Etelos-WA.  In connectionwith the Merger, all outstanding shares of Etelos-WA common stock wereconverted into shares of Etelos, Inc. common stock on a three for oneratio: one share of Etelos Inc. common stock for every three shares of commonstock of Etelos-WA.  Also in connection with the Merger, (i) alloutstanding shares of preferred stock of Etelos-WA were converted in to sharesof common stock of Etelos, Inc., (ii) Etelos, Inc. issued anaggregate of 5,010,000 shares of its common stock to the secured and unsecuredcreditors of Tripath and (iii) all the shares of Tripath Technology werecancelled.  Prior to the Merger, Tripathwas a shell corporation and in accordance with the Plan of Reorganization hadno assets or liabilities.  While Tripathacquired all the outstanding preferred and common stock of Etelos-WA, foraccounting purposes, the acquisition has been treated as a recapitalization ofEtelos-WA with Etelos-WA as the acquirer (a reverse acquisition).  The historical financial statements prior to April 22,2008, are those of Etelos-WA and the description of the business contained inthis report as well as the one contained in the financial statements reflectthe operations of Etelos-WA for the quarterly and six month periods ended June 30,2008 and 2007.  Also, on April 23,2008, Etelos, Inc., formerly Tripath, amended its articles ofincorporation with the state of Delaware to change its total authorized sharesof stock to 300,000,000 shares, of which 250,000,000 shares are designated “CommonStock” with a par value of $0.01 per share and 50,000,000 shares are designated“Preferred Stock” with a par value of $0.01 per share.  The Preferred Stock may be issued from timeto time in one or more series, each of such series to consist of such number ofshares and to have such terms, rights, powers and preferences, and thequalifications and limitations with respect thereto, as stated in theresolutions providing for the issue of such series adopted by the board ofdirectors.

 

Informationconcerning number of shares outstanding for Etelos, Inc. including theconversion prices and number of shares issuable upon conversion of convertiblesecurities and exercise prices of warrants and stock options and the number ofshares issuable upon exercise of the options and warrants, has been adjusted toreflect the three for one conversion ratio effected in connection with the Mergeras if it had occurred at the beginning of the quarterly and six month periodsand as of December 31, 2007.

 

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**TABLEOF CONTENTS**

 
| **Part I —  Financial Information** | ** **                                                                                  | ** ** |
|-----------------------------------------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                    | ** **                                                                                  | ** ** | ** ** |
| Item 1.                                       | Financial Statements  (unaudited)                                                           |       | 1 |
| Item 2.                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 13 |
| Item 3.                                       | Quantitative  and Qualitative Disclosure About Market Risk                                  |       | 26 |
| Item 4.                                       | Controls and  Procedures                                                                    |       | 26 |
|                                          |                                                                                        |       |   |
| **Part II — Other  Information**    |                                                                                        |       |
|                                          |                                                                                        |       |   |
| Item 1.                                       | Legal Proceedings                                                                           |       | 27 |
| Item 1A.                                      | Risk Factors                                                                                |       | 27 |
| Item 2.                                       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       | 43 |
| Item 3.                                       | Defaults  Upon Senior Securities                                                            |       | 43 |
| Item 4.                                       | Submission  of Matters to a Vote of Security Holders                                        |       | 43 |
| Item 5.                                       | Other Information                                                                           |       | 43 |
| Item 6.                                       | Exhibits                                                                                    |       | 43 |

 

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**PART I - FINANCIAL INFORMATION**

 

**ITEM 1. - FINANCIAL STATEMENTS (UNAUDITED)**

** **

**ETELOS, INC.**

**CONDENSED BALANCE SHEETS**

(inthousands, except share data)

(Unaudited)

 
| ** **                                                                                                                                               | ** ** | **June 30,    2008** | ** ** | **December 31,    2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
|                                                                                                                                                     |       |                      |       |                          |       |
| ASSETS                                                                                                                                                   |       |                      |       |                          |       |
| Current assets:                                                                                                                                          |       |                      |       |                          |       |
| Cash and cash  equivalents                                                                                                                               |       | $                         | 1,796      |                          | $          | 928 |   |
| Accounts  receivable, net                                                                                                                                |       | 5                         |       | —                        |       |
| Prepaid expenses  and other current assets                                                                                                               |       | 62                        |       | 20                            |       |
| Total current  assets                                                                                                                                    |       | 1,863                     |       | 948                           |       |
|                                                                                                                                                     |       |                      |       |                          |       |
| Property and  equipment, net                                                                                                                             |       | 81                        |       | 50                            |       |
| Other assets                                                                                                                                             |       | 308                       |       | 41                            |       |
|                                                                                                                                                     |       |                      |       |                          |       |
| **Total  assets**                                                                                                                                        | ** ** | **$**                     | **2,252**  | ** **                    | **$**      | **1,039** | ** ** |
|                                                                                                                                                     |       |                      |       |                          |       |
| LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                                              |       |                      |       |                          |       |
| Current  liabilities:                                                                                                                                    |       |                      |       |                          |       |
| Accounts payable                                                                                                                                         |       | $                         | 437        |                          | $          | 250 |   |
| Accounts payable  related parties                                                                                                                        |       | 2                         |       | 56                            |       |
| Accrued payroll  and related expenses                                                                                                                    |       | 588                       |       | 514                           |       |
| Other accrued  expenses                                                                                                                                  |       | 256                       |       | 241                           |       |
| Deferred revenue                                                                                                                                         |       | 3                         |       | 3                             |       |
| Deferred rent                                                                                                                                            |       | 4                         |       | —                        |       |
| Current portion  notes payable, net of discounts                                                                                                         |       | 2,629                     |       | 3,165                         |       |
| Current portion  notes payable to related parties                                                                                                        |       | 150                       |       | 187                           |       |
| Current portion  capital leases                                                                                                                          |       | 17                        |       | 16                            |       |
| Warrant and  derivative liability                                                                                                                        |       | 10,521                    |       | —                        |       |
| Total current  liabilities                                                                                                                               |       | 14,607                    |       | 4,432                         |       |
|                                                                                                                                                     |       |                      |       |                          |       |
| Long-term notes  payable, net of discounts, less current portion                                                                                         |       | 2,871                     |       | 889                           |       |
| Long-term notes  payable to related parties, less currrent portion                                                                                       |       | 561                       |       | 629                           |       |
| Long-term  deferred rent                                                                                                                                 |       | 1                         |       | —                        |       |
| Long-term  capital leases                                                                                                                                |       | 27                        |       | 36                            |       |
|                                                                                                                                                     |       |                      |       |                          |       |
| Total  liabilities                                                                                                                                       |       | 18,067                    |       | 5,986                         |       |
|                                                                                                                                                     |       |                      |       |                          |       |
| Commitments and  contingencies                                                                                                                           |       |                      |       |                          |       |
|                                                                                                                                                     |       |                      |       |                          |       |
| Stockholders’  deficit:                                                                                                                             |       |                      |       |                          |       |
| Preferred stock,  $0.01 par value: 50,000,000 shares authorized with liquidation preferences:                                                            |       |                      |       |                          |       |
| Series A:  4,166,667 shares authorized; issued and outstanding - no shares at June 30,  2008, and 22,167 at December 31, 2007                            |       | —                    |       | —                        |       |
| Series B:  7,500,000 shares authorized; issued and outstanding - no shares at June 30,  2008, and 40,000 at December 31, 2007                            |       | —                    |       | —                        |       |
| Series C:  20,000,000 shares authorized; issued and outstanding - no shares at June 30,  2008, and 1,482,604 at December 31, 2007                        |       | —                    |       | 15                            |       |
| Common stock,  $0.01 par value: 250,000,000 shares authorized; issued and outstanding -  23,052,624 at June 30, 2008, and 6,791,313 at December 31, 2007 |       | 231                       |       | 68                            |       |
| Additional  paid-in capital                                                                                                                              |       | 18,192                    |       | 5,404                         |       |
| Accumulated  deficit                                                                                                                                     |       | (34,238                   | )          | (10,434                       | )          |
| Total  stockholders’ deficit                                                                                                                        |       | (15,815                   | )          | (4,947                        | )          |
|                                                                                                                                                     |       |                      |       |                          |       |
| **Total  liabilities and stockholders’ deficit**                                                                                                    | ** ** | **$**                     | **2,252**  | ** **                    | **$**      | **1,039** | ** ** |

 

Theaccompanying notes are an integral part of these condensed interim financialstatements

 

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**ETELOS, INC.**

**CONDENSED STATEMENTS OF OPERATIONS**

(inthousands, except per share data)

(Unaudited)

 
| ** **                                                                                        | ** ** | **Three Months Ended** | ** **  | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------|-------------|--------------------------------|------------|
| ** **                                                                                        | ** ** | **June 30,**                | ** **  | **June 30,**              | ** ** |
| ** **                                                                                        | ** ** | **2008**                         | ** **  | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                        | ** ** | ** **                       | ** **  | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                           |       | $                                | 22          |                           | $          | 106 |   | $ | 45 |   | $ | 211 |   |
| Cost of revenue                                                                                   |       | 148                              |        | 69                             |       | 249 |   | 124 |   |
| Gross profit  (loss)                                                                              |       | (126                             | )           | 37                             |       | (204 | ) | 87 |   |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Operating  expenses:                                                                              |       |                             |        |                           |       |   |   |   |   |
| Research and  development                                                                         |       | 1,283                            |        | 292                            |       | 2,476 |   | 554 |   |
| Sales and  marketing                                                                              |       | 508                              |        | 149                            |       | 801 |   | 221 |   |
| General and  administrative                                                                       |       | 630                              |        | 110                            |       | 1,100 |   | 155 |   |
| Total operating  expenses                                                                         |       | 2,421                            |        | 551                            |       | 4,377 |   | 930 |   |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Loss from  operations                                                                             |       | (2,547                           | )           | (514                           | )          | (4,581 | ) | (843 | ) |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Other expense                                                                                     |       |                             |        |                           |       |   |   |   |   |
| Merger costs                                                                                      |       | 13,444                           |        | —                         |       | 13,444 |   | — |   |
| Other expense                                                                                     |       | 15                               |        | —                         |       | 15 |   | — |   |
| Total other  expense                                                                              |       | 13,459                           |        | —                         |       | 13,459 |   | — |   |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Interest  expense, net                                                                            |       | 5,567                            |        | 58                             |       | 5,765 |   | 98 |   |
| Loss before  taxes                                                                                |       | (21,573                          | )           | (572                           | )          | (23,805 | ) | (941 | ) |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Provision for  income taxes                                                                       |       | —                           |        | —                         |       | — |   | — |   |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| **Net  loss**                                                                                     | ** ** | **$**                            | **(21,573** | **)**                          | **$**      | **(572** | **)** | **$** | **(23,805** | **)** | **$** | **(941** | **)** |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Basic and  diluted net loss per share                                                             |       | $                                | (1.13       | )                              | $          | (0.16 | ) | $ | (1.80 | ) | $ | (0.27 | ) |
|                                                                                              |       |                             |        |                           |       |   |   |   |   |
| Weighted average  number of common shares used in computing basic and diluted net loss per  share |       | 19,046                           |        | 3,507                          |       | 13,198 |   | 3,504 |   |

 

The accompanying notesare an integral part of these condensed interim financial statements

 

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**ETELOS, INC.**

**CONDENSED STATEMENTS OF CASH FLOWS**

(inthousands)

(Unaudited)

 
| ** **                                                                                 | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                 | ** ** | **June 30,**              | ** ** |
| ** **                                                                                 | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| ** **                                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities:**                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                              | (23,805    | ) | $ | (941 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                                             |       | 13                             |       | 8 |   |
| Amortization of  notes discount                                                            |       | 165                            |       | — |   |
| Amortization of  financing fees                                                            |       | 32                             |       | — |   |
| Stock based  compensation                                                                  |       | 69                             |       | — |   |
| Interest expense  paid in common stock                                                     |       | 77                             |       | — |   |
| Beneficial  conversion feature                                                             |       | 991                            |       | — |   |
| Change in  valuation of liability relating to embedded derivatives and warrants            |       | 4,377                          |       | — |   |
| Professional  fees paid in common stock                                                    |       | —                         |       | 30 |   |
| Merger costs  paid in common stock                                                         |       | 13,177                         |       | — |   |
| Changes in  operating assets and liabilities:                                              |       |                           |       |   |   |
| Accounts  receivable, net                                                                  |       | (5                             | )          | (61 | ) |
| Prepaid expenses  and other current assets                                                 |       | (41                            | )          | (17 | ) |
| Other assets                                                                               |       | (65                            | )          | — |   |
| Accounts payable                                                                           |       | 153                            |       | 129 |   |
| Accounts payable  related parties                                                          |       | (54                            | )          | 126 |   |
| Accrued payroll  and related expenses                                                      |       | 73                             |       | 59 |   |
| Other accrued  expenses                                                                    |       | 137                            |       | 12 |   |
| Deferred revenue                                                                           |       | —                         |       | 28 |   |
| Deferred rent                                                                              |       | 5                              |       | — |   |
|                                                                                       |       |                           |       |   |   |
| **Net  cash used in operating activities**                                                 | ** ** | **(4,701**                     | **)**      | **(627** | **)** |
|                                                                                       |       |                           |       |   |   |
| **Cash  flows from investing activity:**                                                   |       |                           |       |   |   |
| Purchases of  property and equipment                                                       |       | (44                            | )          | — |   |
|                                                                                       |       |                           |       |   |   |
| **Net  cash used in investing activities**                                                 | ** ** | **(44**                        | **)**      | **—** | ** ** |
|                                                                                       |       |                           |       |   |   |
| **Cash  flows from financing activity:**                                                   |       |                           |       |   |   |
| Proceeds from  notes payable                                                               |       | 5,500                          |       | 600 |   |
| Proceeds from  issuance of common stock                                                    |       | 460                            |       | — |   |
| Payment of fees  on financing transactions                                                 |       | (234                           | )          | — |   |
| Proceeds from  (payments of) notes payable to related parties                              |       | (105                           | )          | 17 |   |
| Payment of  capital leases                                                                 |       | (8                             | )          | (7 | ) |
| Net change in  line of credit                                                              |       | —                         |       | 4 |   |
|                                                                                       |       |                           |       |   |   |
| **Net  cash provided by financing activities**                                             | ** ** | **5,613**                      | ** ** | **614** | ** ** |
| ** **                                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Net  increase (decrease) in cash and cash equivalents**                                  | ** ** | **868**                        | ** ** | **(13** | **)** |
| ** **                                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Cash,  and cash equivalents, beginning of period**                                       | ** ** | **928**                        | ** ** | **15** | ** ** |
| ** **                                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Cash,  and cash equivalents, end of period**                                             | ** ** | **$**                          | **1,796**  | ** ** | **$** | **2** | ** ** |
|                                                                                       |       |                           |       |   |   |
| **Supplemental  disclosure of cash flow information:**                                     |       |                           |       |   |   |
| Cash paid for  interest                                                                    |       | $                              | 126        |   | $ | 33 |   |
|                                                                                       |       |                           |       |   |   |
| **Supplemental  disclosure of non-cash financing activities:**                             |       |                           |       |   |   |
| Record warrants  and embedded derivatives as liabilities                                   |       | $                              | 6,489      |   | $ | — |   |
| Issuance of  common stock for convertible debt                                             |       | $                              | 2,463      |   | $ | — |   |
| Issuance of  common stock for interest conversion                                          |       | $                              | 199        |   | $ | 200 |   |
| Issuance of  detachable warrants                                                           |       | $                              | 73         |   | $ | 42 |   |
| Discount on  convertible notes                                                             |       | $                              | 68         |   | $ | 42 |   |
| Issuance of  common stock for anti-dilution                                                |       | $                              | 55         |   | $ | — |   |
| Repurchase of  common stock                                                                |       | $                              | 36         |   | $ | — |   |
| Conversion of  preferred stock to common stock                                             |       | $                              | 15         |   | $ | — |   |

 

The accompanying notesare an integral part of these condensed interim financial statements

 

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**ETELOS,INC.**

 

**NOTESTO CONDENSED FINANCIAL STATEMENTS**

 

**(Unaudited)**

 

***1. Organization***

 

On February 8, 2007,Tripath Technology Inc., a Delaware corporation (“Tripath”) filed a voluntarypetition for relief under Chapter 11 of the Bankruptcy Code. On February 1,2008, the bankruptcy court issued an order confirming approval of the Plan ofReorganization, including the merger and the transfer of all of Tripath’sexisting assets into a separate bankruptcy estate and the discharge of all ofTripath’s liabilities.  The Plan ofReorganization also contemplated the merger of Etelos, Incorporated, aWashington corporation (“Etelos-WA”) with Tripath.  The overallimpact of the confirmed Plan of Reorganization was for Tripath to emerge fromthe bankruptcy proceeding with no assets and no liabilities as a shellcorporation and for all issued and outstanding securities of and interests inTripath, including debentures, stock options (including, but not limited to,all stock options granted to employees), warrants, and other shares of commonstock to be canceled and extinguished.

 

On April 23,2008, Tripath filed a Current Report on Form 8-K announcing, among otherthings, that Etelos-WA, merged with and into Tripath (the “Merger”), and thatthe surviving corporation changed its name to Etelos, Inc. and its fiscalyear end to December 31.  The effective date of the Merger was April 22,2008, and Etelos, Inc., as the surviving corporation, will conduct thebusiness and operations previously conducted by Etelos-WA.  In connectionwith the Merger, all outstanding shares of Etelos-WA common stock wereconverted into shares of Etelos, Inc. common stock on a three for oneratio: one share of Etelos Inc. common stock for every three shares of commonstock of Etelos-WA.  Also in connection with the Merger, (i) alloutstanding shares of preferred stock of Etelos-WA were converted in to sharesof common stock of Etelos, Inc., (ii) Etelos, Inc. issued anaggregate of 5,010,000 shares of its common stock to the secured and unsecuredcreditors of Tripath and (iii) all the shares of Tripath Technology werecancelled. Also on April 23, 2008, Etelos, Inc., formerly Tripath,amended its articles of incorporation with the state of Delaware to change itstotal authorized shares of stock to 300,000,000 shares, of which 250,000,000shares are designated “Common Stock” with a par value of $0.01 per share and50,000,000 shares are designated “Preferred Stock” with a par value of $0.01per share.  The Preferred Stock may beissued from time to time in one or more series, each of such series to consistof such number of shares and to have such terms, rights, powers and preferences,and the qualifications and limitations with respect thereto, as stated in theresolutions providing for the issue of such series adopted by the board ofdirectors.

 

Prior to the Merger,Tripath was a shell corporation and in accordance with the Plan ofReorganization had no assets or liabilities. While Tripath acquired all the outstanding preferred and common stock ofEtelos-WA, for accounting purposes, the acquisition has been treated as arecapitalization of Etelos-WA with Etelos-WA as the acquirer (a reverseacquisition).  The historical financialstatements prior to April 22, 2008, are those of Etelos-WA and reflect theoperations of Etelos-WA for the quarterly and six month period ended June 30,2008 and 2007.  Proforma financialinformation giving effect to the acquisition as if the acquisition took placeon January 1, 2007, have not been presented because Etelos-WA acquired notangible or intangible assets, liabilities or any of the business operations ofTripath prior to its emergence from bankruptcy and therefore, the historical operationsof Tripath are not an indicator of the future operations of Etelos, Inc.  The operations of Etelos, Inc. subsequent tothe Merger include only those of Etelos-WA.

 

The 5,010,000 shares ofEtelos, Inc. common stock were valued at $2.63 per share, the estimatedfair value of the common stock on the date of the Merger, which resulted in acharge to operations of $13.2 million included in the caption Merger RelatedCosts in the accompanying Statement of Operations.  Etelos, Inc. believes that these shares wereissued primarily for past services provided to Etelos-WA by the securedcreditors and the release of the secured and unsecured creditors claims againstTripath.

 

Informationconcerning number of shares outstanding for Etelos, Inc. including the conversionprices and number of shares issuable upon conversion of convertible securitiesand exercise prices of warrants and stock options and the number of sharesissuable upon exercise of the options and warrants, has been adjusted toreflect this stock split as if it had occurred at the beginning of thequarterly and six month periods and as of December 31, 2007.  Also, the Shareholders’ Deficit section ofthe accompanying Balance Sheet has been adjusted to reflect the legal capitalstructure of Tripath adjusted for the change in authorized shares of common andpreferred stock.

 

***2. The Company and Risks and Uncertainties ***

 

Etelos is a developerand distributor of software productivity solutions that assist business organizationsto effectively use Web Applications.  Etelos provides a revolutionarySoftware-as-a-Service (“SaaS”) ecosystem for building, distributing and usingWeb Applications, including the Etelos MarketplaceTM, which is a marketplace to deploy andsupport such Web Applications.  The purposeof the Etelos Markeyplace is to give businesses choices in applications andhosting and support services to cost effectively accomplish their goals.  Etelos offers subscriptions to its applicationsto end users including its Etelos Marketplace and provides software developedby Etelos to enable Marketplace partners to offer their products and services toend users as a service under a SaaS model. 

 

We beganoperations in 1999 but we did not adopt the SaaS on-demand Web Applicationsdelivery model until 2005. As such, we have a limited operating history in theSaaS industry, including licensing our software, from which to evaluate ourbusiness and prospects.  We incurred a net loss of $4.0 million for theyear ended December 31, 2007, and have an accumulated deficit of $10.4million at December 31, 2007.  During the six months ended June 30,2008, revenue has been limited and revenue derived from SaaS has beenminor.  In addition, we have notgenerated any significant revenue from through the Etelos Marketplace fromlicensing or sale of subscriptions to our products or services or third-partyproducts or services.  We cannot assureyou that our future planned operations will be implemented successfully or thatwe will ever have profits.  Furthermore, we are experiencing the initialcosts and uncertainties of a young operating company, including start-upexpenditures, unforeseen costs and difficulties, complications, and delays, allof which must be resolved and/or paid without the benefit of a predictable revenuestream.  We cannot be sure that we will be successful in meeting thesechallenges and addressing these risks and uncertainties.  If we are unableto do so, then our business will not be successful.

 

Wemaintain the majority of cash balances and all of our short-term investmentswith one financial institution.

 

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As used herein, unlessthe context requires otherwise, the terms the “Company,” “we,” “us,” “our” or “Etelos”refers to Etelos, Inc., the corporation that survived the Merger.

 

***3. Basis of Presentation***

 

The accompanying condensed consolidated financialstatements include our accounts as of June 30, 2008, and December 31,2007, and for the three and six months ended June 30, 2008 and 2007.  These condensed financial statements havebeen prepared by us, without audit, pursuant to the rules and regulationsof the Securities and Exchange Commission, or SEC. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations. The December 31, 2007, consolidated balance sheet was derivedfrom audited financial statements, but does not include all disclosuresrequired by accounting principles generally accepted in the United States ofAmerica. However, we believe that all disclosures are adequate to make theinformation presented not misleading. The accompanying unaudited condensedfinancial statements should be read in conjunction with the audited financialstatements and the notes thereto, included on Form 8-K filed April 23,2008, and Form 8-K/A filed April 25, 2008, by Tripath.

 

In the opinion of our management, all adjustments(which consist of normal recurring adjustments, except as disclosed herein)necessary to fairly present our financial position, results of operations andcash flows for the interim periods presented have been included. The results ofoperations for the three and six months ended June 30, 2008, are notnecessarily indicative of the results to be expected for the full year or forany future periods.

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and reported amounts of revenues and expenses during the reportingperiod. Actual results could differ from those estimates, and such differencescould affect the results of operations reported in future periods and suchdifferences could be material.

 

***4. Going Concern***

 

The financialstatements have been prepared by us with the assumption that we will continueas a going concern.  We have experienced net losses of $23.8 million and $4.0million for the six months ended June 30, 2008, and the year ended December 31,2007, respectively, and have a total stockholders’ deficit of $15.8 million, asof June 30, 2008, all of which raise substantial doubt about our ability tocontinue as a going concern. Our financial statements do not include anyadjustments relating to the recoverability and classification of asset carryingamounts or the amount and classification of liabilities that might arise shouldwe be unable to continue as a going concern.

 

Management has supportedcurrent operations by raising additional operating cash through the privatesale of convertible debentures and notes payable. This has provided us with thecash inflows to continue our business plan, but have not resulted insignificant improvement in our financial position or results of operations.Alternatives we are pursuing to improve our cash flow used in operationsinclude (1) raising additional working capital through additional sale ofpreferred stock, common stock and/or debt and (2) reducing cash operatingexpenses to levels that are in line with current revenues.  Thefirst alternative could result in substantial dilution to existingshareholders. There can be no assurance that our current financial position canbe improved, that we can raise additional working capital, or that we canachieve positive cash flows from operations. Our long-term viability as a goingconcern is dependent upon our ability to (1) locate sources of debt orequity funding to meet current commitments and near-term future working capitalrequirements and (2) achieve profitability and ultimately generatesufficient cash flow from operations to sustain our continuing operations.

 

Ourcash balance including proceeds from our recent debt financings may not besufficient to fund our operations through September 2008.  If cashreserves and our credit facility are not sufficient to sustain operations, thenwe plan to raise additional capital by selling shares of our capital stock orother securities.  However, there are no commitments or arrangements forfuture financings in place at this time and we can give no assurance that suchcapital will be available on favorable terms, or at all.  We may needadditional financing thereafter until we can achieve profitability.  If wecannot, then we will be forced to curtail our operations or possibly be forcedto evaluate a sale or liquidation of our assets.  Even if we aresuccessful in raising additional funds, there is no assurance regarding theterms of any additional investment.  Any future financing may involvesubstantial dilution to existing investors.

 

***5.  Research andDevelopment and Software* *Development Costs***

 

Research and developmentexpenses consist primarily of salaries, payroll taxes, benefits, and relatedexpenditures for technology, software development, project management, andsupport personnel. Costs related to the research and development of newproducts, services and enhancements to existing products are expensed asprovided for by SFAS NO. 86, “*Accounting forCosts of Computer Software to be Sold, Leased or Otherwise Marketed”*(SFAS 86).  Under SFAS 86, costs incurredin the research and development of new software products are expensed asincurred until technological feasibility is established. Research and developmentcosts are capitalized beginning when a product’s technological feasibility hasbeen established and ending when the product is available for general releaseto customers. Technological feasibility is reached when the product reaches theworking model stage. To date, products and enhancements have generally reachedtechnological feasibility and have been released for sale at substantially thesame time and all research and development costs have been expensed.

 

Statement of Position 98-1, “*Accountingfor Costs of Computer Software Developed or Obtained for Internal Use”*(SOP 98-1), which applies to Software as a Service (SaaS) business model, aremet for the capitalization of software development cost.  Under SOP 98-1, software development costs,including costs incurred to purchase third party software, are capitalizedbeginning when the Company has determined certain factors are present,including, among others, that technology exists to achieve the performancerequirements, buy versus internal development decisions have been made, and theCompany’s management has authorized the funding for the project. Capitalizationof software development costs ceases when the software is substantiallycomplete and is ready for its intended use. To date, no software development costs incurred have met the criteriaset forth in SOP 98-1 for capitalization.

 

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***6.  RevenueRecognition***

 

We distributeWeb Applications as a subscription service using the Software-as-a-Service(SaaS) or software-on-demand business model and allow third parties to offertheir products or services through storefronts in the Etelos Marketplace, and to advertise on ourweb site or in our annual magazine for a fee. We also license certain of our software products under perpetual andterms licenses.  Revenues are recognizedon these service and licensing transactions using the criteria in Securitiesand Exchange Commission Staff Accounting Bulletin 104, “*Revenue Recognition in Financial Statements”*and SOP 97-2, “*Software Revenue Recognition*”,respectively, which both provide that revenue may be recognized when all of thefollowing are met:

 
| · |   | persuasive  evidence of an arrangement exists,                             |
|--------|--------|----------------------------------------------------------------------------|
|   |   |                                                                       |
| · |   | the product or  service has been delivered,                                |
|   |   |                                                                       |
| · |   | the fee is fixed  or determinable, and                                |
|   |   |                                                                       |
| · |   | collection of  the resulting receivable is reasonably assured or probable. |

 

For the Software-as-a-Service (SaaS) business model,persuasive evidence is generally an acceptance by the customer of a bindingagreement and authorization by the customer to charge a credit card; deliverygenerally occurs over the term of the subscription agreement related to theSaaS; and the fee is fixed and collection reasonably assured when the customer’scredit card is charged.  Accordingly,revenue is recognized over the period the SaaS is provided.

 

For software licensed under term or perpetualagreements, persuasive evidence of an arrangement is evidenced by a bindingagreement signed by the customer and delivery generally occurs upon delivery ofthe software to a common carrier. If a significant portion of a fee is dueafter our normal payment terms of typically 30 days, then we recognize revenueas the fees become due. If we determine that collection of a fee is notreasonably assured, then we defer the fees and recognize revenue upon cashreceipt, provided that all other revenue recognition criteria are met.

 

Advertising on our web site is recognized as revenueover the period the add appears on our web site and advertising presented inour annual magazine is recognized upon publication of the magazine provided theother criteria for revenue recognition set forth above have been met.

 

Arrangements for whichthe fees are not deemed reasonably assured for collection are recognized uponcash collection.

 

***7.  StockBased Compensation***

 

The Company, under SFASNo. 123 (revised 2004), “*Share-Based Payment*”**(FAS 123R), is applying the “modified prospective method”and used the Black-Scholes Merton model to value all new stock basedcompensation awards granted starting January 1, 2006, and for anymodification, cancellation, or repurchase of awards granted prior to January 1,2006.  As a result, we have recordedcompensation cost in the statement of operations based on the fair value of theaward for the requisite service period. FAS 123(R) also requires us toestimate forfeitures in calculating the expense relating to share-basedcompensation as opposed to only recognizing these forfeitures and thecorresponding reduction in expense as they occur. This resulted in $68.7thousand and $0.0 of expense for the quarters ending June 30, 2008 and 2007respectively and $68.8 and $0.0 of expense for the six months ending June 30,2008 and 2007, respectively.

 

FAS 123(R) requiresthe cash flows resulting from the tax benefits resulting from tax deductions inexcess of the compensation cost recognized for those options to be classified asfinancing cash flows. Due to our loss position, there were no such tax benefitsduring the quarters and six month periods ended June 30, 2008 and 2007.Prior to the adoption of FAS 123(R), those benefits would have been reported asoperating cash flows had we received any tax benefits related to stock optionexercises.

 

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The weighted-average fairvalue of stock-based compensation is based on the single option valuationapproach and is estimated on the date of grant using a Black-Scholes Mertonbased option valuation model. The fair value of forfeitures is an estimate andno dividends have been declared. The fair value of options granted during thethree and six months ended June 30, 2008 and 2007, were calculated basedon the following average assumptions:

 
| ** **               | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **Ended June 30**             | ** ** | **Ended June 30**           | ** ** |
| ** **               | ** ** | **2008**                                | ** ** | **2007**                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Estimate fair  value     |       | $                                       | 1.44       |                                  | $          | — |   | $ | 0.75 |   | $ | — |   |
| Expected lives  in years |       | 7                                       |       | —                                |       | 7 |   | — |   |
| Volatlity                |       | 68.50                                   | %          | 0.00                                  | %          | 56.00 | % | 0.00 | % |
| Risk free  interst rate  |       | 3.46                                    | %          | 0.00                                  | %          | 3.13 | % | 0.00 | % |
| Dividend yield           |       | $                                       | —     |                                  | $          | — |   | $ | — |   | $ | — |   |

 

We used estimatedvolatility of comparable public companies to estimate the expected volatilityused for the Black-Scholes Merton model. The risk-free interest rate assumptionis based upon the US Treasury yield. We historically have not declareddividends and therefore the dividend yield was assumed to be zero in the model.

 

The following tablesummarizes stock option activity under the Company’s stock option plans:

 
| Outstanding at  December 31, 2007 |   | 4,097,083 |   |
|-----------------------------------|--------|-----------|--------|
| Granted                           |   | 693,167   |   |
| Exercised                         |   | (3,750    | )      |
| Cancelled                         |   | (206,007  | )      |
| Outstanding at  June 30, 2008     |   | 4,580,493 |   |

 

There was no cashreceived as a result of options exercised during the quarter ended June 30,2008. There were no equity instruments granted under share-based paymentarrangements and therefore there was no cash used to settle any equityinstrument. We do not plan to repurchase any shares during the remainder of2008.

 

***8.  Net Loss per Share***

 

Basic net loss per shareis computed by dividing the net loss available to common stockholders for theperiod by the weighted average number of shares of common stock outstandingduring the period, excluding any unvested restricted stock that is subject torepurchase. Diluted net income per share is computed using the weighted averagenumber of common shares and, if dilutive, potential common shares outstandingduring the period. Potential common shares consist of unvested restricted stock(using the treasury stock method), the incremental common shares issuable uponthe exercise of stock options and warrants (using the treasury stock method)and the conversion of the Company’s convertible notes and debentures (using theif-converted method).  As their effect isantidilutive, 4,580,493 of common shares exercisable under outstanding employeestock options, 611,111 of common shares exercisable under outstanding warrantsand 6,426,074 shares of common issuable upon conversion of the outstandingconvertible notes payable and debentures have been excluded from thiscalculation.  The average exercise priceof outstanding employee stock options and warrants to purchase the Company’scommon stock is $0.23 and $1.80, respectively, at June 30, 2008.

 

The following table setsforth the computation of basic and diluted net loss per share for the periodspresented (in thousands, except per share amounts):

 
| ** **                     | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|--------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                     | ** ** | **Ended June 30**             | ** ** | **Ended June 30**           | ** ** |
| ** **                     | ** ** | **2008**                                | ** ** | **2007**                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                     | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Numerator:                     |       |                                    |       |                                  |       |   |   |   |   |
| Net loss                       |       | $                                       | (21,573    | )                                     | $          | (572 | ) | $ | (23,805 | ) | $ | (941 | ) |
|                           |       |                                    |       |                                  |       |   |   |   |   |
| Denominator:                   |       |                                    |       |                                  |       |   |   |   |   |
| Weighted average  common stock |       | 19,046                                  |       | 3,507                                 |       | 13,198 |   | 3,504 |   |
|                           |       |                                    |       |                                  |       |   |   |   |   |
| Net loss per  share:           |       |                                    |       |                                  |       |   |   |   |   |
| Basic and  diluted             |       | $                                       | (1.13      | )                                     | $          | (0.16 | ) | $ | (1.80 | ) | $ | (0.27 | ) |

 

***9. Recently Issued Accounting Standards***

 

In February 2008, the Financial AccountingStandards Board (FASB) issued FASB Staff Position (FSP) No. FAS 157-2,“*Effective Date of FASB Statement No. 157*”(FSP FAS 157-2), which delays the effective date of Statement of FinancialAccounting Standards (SFAS) No. 157, *“Fair Value Measurements”*(SFAS 157) for all non-financial assets and non-financial liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually) for fiscal years beginningafter November 15, 2008, and interim periods within those fiscal years foritems within the scope of this FSP. We are currently evaluating the impact ofadopting FSP FAS 157-2 for non-financial assets and non-financialliabilities on our consolidated financial position, cash flows, and results ofoperations.

 

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In December 2007, the FASB issued SFAS No. 141(R),“*Business Combinations”* (FAS141R), which requires an acquirer to measure the identifiable assets acquired,the liabilities assumed, and any noncontrolling interest in the acquiree attheir fair values on the acquisition date, with goodwill being the excess valueover the net identifiable assets acquired. FAS 141R is effective for financialstatements issued for fiscal years beginning after December 15, 2008.Also, in December 2007, the FASB issued SFAS No. 160, “*Noncontrolling Interests in Consolidated FinancialStatements,**an**amendment**of ARB No. 51”*  (FAS 160), which clarifies that anoncontrolling interest in a subsidiary should be reported as equity in theconsolidated financial statements. The calculation of earnings per share willcontinue to be based on income amounts attributable to the parent. FAS 160 iseffective for financial statements issued for fiscal years beginning after December 15,2008. We are currently evaluating the impact of adopting SFAS 141R andSFAS 160 on our consolidated financial position, cash flows, and resultsof operations.

 

In June 2008,the FASB issued FSP No. EITF 03-6-1, “*DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities*” (FSP EITF 03-6-1), which requiresentities to apply the two-class method of computing basic and diluted earningsper share for participating securities that include awards that accrue cashdividends (whether paid or unpaid) any time common shareholders receivedividends and those dividends do not need to be returned to the entity if theemployee forfeits the award. FSP EITF 03-6-1 will be effective for theCompany on January 1, 2009, and will require retroactive disclosure. TheCompany is currently evaluating the impact of adopting FSP EITF 03-6-1 onits consolidated financial position, cash flows, and results of operations.

 

***10. Convertible Notes and Debentures and Embedded Derivativeand Warrant Liability***

 

Convertible notesand debentures comprise (in thousands):

 
| ** **                                | ** ** | **June 30,  2008** | ** ** | **December  31, 2007** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| 20% convertible  notes                    |       | $                       | —     |                        | $          | 850 |   |
| 6% convertible  notes                     |       | 1,764                   |       | 3,326                       |       |
| January 2008  Debentures                  |       | 2,000                   |       | —                      |       |
| April 2008  Debentures                    |       | 3,500                   |       | —                      |       |
|                                      |       | 7,264                   |       | 4,176                       |       |
| Less discount on  long term notes payable |       | (21                     | )          | (16                         | )          |
| Less amount  classified as current        |       | (4,431                  | )          | (3,344                      | )          |
| Long term                                 | ** ** | **$**                   | **2,812**  | ** **                  | **$**      | **816** | ** ** |

 

*20%Convertible Notes*

 

During the period October 2006to June 2007, we issued 20 percent convertible notes with a face value of $850thousand and detachable warrants to purchase shares of our common stock inexchange for $850 thousand. The notes mature on June 1, 2008, withinterest due and payable on October 1, 2007, and the last day of eachcalendar quarter thereafter, through the maturity date. At our option, upon theclosing of a Series D preferred stock offering having aggregate grossproceeds not less than $7.0 million, excluding the proceeds collected inconnection with this financing, note holders may elect to convert theoutstanding principal and the accrued and unpaid interest into Series Dpreferred stock at the purchase price per share of Series D preferredstock. In addition, a mandatory conversion provision would be triggered by theclosing of a public offering at a conversion price equal to or greater than thenote conversion price. There is a provision for a conversion price adjustmentwhich would be triggered upon a stock split, reverse stock split, or issuanceof stock dividends, whereby the conversion price would be adjusted to ensurethat the holder would be receiving the same number of shares, as though theconversion right had been exercised prior to the triggering event. We arerequired to reserve, at all the times, the number of authorized unissued sharessuch that we have enough shares to issue in the event that the conversion rightis exercised.  As of June 30, 2008, $750thousand of the 20% convertible notes have been converted into 1,000,000 sharesof the Company’s common stock and the balance of $100 thousand have been paidin cash.

 

The detachable warrantsallow the holders to purchase up to 283,333 shares of our common stock at anexercise price of $0.09 per share. As of June 30, 2008, all of thewarrants had been exercised. The warrants were determined to have*de minimus* value at the issuance date.

 

*6%Convertible Notes*

 

During the period August 2007to October 2007, we issued 6 percent convertible notes with a face valueof $3,326.4 thousand at an original issue discount of 10 percent withdetachable warrants to purchase shares of our common stock in exchange for $3,024thousand.  These notes mature on March 31,2009, with interest due and payable on February 1, 2008, and on the lastday of each calendar quarter thereafter. We are required to make payments onthe outstanding principal balance beginning September 1, 2008,and on the 1stday of each calendar quarter thereafter. The default interest rate is 8percent. The notes and unpaid interest are convertible into shares of ourcommon stock: (i) at our option upon the closing of a Preferred Series Dround at $0.75 per share, and (ii) mandatorily upon; (a) closing of Series EPreferred Stock offering, no later than January 31, 2008, having aggregategross proceeds to the Company of not less than $5.0 million at the price pershare of the Series E preferred stock less a 10% discount, (b) closingof public offering at a conversion rate of $0.75 per preferred share, or (c) achange of 40 percent of the control, at a conversion rate of $0.75 perpreferred share. As of June 30, 2008, $1,712 thousand of the face value ofthe 6% convertible notes have been converted to 2,283 thousand shares of theCompany’s common stock and $1,764 thousand remain outstanding.

 

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In addition, the purchasersof the 6% Convertible Notes received warrants, which are fully exercisable, topurchase 1,080,000 shares of the Company’s common stock at an exercise price of$0.12.  The warrants expire the earlierof August through October 2013 or are automatically terminated upon theCompany’s, (i) public offering, (ii) sale of the Company, or (iii) changein control.  At June 30, 2008, allof these warrants have been exercised or expired and none are outstanding.

 

*January 2008Debentures*

 

On January 31,2008, we issued convertible debentures (“the January 2008 Debentures”)with a principal amount of $2 million and detachable warrants to purchase 222,222shares of our common stock in exchange for $1.9 million.  The January 2008 Debentures are due on January 31,2010, and bear interest at 6 percent per annum, which is payable semiannuallyon January 1 and July 1, commencing on July 1, 2008.  Monthly principal payments equal to 1/18th ofthe principal amount begin on September 1, 2008.  We have the right to pay interest and monthlyprincipal payments in cash, or upon notice to the holders and compliance withcertain equity conditions. We can pay all or a portion of any such payment incommon stock valued at a price equal to the lesser of the then effectiveconversion price (currently $1.35) or 85 percent of the average of the volumeweighted average price per share for our common stock for the 10 consecutivetrading days immediately prior to the applicable payment date.  The equity conditions that we must meetinclude having a currently effective registration statement covering the sharesof common stock issuable upon conversion of the debenture, and having the dailydollar trading volume for our common stock exceed $250,000 for each of the 20consecutive trading days before the date in question.  The January 2008 Debentures and any accruedinterest are convertible at anytime at the discretion of the holder at aconversion price per share of $1.35, subject to a cap on the beneficialownership of our shares of common stock by the holder and its affiliatesfollowing such conversion. The conversion price is adjusted upon a stock split,reverse stock split, or upon issuance of stock dividends, whereby theconversion price would be adjusted to ensure that the holder would be receivingthe same number of shares, as though the conversion right had been exercisedprior to the triggering event.  Further,the conversion price is adjusted if common stock or equivalents aresubsequently sold or re-priced at a price below the conversion price or rights,options or warrants are issued to holders of the Company’s common stockentitling them to purchase common stock at prices lower than the volumeweighted average price on the date issued.

 

We have the option toredeem the January 2008 Debentures before their maturity by payment in cash ofan amount equal to 120 percent of the then-outstanding principal amount, plusaccrued interest and other charges, and the right to force conversion of thedebentures if the average of the volume weighted average price of our commonstock exceeds $3.39 for 20 trading days out of a consecutive 30 trading dayperiod.  This redemption option andforced conversion right are subject to the Company meeting certain equityconditions, including having the daily dollar trading volume for our commonstock exceed $250 thousand for each of the 20 consecutive trading days beforethe date in question and having a currently effective registration statementcovering the shares of common stock issuable upon conversion of the debenturesand the forced conversion option, subject to the applicable cap on thebeneficial ownership of our shares of common stock by the holder and itsaffiliates following such conversion. The January 2008 Debentures are collateralized by substantially all theassets of the Company.

 

The January 2008 Debenturesimpose certain covenants on us, including restrictions against incurringadditional indebtedness, creating any liens on our property, amending ourcertificate of incorporation or bylaws, redeeming or paying dividends on sharesof our outstanding common stock, and entering into certain related partytransactions.  The January 2008 Debentures also define certain events ofdefault, including, without limitation, failure to make a payment obligation,failure to observe other covenants of the debenture or related agreements(subject to applicable cure periods), breach of representation or warranty,bankruptcy, default under another significant contract or credit obligation,delisting of our common stock, a change in control, failure to secure andmaintain an effective registration statement covering the resale of the commonstock underlying the debentures and the warrants, or failure to deliver sharecertificates in a timely manner.  In the event of default, the holders ofthe January 2008 Debentures have the right to accelerate all amountsoutstanding under the debentures and demand payment of a mandatory defaultamount equal to 130 percent of the amount outstanding plus accrued interest andexpenses.

 

Debt issuance costs of$85.2 thousand were incurred in conjunction with the issuance of the January2008 Debentures, which have been capitalized as Other assets and are amortizedusing the effective interest method.

 

The detachable warrants,which are fully exercisable, to purchase 222,222 shares of our common stock,expire in January 2011 and are exercisable at a price of $1.80 per share,subject to adjustment, for the events described above, which adjust theconversion price of the January 2008 Debentures.  As of June 30,2008, none of these warrants had been exercised.

 

*April 2008Debentures*

 

On April 22, 2008, weissued convertible debentures (“the April 2008 Debentures”) with aprincipal amount of $3,500.0 thousand and detachable warrants to purchase 388,889shares of our common stock in exchange for $ 3,400.0 thousand.  The April 2008 Debentures are due on April 30,2010, and have the identical terms and conditions to the January 2008 Debenturesdescribed above.

 

Debt issuance costs of $149thousand were incurred in conjunction with the issuance of the April 2008 Debentures,which have been capitalized as Other assets and are amortized using theeffective interest method.

 

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The detachable warrants,which are fully exercisable, to purchase 388,889 shares of our common stock,expire in April 2011 and are exercisable at a price of $1.80 per share,subject to adjustment, for the events described above, which adjust theconversion price of the January 2008 Debentures.  As of June 30,2008, none of these warrants had been exercised.

 

In connection with theJanuary 2008 Debentures and the April 2008 Debentures, we also entered into aregistration rights agreement with the investors, pursuant to which we agreedto file a registration statement covering the resale of the shares of commonstock that may be issued to such investors upon the conversion of thedebentures, payment in kind, and the exercise of the related warrants.  Weagreed to maintain the effectiveness of the registration statement (subject tocertain limitations) for a period of time until the holders can sell theunderlying common stock without volume restrictions under Rule 144 of theSecurities Act of 1933, or the Securities Act. If the registration statement isnot declared effective by an agreed to date, or if we fail to maintain theeffectiveness of the registration statement, then we are required to pay toeach investor, as partial liquidated damages, cash equal to 1.0 percent of theaggregate purchase price paid by such investor for the securities purchased inthe financing and then held by such investor, and must pay to such investor 1.0percent for each subsequent 30-day period that the default remains uncured, upto a maximum aggregate liquidated damages amount of 10 percent of the aggregatepurchase price paid by the holders of the debentures.  We have determinedthat it is not probable that there will be any material damages and accordinglyhave not estimated any provision for default.

 

Our registration statement was effective July 31,2008, which was 8 days after the deadline in the registration rights agreements.Accordingly, we may be liable for penalties in the amount of $14.7 thousand,which we have accrued in our liabilities.

 

*Accountingfor Convertible Notes and Debentures, Embedded Derivatives and Warrants*

* *

The Company has evaluatedthe embedded derivatives included in the 20% and 6% Convertible Notes (theConvertible Notes) and the January 2008 and April 2008 Debentures,which are not clearly and closely related to the Convertible Notes and January 2008and April 2008 Debentures, consisting of the conversion features andcertain put and call features described above, under the guidance in Statementof Financial Accounting Standard No. 133 “A**ccountingfor Derivative Instruments and Hedging Activities****” and its relatedguidance and interpretations (SFAS 133) on the issuance date of the ConvertibleNotes and January 2008 and April 2008 Debentures and on each subsequentreporting date.  The purpose of theevaluation is to determine whether the embedded derivatives need to be**bifurcatedfrom the debt host and accounted for as a derivative at their estimated fairvalue as a liability**at thedate of issuance and thereafter, adjusted to market with a charge or credit tothe Company’s statement of operations. SFAS 133 generally indicates that if the conversion features are (i) indexedto the Company’s capital stock and (ii) would be classified as equity if afreestanding derivative under the guidance in EITF 00-19,”***Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock*” (EITF 00-19), theembedded derivatives need not be bifurcated from the debt host.  EITF 00-19 generally requires, among otherfactors, that (i) the Company can settle the derivative in cash or its ownstock, at its option, (ii) settlement can be made in unregistered shares,and (iii) the Company has sufficient authorized shares to issue shares ofits common stock for all equity instruments convertible to or which can beexercised for its capital stock.  SFAS133 also provides guidance on when put and call features included in a debthost agreement are not clearly and closely related to the debt host must bebifurcated and recorded as ability.  Onlythe January 2008 and April 2008 Debentures include put and callfeatures.

 

The Company concludedthat the conversion features embedded in the 6% Convertible Notes met thecriteria in SFAS 133 at issuance and through April 21, 2008, the day priorto the merger with Tripath, because the conversion to the Company’s commonstock could only be settled in its capital stock, the capital stock could beunregistered and the sufficiency of the authorized shares was under the Company’scontrol as it could control the outcome of a shareholder vote to increase theauthorized shares.  However, on the dateof the merger with Tripath, April 22, 2008, the Company concluded it nolonger had control to ensure the sufficiency of its authorized shares of commonstock and recorded the embedded conversion feature in the 6% Convertible Noteswith an estimated fair value of $3,674 thousand and recorded the amount in theline entitled “Warrant and derivative liability” in the accompanying balancesheet.  The fair value of the conversionfeature was subsequently revalued to $7,554 thousand at June 30, 2008,with the related charge of $3,880 thousand included in the Company’s condensedstatement of operations in interest expense for the quarter and six monthsended June 30, 2008.  The Companydetermined the estimated fair value of the conversion feature on April 22and June 30, 2008, by using the Black-Scholes Merton valuation model andthe following assumptions: fair value of the Company’s common stock of $2.91and $4.00, respectively, per share; terms of .95 years and .75 years,respectively; risk free interest rates of 1.82% and 2.27%, respectively; andvolatility of 47.16% and 56.13%, respectively. Probabilities were then appliedto the outputs using the Matlab Monte Carlo Simulation of the Company’s stockprices to arrive at a value for the conversion options.  Accretion charged to interest expense for the6% Convertible Notes in the six months ended June 30, 2008, was $147thousand. Also during the quarter and six months ended June 30, 2008, the Companyrecorded a beneficial conversion features related to accrued interest on the 6%Convertible notes, which were or could have been converted to the Company’scommon stock, through the date the conversion features was recorded, as aliability of $58 thousand.

 

The Company concludedthat the conversion features embedded in the January 2008 Debentures metthe criteria in SFAS 133 at issuance and through March 31, 2008, andtherefore, were not bifurcated from the debt host because the conversion to theCompany’s common stock could only be settled in its common stock, the commonstock could be unregistered and the sufficiency of the authorized shares was underthe Company’s control as it could control the outcome of a shareholder vote toincrease the authorized shares.  While weconcluded that the put and call embedded in the January 2008 Debentureswas not clearly and closely related to the debt host, the estimated fair valueof the put and call was determined to be de minimus and therefore was not bifurcatedfrom the debt host.  However, on the dateof the merger with Tripath, April 22, 2008, the Company concluded it nolonger had control to ensure the 

 

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sufficiency of itsauthorized shares of common stock nor could it settle the conversion feature inunregistered shares and therefore, recorded the embedded conversion feature andput and call in the January 2008 Debentures with an estimated value fairvalue of $896 thousand and recorded the amount in the line entitled “Warrantand derivative liability” in the accompanying balance sheet.  The fair value of the conversion feature wassubsequently revalued to $578 thousand at June 30, 2008, with the related creditof $318 thousand included in the Company’s consolidated statement of operationsfor the quarter and six months ended June 30, 2008.  The Company determined the estimated fairvalue of the conversion options on April 22 and June 30, 2008, using theBlack-Scholes Merton valuation model and the following assumptions: fair valueof the Company’s common stock of 2.91 and $4.00, respectively, per share; termsof 1 year and 1.75 years and 1.2 years and 1.5 years, respectively; risk freeinterest rates of 1.84% and 2.14% and 2.41% and 2.50%, respectively; andvolatility of 47.16% and 48.48% and 49.08% and 49.97%, respectively.  Probabilities were than applied to theoutputs using the Matlab Monte Carlo Simulation of the Company’s stock pricesto arrive at a value for the conversion options.  Accretion charged to interest expense for the January2008 Debentures in the six months ended June 30, 2008, was $20 thousand.

 

The Company concludedthat the embedded conversion features in the April 2008 Debentures shouldbe bifurcated from the debt host and recorded as liabilities because theconversion features must be settled in registered shares and that due to the Mergerwith Tripath, we no longer had control over a shareholder vote to ensure thesufficiency of our authorized shares of common stock. We also concluded thatthe put and call in the April 2008 Debentures were embedded derivatives andwere not clearly and closely related to the debt host and therefore should bebifurcated from the debt host along with the conversion features and recordedas a liability at their estimated fair value at issuance and June 30,2008.  The estimated fair value of theembedded conversion features and put and call was $1,057 thousand $950 thousandat April 23, 2008, and June 30, 2008, respectively, and recorded inthe line entitled “Warrant and derivative liability” in the accompanyingBalance Sheet. The adjustments to revalue the estimated fair value of theconversion features and put and calls at June 30, 2008, of $557 thousandwas credited to in the Company’s consolidated statement of operations for thequarter and six months ended June 30, 2008.  The resulting discount on the April 2008Debentures of $2,097 thousand, which included the estimated fair values of therelated detachable warrants described below, is accreted from April 2008,the date of issuance, to April 30, 2010, the maturity date of the April 2008Debentures, using the interest method with the relating charge to interestexpense in the Company’s statement of operations.  Accretion charged to interest expense for theApril 2008 Debentures in the quarter and six months ended June 30,2008, was $345 thousand.  The Companydetermined the estimated fair value of the conversion options on April 22 andJune 30, 2008, using the Black-Scholes Merton valuation model and the followingassumptions: fair value of the Company’s common stock of 2.91 and $4.00,respectively, per share; terms of 1 year and 2 years and 1.4 years and 1.8years, respectively; risk free interest rates of 1.87% and 2.24% and 2.47% and2.58%, respectively; and volatility of 45.76% and 49.00% and 50.29% and 49.64%,respectively.  Probabilities were thenapplied to the outputs using the Matlab Monte Carlo Simulation of the Company’sstock prices to arrive at a value for the conversion options.

 

The Company evaluated theterms and conditions of the detachable warrants issued with the January 2008and April 2008 Debentures under the guidance in EITF 00-19 to determinewhether the detachable warrants should be accounted for as equity or aliability and thereafter adjusted to their respective estimated fair value ateach reporting date.

 

The Company concludedthat the detachable warrants issued with the January 2008 Debentures metthe criteria in SFAS 133 at issuance and through March 31, 2008, andtherefore, were accounted for as equity because the warrants could only besettled by issuance of the Company’s common stock, the common stock could beunregistered, and the sufficiency of the authorized shares was under theCompany’s control as it could control the outcome of a shareholder vote toincrease the authorized shares.  However,on the date of the merger with Tripath, April 22, 2008, the Companyconcluded it no longer had control to ensure the sufficiency of its authorizedshares of common stock nor could it settle the warrants in unregistered sharesand therefore, recorded the estimated value fair value of the warrants of $320thousand in the line entitled “Warrant and embedded derivative liability” inthe accompanying Balance Sheet.  The fairvalue of the warrants was revalued to $544 thousand at June 30, 2008, withthe related charge of $244 thousand included in the Company’s consolidatedstatement of operations for the quarter and six months ended June 30,2008. The Company determined the estimated fair value of the warrants on April 22and June 30, 2008, by using the Black Scholes Merton valuation model andthe following assumptions: fair value of the Company’s common stock of $2.91and $4.00, respectively, per share; terms of 2.5 years and 2.5 years,respectively; risk free interest rates of 2.54% and 2.77%, respectively; and volatilityof 47.81% and 49.53%, respectively.

 

The Company concludedthat the detachable warrants issued with the April Debentures did not meetthe criteria in SFAS 133 at issuance because it no longer had control to ensurethe sufficiency of its authorized shares of common stock nor could it settlethe warrants in unregistered shares and therefore, recorded the estimated valuefair value of the warrants of $590 thousand in the line entitled “Warrant andembedded derivative liability” in the accompanying Balance Sheet.  The fair value of the warrants was revaluedto $980 thousand at June 30, 2008, with the related charge included in theCompany’s consolidated statement of operations for the quarter and six monthsended June 30, 2008. The Company determined the estimated fair value ofthe warrants on April 22 and June 30, 2008, by using the BlackScholes Merton valuation model and the following assumptions: fair value of theCompany’s common stock of $2.91 and $4.00, respectively, per share; terms of 3years and 3 years, respectively; risk free intererst rates of 2.43% and 2.91%,respectively; and volatility of 49.17% and 49.80%, respectively.

 

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***11. Notes Payable to Related Parties***

 

We previously enteredinto a series of unsecured loan transactions with relatives of our executivechairman and chief technology officer.  On December 30, 2007, inconnection with settlement of the loans, we entered into three unsecuredpromissory notes with an aggregate original principal amount of $815,827, eachof which will become collateralized by certain presently unidentified assets ofthe Company if and when Daniel J.A. Kolke is no longer an employee nor a memberof our board of directors.  Such security interest, if granted, would besubordinated to any and all bank debt or convertible corporate debt. These three notes are outstanding in an aggregate balance of $711 thousand asof June 30, 2008.  Future payments ofprincipal and interest under the terms of the notes are the following for thetwelve months ending June 30:

 
| **2009**                                   |       | $       | 199        |       |
|--------------------------------------------|------------|---------|------------|------------|
| **2010**                                   |       | 78      |       |
| **2011**                                   |       | 78      |       |
| **2012**                                   |       | 78      |       |
| **2013**                                   |       | 78      |       |
| **2014 and later**                         |       | 482     |       |
| Total minimum  loan payments               | ** ** | **993** | ** ** |
| Less: amount  representing interest        |       | (282    | )          |
| Present value of  minimum loan payments    |       | 711     |       |
| Less: current  portion of loan obligations |       | (150    | )          |
| Long-term loan  obligations                | ** ** | **$**   | **561**    | ** ** |

 

***12. Credit Facility***

 

In October 2007, weentered into a one year credit facility with Bridge Bank which provides forborrowing of up to $250 thousand at an annual interest rate equal to the bank’sprime rate plus 2.5 percent. The credit facility is collateralized bysubstantially all of our assets and expires in October 2008.  Thecredit facility contains financial and reporting covenants that require us tomaintain certain financial ratios only when we have an outstanding balance. Thefacility has monthly repayment terms of both interest and principal amortizedover an imputed twelve month period.  We issued warrants to Bridge Bank topurchase up to 10,417 shares of our common stock at an exercise price of $1.20per share in connection with this facility. The Bank elected not toexercise its warrants as of the Reverse Merger Date and the warrants are nolonger outstanding and exercisable. There was no borrowing under this facility during the six months ending June 30,2008.

 

***13. Contingency***

 

During June 2008, theCompany paid federal and state payroll withholding taxes, including its portionof such payroll taxes and interest and penalty totaling $572 thousand, relatingto 2007.  These amounts were accrued asof December 31, 2006 and 2007 and at March 31, 2008.  In June 2008, calendar and fiscal year the Companyalso became aware that it had not made certain payroll tax filings and had notfiled its federal and state income tax returns for calendar and fiscal years 2004,2005 and 2006.  During June 2008, the Companymade these filings. However, the Internal Revenue Services has notified theCompany that certain payroll tax and income tax filings other than these also havenot been filled in prior years.  TheCompany is in the process of determining whether these payroll and income taxreturns were filed and if not will either refile the returns or prepare suchreturns and make appropriate filings with the Internal Revenue Service.  The Company believes it owes no more state orfederal payroll taxes applicable to prior years and that it owes no federal orstate income taxes because it had annual losses in each year of operationssince its inception in 1999.  However,because of the uncertainties related to both the amount and range of loss ofthis matter, management is unable to make a reasonable estimate of theliability that could result from an unfavorable outcome. As additionalinformation becomes available, the Company will assess its potential liabilityand revise its estimates.  

 

***14. Subsequent Events***

 

In July 2008, KaufmanBros. L.P. filed suit against us in the United States District Court for theSouthern District of New York (Case No. 80 CV 5716).  The complaint arises our of an advisoryservices agreement, pursuant to which Kaufman Bros. was to provide us withadvisory services in connection with financings and strategic transactions. Wenotified Kaufman Bros. that we believed it had failed to provide the requiredservices under the agreement, and that we were therefore entitled to terminatethe agreement for cause. In the suit, Kaufman Bros. was seeking (i) monetary damagesof $400,000 for anticipatory breach of the agreement; (ii) $73,800 in feesallegedly owed in connection with a previously closed financing transaction;(iii) and injunction prohibiting us from cancelling any shares issued toKaufman Bros. as compensation, (iv) a declaration from the court that we arenot entitled to a refund of any fees previously paid to Kaufman Bros., and (v)a declaration that we are obligated to pay Kaufman Bros. a commission on anyfinancing or transaction that we enter into within 18 months following the terminationof the agreement.  On July 15, 2008,Kaufman Bros. voluntarily filed a notice of dismissal without prejudice.  Settlement discussions were unsuccessful andKaufman Bros. has re-filed substantially the same claims in the Supreme Courtof New York - County of New York (Index No. 08-602239). The Company has beenserved and is developing its defense plan. However, because of theuncertainties related to both the amount and range of loss of this matter,management is unable to make a reasonable estimate of the liability that couldresult from an unfavorable outcome. As additional information becomesavailable, the Company will assess its potential liability and revise itsestimates.  

 

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

**SPECIALNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

This report containsforward-looking statements.  These forward-looking statements are subjectto certain risks and uncertainties that could cause actual results to differmaterially from historical results or anticipated results, including those setforth under “PART II — OTHER INFORMATION — ITEM 1A — Risk Factors,” below,and elsewhere in this report.  In some cases, you can identify forwardlooking statements by terms such as “may,” “intend,” “might,” “should,” “could,”“would,” “expect,” “believe,” “anticipate,” “estimate,” “predict,” “potential,”or the negative of these terms, and similar expressions are intended toidentify forward-looking statements.  Such statements are subject to certainrisks and uncertainties, which could cause actual results to differ materiallyfrom those projected.  Readers are cautioned not to place undue relianceon these forward-looking statements, which speak only as of the datehereof.  We undertake no obligation to publicly release the result of anyrevisions to these forward-looking statements, which may be made to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events.  The forward-looking statements in this report arebased upon management’s current expectations and beliefs, which managementbelieves are reasonable.

 

In this report, unlessthe context indicates otherwise, the terms “Etelos,” “Company,” “we,” “us,” and“our” refer to Etelos, Inc., a Delaware corporation, as the survivingcorporation of the merger between Tripath Technology, Inc., a Delawarecorporation, and Etelos, Incorporated, a Washington corporation.

 

**OVERVIEW**

 

The following discussionand analysis provides a summary of the significant factors affecting ouroperating results, financial condition, liquidity and cash flow during theperiod ended June 30, 2008.  This discussion and analysis shouldbe read with the financial statements and financial statement footnotesincluded in this report.

 

**Business**

 

We are a leading providerof software solutions that assist organizations to effectively use WebApplications to accomplish their goals.  We provide a revolutionarySoftware-as-a-Service (SaaS) ecosystem for building, distributing, and usingWeb Applications, including a marketplace to deploy and support them: givingbusinesses choices in Web Applications, hosting, and support services to costeffectively accomplish their goals.

 

We have developedproducts for Web Applications, which include open standards-based tools for Webdevelopers, businesses and individual users such as the Etelos ApplicationServerTM (EASTM)and the Etelos Development EnvironmentTM (EDETM). EAS and EDE support many common programming languages and also

 

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support the EnglishApplication Scripting Engine (EASETM), a simple-to-use open standards-basedscripting language developed by us.  In order to support broader adoptionof our products, EASE and other components of the EDE are made available todevelopers at market appropriate pricing.  This is done to support thedevelopment of new Web Applications and the migration of existing WebApplications into the Etelos ecosystem where there are tools and other supportmechanisms for the marketing, distribution, and support of theseapplications.  We generally receive a transaction fee or subscription feefor transactions that occur within the Etelos ecosystem via the EtelosMarketplaceand, under StorefrontOperating Agreements, share that revenue with Marketplace partners, calculatedas a percentage of gross revenues from the sale of subscriptions to Marketplacepartner products and service in the Etelos Marketplace.

 

The Etelos Marketplacesupports and encourages communities of developers, distributors, and consumersto expand their offerings, collaborate on new ideas and improvements, andprovide scalable solutions using Web Applications available to others.

 

**RecentFinancings**

 

*January 2008Debentures.*

 

On January 31, 2008,we entered into a securities purchase agreement with three unaffiliatedinstitutional investors for the sale of 6 percent secured convertibledebentures and common stock purchase warrants.  We refer to these debentures as our January 2008 Debentures. In this transaction we issued an aggregate of $2.0 million principal amount ofdebentures and warrants to purchase an aggregate of 222,222 shares of ourcommon stock.  This transaction resulted in net proceeds to us of $1.9 million.

 

The warrants are threeyear warrants to purchase shares of our common stock at a price of $1.80 pershare, subject to adjustment, including full-ratchet anti-dilutionprotection.  As of June 30, 2008, none of these warrants had beenexercised.

 

For a more detaileddiscussion of our January 2008 Debentures, please see the section entitled “January2008 Debentures” under “Note 10. Convertible Notes and Debentures and EmbeddedDerivative and Warrant Liability” to our financial statements contained in “Item1. Financial Statements,” of this report.

 

*April 2008**Debentures*

* *

On April 22, 2008,we entered into a securities purchase agreement with two unaffiliatedinstitutional investors for the sale of original issue discount 6 percentconvertible debentures and common stock purchase warrants.  We refer to thesedebentures as our April 2008 Debentures.  In this transaction weissued an aggregate of $3.5 million principal amount of debentures and warrantsto purchase an aggregate of up to 388,889 shares of our common stock.  Thewarrants have a term of five years and an exercise price of $1.80 per share,subject to adjustment, including full-ratchet anti-dilution protection. This transaction resulted in net proceeds to us of $3.4 million.

 

For a more detaileddiscussion of our April 2008 Debentures, please see the section entitled “April2008 Debentures” under “Note 10. Convertible Notes and Debentures and EmbeddedDerivative and Warrant Liability” to our financial statements contained in “Item1. Financial Statements,” of this report.

 

As further discussedunder “Liquidity and Capital Resources,” below, we believe our cash balance at June 30,2008, is sufficient to fund our operations through at least September 2008. If cash reserves are not sufficient to sustain operations, then we plan toraise additional capital by selling shares of capital stock or other debt orequity securities.  However, there are no commitments or arrangements forfuture financings in place at this time, and there can be no assurance thatsuch capital will be available on favorable terms to us or at all.

 

**CriticalAccounting Policies Involving Management Estimates and Assumptions**

 

Our discussion andanalysis of our financial condition and results of operations is based on ourfinancial statements.  In preparing our financial statements in conformitywith accounting principles generally accepted in the United States, we mustmake a variety of estimates and assumptions that affect the reported amounts ofassets and liabilities, the disclosure of contingent assets and liabilities,and the reported amounts of revenues and expenses.  We have identified thefollowing accounting policies that we believe require application of management’smost subjective judgments, often requiring the need to make estimates about theeffect of matters that are inherently uncertain and may change in subsequentperiods.

 

*Allowance for Doubtful Accounts*

 

We provide, whenappropriate, an allowance for doubtful accounts to ensure that our tradereceivables are not overstated due to un-collectibility. The collectibility ofour accounts receivables is evaluated based on a variety of factors, includingthe length of time receivables are past due, indication of the customer’swillingness to pay, significant one-time events and historical experience.  We have not recorded an allowance fordoubtful accounts at this time as we believe all our accounts receivable willbe collected.

 

*Revenue Recognition*

 

We provide Web Applicationsas a subscription service using the Software-as-a-Service (SaaS) orsoftware-on-demand business model and allow third parties to offer theirproducts and service through Storefronts in the Etelos Marketplace, and toadvertise on our web site or in our annual magazine for a fee.  We also license our software under perpetualand term licenses.  Revenues arerecognized on these service and licensing transactions using the criteria inSecurities and Exchange Commission Staff Accounting Bulletin 104, “ *Revenue Recognition in Financial Statements* “ (SAB 104) andSOP 97-2, “*Software Revenue Recognition*”, (SOP 97-2)respectively, which both provide that revenue may be recognized when all of thefollowing criteria are met:

 
|   | · | persuasive evidence of  an arrangement exists,                             |
|--------|--------|----------------------------------------------------------------------------|
|   |   |                                                                       |
|   | · | the product or service  has been delivered,                                |
|   |   |                                                                       |
|   | · | the fee is fixed or  determinable, and                                |
|   |   |                                                                       |
|   | · | collection of the  resulting receivable is reasonably assured or probable. |

 

We must first determinewhether SAB 104 or SOP 97-2 applies to our revenue transactions.  We than determine if the criteria above havebeen met by assessing the SAB 104 and SOP 97-2 and their variousinterpretations in view of the agreements and other documentation related tothe revenue transactions.  Theinterpretation of the agreements often requires considerable judgment as wellas determining what accounting literature is appropriate and how that literatureshould be applied.  If our standardagreements are used to establish evidence of the arrangement, then our revenueis generally recognized as follows:

 
|   | · | For SaaS revenue  transactionsd, persuasive evidence of an arrangement exists upon acceptance  by the customer of a binding agreement and authorization by the customer to  charge a credit card; delivery generally occurs over the term of the  subscription agreement related to the SaaS; and the fee is fixed and  collection reasonably assured when the customer’s credit card is  charged.  Accordingly, revenue is  recognized over the period the SaaS is provided. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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|   | · | For software licensed  under term or perpetual agreements, persuasive evidence of the arrangement is  evidenced by a binding agreement signed by the customer and delivery  generally occurs upon delivery of the software to a common carrier. If a  significant portion of a fee is due after our normal payment terms of  typically 30 days, we recognize revenue as the fees become due. If we  determine that collection of a fee is not reasonably assured, we defer the  fees and recognize revenue upon cash receipt, provided that all other revenue  recognition criteria are met. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | · | Advertising on our web  site is recognized as revenue over the period the advertisements appears on  our web site and advertising presented in our annual magazine is recognized  upon publication of the magazine provided all the other criteria set forth  above for revenue                                                                                                                                                                                                                                                                                                              |

 

However, if the terms andconditions of an agreement are nonstandard, then significant contractinterpretation is sometimes required to determine the appropriate accountingfor these transactions including: (1) whether an arrangement exists; (2) howthe arrangement consideration should be allocated among potential multipleelements; (3) when to recognize revenue on the deliverables; (4) whetherall elements of the arrangement have been delivered; (5) whether thearrangement should be reported gross as a principal versus net as an agent; (6) whetherwe receive a separately identifiable benefit from the purchase arrangementswith our customer for which we can reasonably estimate fair value; and (7) whetherthe arrangement should be characterized as revenue or a reimbursement of costsincurred. In addition, our revenue recognition policy requires an assessment asto whether collection is reasonably assured, which inherently requires us toevaluate the creditworthiness of our customers. Changes in judgments on theseassumptions and estimates could materially impact the timing or amount ofrevenue recognition.

 

*Internal Use Software*

 

Under SFAS NO. 86, “*Accounting for Costs of Computer Software to be Sold, Leased orOtherwise Marketed*” (SFAS 86), costs incurred in the research anddevelopment of new software products are expensed as incurred untiltechnological feasibility is established. Alternatively, Statement of Position 98-1, “*Accountingfor Costs of Computer Software Developed or Obtained for Internal Use*”(SOP 98-1), applies to software development costs that are not related tosoftware to be sold, licensed, leased or otherwise marketed as a separateproduct or as part of a product or process and are within the scope of SFAS 86.  Under SOP 98-1, software development costsincurred for software that is only used internally, including costs incurred topurchase third party software, are capitalized beginning when the Company hasdetermined certain factors are present, including among others, that technologyexists to achieve the performance requirements, buy versus internal developmentdecisions have been made, and the Company’s management has authorized thefunding for the project.  We mustdetermine whether SFAS 86 or SOP 98-1 is applicable to our software developmentcosts.  We must than determine whensoftware capitalization should begin and cease and what costs under theapplicable standard can be capitalized. Both of these tasks involves considerable judgment and can result inmaterial different amounts of software being capitalized and have a significantimpact on our reported results of operations. To date, because we plan to license all our software products, we havedetermined that the provisions of SFAS 86 should be applied to the cost of ourproduct development.  As products andenhancements have generally reached technological feasibility and have beenreleased for sale at substantially the same time, all research and developmentcosts have been expensed.

 

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*Stock-Based Compensation Expense*

 

Effective January 1,2006, we adopted SFAS 123R using the modified prospective method andtherefore have not restated prior periods’ results. Under the fair valuerecognition provisions of SFAS 123R, we recognize stock-based compensationexpense net of an estimated forfeiture rate and therefore only recognizecompensation cost for those shares expected to vest over the service period ofthe award.  Calculating stock-basedcompensation expense requires the input of highly subjective assumptions,including the expected term of the stock-based awards, stock price volatility,and the pre-vesting option forfeiture rate. We estimate the expected life ofoptions granted based on historical exercise patterns, which we believe arerepresentative of future behavior. We estimate the volatility of our commonstock on the date of grant based on the historical volatility of other publiclytraded companies in our industry. The assumptions used in calculating the fairvalue of stock-based awards represent our best estimates, but these estimatesinvolve inherent uncertainties and the application of management judgment. As aresult, if factors change and we use different assumptions, our stock-basedcompensation expense could be materially different in the future. In addition,we are required to estimate the expected forfeiture rate, as well as theprobability that performance conditions that affect the vesting of certainawards will be achieved, and only recognize expense for those shares expectedto vest. We estimate the forfeiture rate based on historical experience of ourstock-based awards that are granted, exercised, and cancelled. If our actualforfeiture rate is materially different from our estimate, the stock-basedcompensation expense could be significantly different from what we haverecorded in the current period.

 

*Accountingfor Convertible Notes and Debentures, Embedded Derivatives and Warrants*

 

The Company evaluates theembedded derivatives included in the debt instruments it issues under theguidance in Statement of Financial Accounting Standard No. 133 “A**ccounting for Derivative Instruments andHedging Activities****” and its related guidance and interpretations (SFAS133) on the issuance date of the debt and on each subsequent reporting date**to determine whether such embedded derivatives are clearly and closely relatedto the debt host**.  The purpose of the evaluation is to determinewhether the embedded derivatives, which are not clearly and closely related tothe debt host, need to be**bifurcated from the debt hostand accounted for as a derivative at their estimated fair value as a liability**or asset at the date ofissuance and thereafter, adjusted to estimated fair value with a charge orcredit to the Company’s statement of operations.  SFAS 133 generally indicates that if theconversion features are (i) indexed to the Company’s capital stock and (ii) wouldbe classified as equity if a freestanding derivative under the guidance in EITF00-19, “***Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*” (EITF 00-19), then the embedded derivatives need not bebifurcated from the debt host.  We also evaluatethe warrants issued with the debt under EITF 00-19 to determine whether theproceeds allocated to the warrants or the fair value of the warrants should berecorded as equity or a liability, respectively, and if a liability adjusted tofair value**with a charge or creditto the Company’s statement of operations. **EITF 00-19 generally requires, among otherfactors, that (i) the Company can settle the derivative in cash or its ownstock, at its option, (ii) settlement can be made in unregistered shares,and (iii) the Company has sufficient authorized shares to issue shares ofits common

 

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stock for all equityinstruments convertible to or which can be exercised for its capitalstock.  SFAS 133 also provides guidanceon when put and call features included in a debt host agreement are not clearlyand closely related to the debt host and must be bifurcated and recorded asliability.  The guidance in SFAS 133 iscomplex and it has many interpretations. Accordingly, we must use judgment to apply and interpret this guidanceas well as ensure we have applied the correct guidance.

 

If the embeddedderivatives or warrants must be recorded as a liability, then we must makecertain assumptions to value the embedded derivative.  This includes computing the discounted netpresent value (DNPV) of the debt and making assumptions about interest rates,probabilities of outcomes, volatility, fair value of the Company’s stock priorto its merger with Tripath, and discount rates. The discount factor is the Company’s estimate of the appropriate rate ofreturn that an investor would expect from a similar debenture not taking intoconsideration the conversion feature or warrants.  All of these assumptions have a materialimpact on the value attributed to the derivative or warrant.

** **

**Resultsof Operations**

 

**Fluctuationsin Operating Results**

 

We are in the early stagesof our operations. Our results of operations are likely to fluctuate fromperiod to period.  We anticipate that our quarterly and annual results ofoperations will be impacted for the foreseeable future by several factors,including the timing and volume of sales of our products.  Due to thesefactors, each of which will have a substantial impact on our future operations,we believe that the period-to-period comparisons of our operating results arenot a good indication of our future performance.

 

**ThreeMonths Ended June 30, 2008, Compared with Three Months Ended June 30,2007**

 

**Revenues**

 

Revenues were $22thousand and $106 thousand for quarters ending June 30, 2008 and 2007,respectively. Revenues decreased by $84 thousand, or 79.2 percent, in the threemonths ending June 30, 2008, compared to same period in 2007.  Thedecrease in revenues is due in part to reductions in revenues from the sale ofnewsletters and related hosting services and a one-time sale of software inJune 2007.  In addition, as the quarter ending June 30, 2007, was thefirst quarter of our sales of our customer resource management product, weexpected a spike of activity during that quarter, which was not repeated in thequarter ending June 30, 2008.

 

**Costof Revenue**

 

Cost of revenue includesour costs of hardware, software and other resources used in delivery of ourproducts and services. Cost of revenue was $148 thousand and $69 thousand forthe quarters ending June 30, 2008 and 2007, respectively. Cost of revenuefor the second quarter of 2008 increased by $79 thousand, or by 114.5percent.  The increase in cost of revenue from 2007 to 2008 was primarilyattributable to the increased costs of hosting and Internet band-widthassociated with the deployment of our products and services. Stated as apercentage of revenues, cost of revenue for the second quarter of 2008 was 672.7percent and for the corresponding period of 2007 was 65.1 percent.

 

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**OperatingExpenses**

 

*Researchand Development.*** **Research and development expenses include primarily employee and employeerelated expenses. Research and development expenses were $1,283 thousand and $292thousand for the quarters ending June 30, 2008 and 2007, respectively.Stated as a percentage of revenues, research and development expense for thecorresponding periods was 5,831.8 percent and 275.5 percent,respectively.  Research and development expenses increased by $991thousand or by 339.4 percent, in the first quarter of 2008 compared to the sameperiod in 2007.  This increase was primarily due to additional hiring ofengineers for research and development.

 

*Salesand Marketing Expenses.*** **Sales and marketing expenses include payroll, employee benefits, and otherheadcount-related costs associated with sales and marketing personnel andtravel, advertising, promotions, trade shows, seminars, and other programs.Sales and marketing expenses were $508 thousand and $149 thousand for thequarters ending June 30, 2008 and 2007, respectively. The $359 thousand,or 240.9 percent, increase in sales and marketing expense was due to increasedhiring of sales and marketing personnel and increased focus on sales and marketingactivities. Stated as a percentage of revenues, sales and marketing expense forthe corresponding periods was 2,309.1 percent and 140.6 percent, respectively.

 

*Generaland Administrative.*** **General and administrative expenses include payroll and related employeebenefits, and other headcount-related costs associated with finance,facilities, legal and other administrative expenses. General and administrativeexpenses were $630 thousand and $110 thousand for the quarters ending June 30,2008 and 2007, respectively. The $520 thousand, or 472.7 percent, increase ingeneral and administrative expense was primarily attributable to increasedhiring of accounting, administrative, legal and compliance personnel andgreater use of consultants and temporary personnel as we worked to complete thereverse merger and prepare our infrastructure to support being a publiccompany.  Stated as a percentage of revenues, general and administrativeexpense for the corresponding periods was 2,863.6 percent and 103.8 percent,respectively.

 

**OtherIncome (Expense)**

** **

Net other expense of$13,459 thousand for the quarter ending June 30, 2008, $13.4 million is relatedto the costs associated with completing the Merger with Tripath. The costsinclude the value of 5,010,000 shares of Etelos common stock paid to Tripathcreditors, which were valued on April 22, 2008, at $2.63 per share for a totalcost of $13.2 million. The remaining expense consists of legal, according andother professional fees paid in cost to complete the Merger. There were nosimiliar costs in 2007.

 

**InterestExpense**

 

Net interest expense was$5,567 thousand for the quarter ending June 30, 2008, compared to $58thousand for the comparable period of 2007.  Included in interestexpense are noncash charges of $960 thousand related to accretion of notes anddebentures payable, $77 thousand related to the payment of interest in commonstock, $991 thousand related to the recognition of beneficial conversionfeatures on accrued interest on notes payable, which can be converted to commonstock, and $3,417 thousand related to the change in the warrant and derivativeliability, all of which total $5,445 thousand. The increase in interest expense was primarily due to multiple rounds ofconvertible debt financing completed during 2007 and the first half of 2008.

 

**NetLoss**

 

Our net loss was $21.6million and $572 thousand for the quarters ending June 30, 2008 and2007, respectively, an increase of $21.0 million, or 3,671.5, percent. The increase in net loss from 2007 to 2008 was primarily due to decreasedrevenue and increased salaries and other employee-related costs incurred duringa period of transition in which we were deeply involved in preparations forcompleting the reverse merger process, in addition to the Merger and interestcharges explained above.

 

**SixMonths Ended June 30, 2008, Compared with Six Months Ended June 30,2007**

 

**Revenues**

 

Revenues were $45thousand and $211 thousand for periods ending June 30, 2008 and 2007,respectively. Revenues decreased by $166 thousand, or 78.7 percent, in the sixmonths ending June 30, 2008, compared to same period in 2007.  Thedecrease in revenues is due in part to reductions in revenues generated fromthe sale of newsletters and related hosting services and a one-time sale ofsoftware in June 2007.  In addition, as the quarter ending June 30,2007, was the first quarter of our sales of our customer resource managementproduct, we expected a spike of activity during that quarter, which was notrepeated in the quarter ending June 30, 2008.

 

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**Costof Revenue**

 

Cost of revenue includesour costs of hardware, software and other resources used in delivery of ourproducts and services. Cost of revenue was $249 thousand and $124 thousand forthe periods ending June 30, 2008 and 2007, respectively. Cost of revenuefor the first six months of 2008 increased by $125 thousand, or by 100.8percent.  The increase in cost of revenue from 2007 to 2008 was primarilyattributable to the increased costs of hosting and Internet band-widthassociated with the deployment of our products and services. Stated as apercentage of revenues, cost of revenue for the first six months of 2008 was 553.3percent and for the corresponding period of 2007 was 58.8 percent.

 

**OperatingExpenses**

 

*Researchand Development.*** **Research and development expenses include primarily employee and employeerelated expenses. Research and development expenses were $2,476 thousand and $554thousand for the periods ending June 30, 2008 and 2007, respectively.Stated as a percentage of revenues, research and development expense for the correspondingperiods was 5,502.2 percent and 262.6 percent, respectively.  Research anddevelopment expenses increased by $1,922 thousand or by 346.9 percent, in thefirst six months of 2008, compared to the same period in 2007.  Thisincrease was primarily due to additional hiring of engineers for research anddevelopment.

 

*Salesand Marketing Expenses.*** **Sales and marketing expenses include payroll, employee benefits, and otherheadcount-related costs associated with sales and marketing personnel andtravel, advertising, promotions, trade shows, seminars, and other programs.Sales and marketing expenses were $801 thousand and $221 thousand for theperiods ending June 30, 2008 and 2007, respectively. The $580 thousand, or267.4 percent, increase in sales and marketing expense was due to increasedhiring of sales and marketing personnel and increased focus on sales andmarketing activities. Stated as a percentage of revenues, sales and marketingexpense for the corresponding periods was 1,780.0 percent and 104.7 percent,respectively.

 

*Generaland Administrative.*** **General and administrative expenses include payroll and related employeebenefits, and other headcount-related costs associated with finance,facilities, legal and other administrative expenses. General and administrativeexpenses were $1,100 thousand and $155 thousand for the periods ending June 30,2008 and 2007, respectively. The $945 thousand, or 609.7 percent, increase ingeneral and administrative expense was primarily attributable to increasedhiring of accounting, administrative, legal, and compliance personnel andgreater use of consultants and temporary personnel as we worked to complete thereverse merger and prepare our infrastructure to support being a publiccompany.  Stated as a percentage of revenues, general and administrativeexpense for the corresponding periods was 2,444.4 percent and 73.5 percent,respectively.

 

**OtherIncome (Expense)**

** **

Net other expense of $13,459thousand for the six months ending June 30, 2008, $13.4 million is related tothe costs associated with completing the Merger with Tripath. The costs includethe value of 5,010,000 shares of Etelos common stock paid to Tripath creditors,which were valued on April 22, 2008, at $2.63 per share for a total cost of$13.2 million. The remaining expense consists of legal, according and other professionalfees paid in cost to complete the Merger. There were no similiar costs in 2007.

 

**InterestExpense**

 

Net interest expense was$5,765 thousand for the six months ending June 30, 2008, compared to $98thousand for the comparable period of 2007.  Included in interestexpense are noncash charges of $960 thousand related to accretion of notes anddebentures payable, $77 thousand related to the payment of interest in commonstock, $991 thousand related to the recognition of beneficial conversionfeatures on accrued interest on notes payable, which can be converted to commonstock, and $3,417 thousand related to the change in the warrant and derivativeliability, all of which total $5,445 thousand. The increase in interest expense was primarily due to multiple rounds ofconvertible debt financing completed during 2007 and the first half of 2008.

 

**NetLoss**

 

Our net loss was $23.8 millionand $941 thousand for the periods ending June 30, 2008 and 2007,respectively, an increase of $22.9 million, or 2,429.8 percent.  Theincrease in net loss from 2007 to 2008 was primarily due to decreased revenueand increased salaries and other employee-related costs incurredduring a period of transition in which we were deeply involved in preparationsfor completing the reverse merger process, in addition to the Merger andinterest charges explained above.

 

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**Liquidityand Capital Resources**

** **

On June 30, 2008, wehad $1.8 million in cash and cash equivalents, and prepaid expenses and othercurrent assets of $67 thousand. Our working capital deficit at June 30,2008, was $12.7 million, compared to a deficit of $3,484 thousand at June 30,2007. The increase in working capital deficit is mainly attributable to thewarrant and derivative liability recorded in June 2008 and further discussed inthe “Note 7- Convertible Notes and Debentures and Embedded Derivative andWarrant Liability”.

 

Net cash used byoperating activities during the period ended June 30, 2008 was $4.7million, compared to $627 thousand during the period ended June 30,2007. The primary use of cash from operating activities during the first sixmonths of 2008 was operating expenses of $4.4 million.

 

Net cash provided byfinancing activities for first six months of 2008 was $5.6 million, primarilyfrom the issuance of convertible Notes. During the six months ended June 30,2008, we issued our January 2008 Debentures and our April 2008 Debenturesfurther discussed in “Note 7 – Convertible Notes and Debentures and EmbeddedDerivative and Warrant Liability”.

 

We believe our cashbalance at June 30, 2008, is sufficient to fund our operations through at leastSeptember 2008.  If cash reserves and our credit facility are notsufficient to sustain operations, then we plan to raise additional capital byselling shares of our capital stock or other securities.  However, thereare no commitments or arrangements for future financings in place at this timeand we can give no assurance that such capital will be available on favorableterms, or at all.  We may need additional financing thereafter until wecan achieve profitability.  If we cannot, then we will be forced tocurtail our operations or possibly be forced to evaluate a sale or liquidationof our assets.  Even if we are successful in raising additional funds,there is no assurance regarding the terms of any additional investment. Any future financing may involve substantial dilution to existinginvestors.

 

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**Commitmentsand Contingencies**

 

September 2007Notes

 

Our September 2007notes were issued as part of a private placement that was completed duringAugust and September 2007.  In thatprivate placement we issued a total of approximately $3.3 million of 6%convertible notes at an original issue discount of 10% with warrants topurchase 1,080,000 shares of common stock with an exercise price of $1.20 pershare. In connection with the Merger that closed on April 22, 2008, $1.5million of these notes were converted at $0.75 per share. At the time of theMerger, 974,667 of the warrants had been exercised and the remaining 33,333warrants expired by their terms upon closing the Merger.

 

Under the terms of theremaining $1.8 million of the notes that were not converted, principal ispayable beginning on September 1, 2008, and the last day of each calendarquarter thereafter, and interest is payable beginning February 1, 2008. OnJune 15, 2008, the holders of these notes agreed to either convert theaccrued interest to shares of common stock at a rate of one share for each $1.35of interest owed or to add the accrued interest to the principal, and to waiveany default arising out of our failure to pay the accrued and unpaid interest throughJune 15, 2008. 

 

The principal paymentamounts remaining on our September 2007 notes are scheduled to be paid asfollows (in thousands):

 
| **Date**   | ** ** | **September 2007 Notes** | ** ** |
|------------|------------|------------------------------------|------------|
| 9/1/2008   |       | $                                  | 441        |   |
| 9/30/2008  |       | $                                  | 441        |   |
| 12/31/2008 |       | $                                  | 441        |   |
| 3/31/2009  |       | $                                  | 441        |   |
|       |       | $                                  | 1,764      |   |

 

Assuming principalpayments are made in accordance with the schedule set forth above, the amountof interest to be paid through the March 31, 2009, maturity date is $55.9thousand with respect to our September 2007 notes, or on average, $3.1 thousandper month.

 

January 2008 Debentures

 

In January 2008, weissued our January 2008 Debentures with an aggregate principal amount of$2.0 million.  As of June 30, 2008, the entire principal amount ($2.0million) is outstanding and no payments of principal or interest have becomedue or paid.  Under the terms of these debentures, we are to begin makingmonthly redemption payments on September 1, 2008.  The maturity date ofthese debentures is January 31, 2010.  The total monthly principalpayment amounts on our January 2008 Debentures are scheduled to be paid asfollows:

 

**MonthlyPrincipal Payment Amount (in thousands)**

 

| **Date**  | ** ** | **January 2008  Debentures** | ** ** |
|-----------|------------|------------------------------|------------|
| 9/1/2008  |       | $                            | 111        |   |
| 10/1/2008 |       | $                            | 111        |   |
| 11/1/2008 |       | $                            | 111        |   |
| 12/1/2008 |       | $                            | 111        |   |
| 1/1/2009  |       | $                            | 111        |   |
| 2/1/2009  |       | $                            | 111        |   |
| 3/1/2009  |       | $                            | 111        |   |
| 4/1/2009  |       | $                            | 111        |   |
| 5/1/2009  |       | $                            | 111        |   |
| 6/1/2009  |       | $                            | 111        |   |
| 7/1/2009  |       | $                            | 111        |   |
| 8/1/2009  |       | $                            | 111        |   |
| 9/1/2009  |       | $                            | 111        |   |
| 10/1/2009 |       | $                            | 111        |   |
| 11/1/2009 |       | $                            | 111        |   |
| 12/1/09   |       | $                            | 111        |   |
| 1/1/2010  |       | $                            | 111        |   |
| 1/31/2010 |       | $                            | 113        |   |
|      |       | $                            | 2,000      |   |

 

Assuming monthlyprincipal payments are made in accordance with the schedule set forth above,the amount of interest to be paid through the January 31, 2010, maturitydate is $240 thousand with respect to our January 2008 Debentures, or onaverage, $13.3 thousand per month.

 

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** **

April 2008 Debentures

 

In April 2008, weissued our April 2008 Debentures with an aggregate principal amount of$3.5 million. Under the terms of these debentures, we are to begin makingmonthly redemption payments upon the earlier of (i) the 1st of the monththat follows the effective date of the registration statement we filed to coverthe resale of the shares of common stock underlying our April 2008 Debentures,and (ii) November 1, 2008.  The maturity date of thesedebentures is April 30, 2010.  The aggregate face value of ouroutstanding April 2008 Debentures is $3.5 million at June 30, 2008. The total monthly principal payment amounts on our April 2008 Debenturesare scheduled to be paid as follows, assuming such payments begin on November 1,2008:

** **

**MonthlyPrincipal Payment Amount (in thousands)**

 

| **Date**  | ** ** | **April 2008  Debentures** | ** ** |
|-----------|------------|----------------------------|------------|
| 11/1/2008 |       | $                          | 194        |   |
| 12/1/2008 |       | $                          | 194        |   |
| 1/1/2009  |       | $                          | 194        |   |
| 2/1/2009  |       | $                          | 195        |   |
| 3/1/2009  |       | $                          | 194        |   |
| 4/1/2009  |       | $                          | 195        |   |
| 5/1/2009  |       | $                          | 194        |   |
| 6/1/2009  |       | $                          | 195        |   |
| 7/1/2009  |       | $                          | 194        |   |
| 8/1/2009  |       | $                          | 195        |   |
| 9/1/2009  |       | $                          | 194        |   |
| 10/1/2009 |       | $                          | 195        |   |
| 11/1/2009 |       | $                          | 194        |   |
| 12/1/09   |       | $                          | 195        |   |
| 1/1/2010  |       | $                          | 194        |   |
| 2/1/2010  |       | $                          | 195        |   |
| 3/1/2010  |       | $                          | 194        |   |
| 4/1/2010  |       | $                          | 195        |   |
|      |       | $                          | 3,500      |   |

 

Assuming monthlyprincipal payments are made in accordance with the schedule set forth above,the amount of interest to be paid through the April 30, 2010, maturity dateis $420 thousand with respect to our April 2008 Debentures, or on average,$23.3 thousand per month.

 

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We have the right to payinterest and monthly principal payments due in respect of our January 2008and April 2008 Debentures in cash, or upon notice to the holders andcompliance with certain equity conditions, we can pay all or a portion of anysuch payment in common stock valued at a price equal to the lesser of the theneffective conversion price (currently $1.35) or 85 percent of the average ofthe VWAP per share for our common stock for the 10 consecutive trading daysimmediately prior to the applicable payment date.  On the other hand, ifthe holders voluntarily elect to convert all or a portion of the debenturesinto common stock, then the conversion price will be the then-effectiveconversion price.  The conversion of these debentures could result in substantialdilution to our existing stockholders.

 

The equity conditionsthat we must meet include having a currently effective registration statementcovering the shares of common stock issuable upon conversion of the debenture,and having the daily dollar trading volume for our common stock exceed $250,000for each of the 20 consecutive trading days before the date in question.  We do not currently meet these equityconditions and it may prove difficult for us to meet them.

 

Subject to compliancewith certain equity conditions, and subject also to the applicable cap on thebeneficial ownership of our shares of common stock by the holder and itsaffiliates following such conversion, we have the right to force conversion ofthe entire amount of principal and accrued interest of the debentures if theaverage of the VWAP for our common stock exceeds $3.39 for 20 trading days outof a consecutive 30 trading day period.  If the price of our common stockis below $3.39 per share but is substantially above $1.35 per share, then weanticipate that the holders of these debentures will elect to convert monthlypayments of interest and principal into shares of common stock rather thanreceive cash.  If the price of our common stock is below $1.35, thecurrent conversion price, then we intend to make principal and interestpayments in cash to the extent that our cash flows from operations providesufficient ability to do so.

 

If our cash flows fromoperations are not sufficient to make principal and interest payments in cash,then we will evaluate other equity financing opportunities, the proceeds ofwhich could be used to repay the debentures.  If we are unable to pay theprincipal and interest in cash, or elect not to do so to preserve workingcapital, then we will make the payments with our common stock pursuant to theterms of the agreements including a conversion price based on the lower of thethen effective conversion price or 85 percent of the average of the VWAP pershare for our common stock for the 10 consecutive trading days.

 

If we are unable to makeall payments, whether in cash or stock, due on our September 2007 notes and ourJanuary Debentures and April Debentures, then we would be in default under suchsecurities.  The holders of suchsecurities would be entitled to demand that all amounts due thereunder beimmediately paid in cash, and with respect to our January Debentures and AprilDebentures, the holders would have the right to demand that we pay 130 percentof the outstanding principal amount and the interest rate accrues at a rateequal to the lesser of 18% per annum or the maximum rate permitted underapplicable law.  In addition, the holdersof our January Debentures and April Debentures would have the right to forecloseon all of our assets pursuant to the terms of the security agreement we enteredinto with such holders and they would have the right to take possession of ourassets and operate our business.

 

Operating andCapital Leases

 

We have non-cancelableleases for corporate facilities and equipment.  Rent expense under theleases totaled $126 thousand and $49 thousand for the periods ending June 30,2008 and 2007, respectively.  Future minimum rental payments requiredunder non-cancelable leases are as follows for the twelve months ending June 30:

 
| ** **                                          | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|---------------------|------------|
|                                                |       |                  |       |                |       |
| 2009                                                |       |                  | $          | 263                 |       | $ | 25 |   |
| 2010                                                |       |                  | 160        |                | 15         |   |
| 2011                                                |       |                  | 6          |                | 13         |   |
| 2012                                                |       |                  | 6          |                | 9          |   |
| 2013                                                |       |                  | 2          |                | —     |   |
| Total minimum  lease payments                       |       | $                     | 437        |                | $          | 62 |   |
| Less: amount  representing interest                 |       |                  |       | (18                 | )          |
| Present value of  minimum lease payments            |       |                  |       | 44                  |       |
| Less: current  portion of capital lease obligations |       |                  |       | (17                 | )          |
| Long-term  capital lease obligations                |       |                  |       | $                   | 27         |   |

 

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**Off-BalanceSheet Arrangements**

 

We did not have anyoff-balance sheet arrangements as of the six months ending June 30, 2008,nor do we have any as of August 15, 2008.

 

**GoingConcern Issue**

 

We remain dependent onoutside sources of funding until our results of operations provide positivecash flows.  Our independent auditors issued a going concern explanatoryparagraph in their report dated April 22, 2008. With our currentlevel of funding, substantial doubt exists about our ability to continue as agoing concern.

 

During the quarter ended June 30,2008, we have been unable to generate cash flows sufficient to support ouroperations and have been dependent on debt and equity raised from qualifiedindividual investors.

 

These factors raisesubstantial doubt about our ability to continue as a goingconcern.  The financial statements contained herein do not includeany adjustments relating to the recoverability and classification of recordedasset amounts or amounts and classification of liabilities that might benecessary should we be unable to continue in existence.  Our abilityto continue as a going concern is dependent upon our ability to generate sufficientcash flows to meet our obligations on a timely basis, to obtain additionalfinancing as may be required, and ultimately to attain profitableoperations.  However, there is no assurance that profitable operations orsufficient cash flows will occur in the future.

 

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We have supported currentoperations by raising additional operating cash through the private sale of ourconvertible debentures.  This has provided us with the cash inflows tocontinue our business plan, but has not resulted in significant improvement inour financial position. We are considering alternatives to address our cashflow situation that include: (1) raising capital through additional saleof our common stock and/or debentures and (2) reducing cash operatingexpenses to levels that are in line with current revenues.

 

The first alternativecould result in substantial dilution of existing stockholders. There can be noassurance that our current financial position can be improved, that we canraise additional working capital, or that we can achieve positive cash flowsfrom operations. Our long-term viability as a going concern is dependent uponour ability to (i) locate sources of debt or equity funding to meetcurrent commitments and near-term future requirements and (ii) achieveprofitability and ultimately generate sufficient cash flow from operations tosustain our continuing operations.

 

**RecentAccounting Pronouncements**

 

In February 2008,the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, “*Effective Date of FASB Statement No. 157*” (FSPFAS 157-2), which delays the effective date of Statement of FinancialAccounting Standards (SFAS) No. 157, “*Fair Value Measurements*”(SFAS 157) for all non-financial assets and non-financial liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually) for fiscal years beginningafter November 15, 2008, and interim periods within those fiscal years foritems within the scope of this FSP. We are currently evaluating the impact ofadopting FSP FAS 157-2 for non-financial assets and non-financialliabilities on our consolidated financial position, cash flows, and results ofoperations.

 

In December 2007,the FASB issued SFAS No. 141(R), “*BusinessCombinations*” (FAS141R), which requires an acquirer to measure the identifiable assets acquired,the liabilities assumed, and any noncontrolling interest in the acquiree attheir fair values on the acquisition date, with goodwill being the excess valueover the net identifiable assets acquired, FAS 141R is effective for financialstatements issued for fiscal years beginning after December 15, 2008.Also, in December 2007, the FASB issued SFAS No. 160, “*Noncontrolling Interests in Consolidated FinancialStatements,**an amendment of ARB No. 51*” (FAS 160), which clarifies that anoncontrolling interest in a subsidiary should be reported as equity in theconsolidated financial statements. The calculation of earnings per share willcontinue to be based on income amounts attributable to the parent. FAS 160 iseffective for financial statements issued for fiscal years beginning after December 15,2008. We are currently evaluating the impact of adopting SFAS 141R andSFAS 160 on our consolidated financial position, cash flows, and resultsof operations.

 

In June 2008,the FASB issued FSP No. EITF 03-6-1, “*DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities*” (FSP EITF 03-6-1), which requiresentities to apply the two-class method of computing basic and diluted earningsper share for participating securities that include awards that accrue cashdividends (whether paid or unpaid) any time common shareholders receivedividends and those dividends do not need to be returned to the entity if theemployee forfeits the award. FSP EITF 03-6-1 will be effective for theCompany on January 1, 2009 and will require retroactive disclosure. TheCompany is currently evaluating the impact of adopting FSP EITF 03-6-1 onits consolidated financial position, cash flows, and results of operations.

 

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**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Intentionally omittedpursuant to Item 305(e) of Regulation S-K.

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

(a) Disclosurecontrols and procedures are controls and other procedures that are designed toensure that information required to be disclosed in our reports filed pursuantto the Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate, to allowfor timely decisions regarding required disclosure.

 

Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within our company have been detected. The design of any system of controls isbased in part upon a cost-benefit analysis and certain assumptions about thelikelihood of future events and any design may not succeed in achieving itsstated goals under all potential future conditions. While our management doesnot believe that our controls will prevent all errors or all instances offraud, our disclosure controls and procedures are designed to provide areasonable assurance of achieving their objectives.

 

As required by ExchangeAct Rule 13a-15(b), we carried out an evaluation, under the supervision andwith the participation of our management, including our chief executive officerand chief financial officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of June 30, 2008, the end ofthe period covered by this report. Based on that evaluation, our chiefexecutive officer and chief financial officer concluded that our disclosurecontrols and procedures were effective at the reasonable assurance level as of June 30,2008.

 

(b) We made thefollowing changes in our internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during ourmost recent fiscal quarter, and subsequent to that period, that has materiallyaffected, or is likely to materially affect, our internal control overfinancial reporting.  We implemented and refined numerous Accounting /Finance, Human Resources, and Sales contract processes and procedures, whichallow us to have more consistent agreements, with a more visible trail ofsupporting documents. 

 

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**PART II — OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

From time to time, webecome subject to various legal proceedings and claims, both asserted andunasserted, that arise in the ordinary course of business. Litigation ingeneral, and securities litigation in particular, can be expensive anddisruptive to normal business operations. Moreover, the results of legalproceedings are difficult to predict. An unfavorable resolution of one or moreof these lawsuits would materially adversely affect our business, results ofoperations, or financial condition. We cannot estimate the loss or range ofloss that may be reasonably possible for any of the contingencies describedabove and accordingly have not recorded any associated liabilities in ourconsolidated balance sheets. We accrue legal costs when incurred.

 

In July 2008, KaufmanBros. L.P. filed suit against us in the United States District Court for theSouthern District of New York (Case No. 08 CV 5716).  The complaint arises out of an advisoryservices agreement, pursuant to which Kaufman Bros. was to provide us withadvisory services in connection with financings and strategictransactions.  We notified Kaufman Brosthat we believed it had failed to provide the required services under theagreement, and that we were therefore entitled to terminate the agreement for cause.In the suit, Kaufman Bros. was seeking (i) monetary damages of $400,000 foranticipatory breach of the agreement; (ii) $73,800 in fees allegedly owed inconnection with a previously closed financing transaction; (iii) an injunctionprohibiting us from cancelling any shares issued to Kaufman Bros. ascompensation, (iv) a declaration from the court that we are not entitled to arefund of any fees previously paid to Kaufman Bros., and (v) a declaration thatwe are obligated to pay Kaufman Bros. a commission on any financing ortransaction that we enter into within 18 months following the termination ofthe agreement. On July 15, 2008, Kaufman Bros. voluntarily filed a notice ofdismissal without prejudice. Settlement discussions were unsuccessful andKaufman Bros. has re-filed substantially the same claims in the Supreme Courtof New York - County of New York ( Index No. 08-602239).  The Company has been served and is developingits defense plan.

 

**ITEM1A.  RISK FACTORS**

 

*Investmentin our common stock involves a high degree of risk. You should carefullyconsider the risks described below together with all of the other informationincluded in this report before making an investment decision. If any of thefollowing risks actually occur, our business, financial condition or results ofoperations could suffer. In that case, the market price of our common stockcould decline, and you may lose all or part of your investment.*

 

**RisksRelated to our Business**

 

***We have a limited operating history, have experiencedsignificant expenditures related to funding our initial product development,and are currently carrying a net loss.  If our business model is notsuccessful, or if we are unable to generate sufficient revenue to offset ourstart-up expenditures, then we may not become profitable, and the value of yourinvestment may decline.***

 

We began our operationsin 1999 but we did not adopt the SaaS on-demand Web Applications delivery modeluntil 2005. As such, we have a limited operating history in the SaaS industryfrom which to evaluate our business and prospects.  We incurred a net lossof $23.8 million for the six months ended June 30, 2008, and $4.0 million forthe year ended December 31, 2007, and have an accumulated deficit of $15.8million at June 30, 2008.  We cannot assure you that our futureplanned operations will be implemented successfully or that we will ever haveprofits.  Furthermore, we are experiencing the initial costs anduncertainties of a young operating company, including start-up expenditures,unforeseen costs and difficulties, complications, and delays, all of which mustbe resolved and/or paid without the benefit of a predictable revenuestream.  We cannot be sure that we will be successful in meeting thesechallenges and addressing these risks and uncertainties.  If we are unableto do so, then our business will not be successful.

 

***Our limited operating history may not serve as an adequatebasis to judge our future prospects and results of operations.***

 

We began our operationsin 1999 but we did not adopt the SaaS on-demand Web Application delivery modeluntil 2005. Our limited operating history in the SaaS industry may not providea meaningful basis on which to evaluate our business. Since our inception ourrevenues have not always grown from year to year.  We cannot assure youthat we will achieve our growth targets, or that we will achieve positivecash-flow or profitability, or that we will not incur negative cash flow or netlosses in the future. We expect that our operating expenses will increase as weexpand. Any significant failure to realize anticipated revenue growth couldresult in significant operating losses beyond our forecasts. We will continueto encounter risks and difficulties frequently experienced by companies at asimilar stage of development, including our potential failure to:

 

·                                               maintainand improve our technology;

 

·                                               expandour product offerings and maintain the high quality of products offered in theEtelos MarketplaceTM;

 

·                                               manageour expanding operations, including the integration of any future acquisitions;

 

·                                               obtainsufficient working capital to support our expansion and to fill customers’orders in time;

 

·                                               maintainadequate control of our expenses;

 

·                                               implementour product development, marketing, sales, and acquisition strategies and adaptand modify them as needed; and/or

 

·                                               anticipateand adapt to changing conditions in the markets in which we operate as well asthe impact of any changes in government regulation, mergers and acquisitionsinvolving our competitors, technological developments, and other significantcompetitive and market dynamics.

 

If we are not successfulin addressing any or all of these risks, then our business may be materiallyand adversely affected.

 

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***Our limited operating history makes it difficult to evaluateour current business and future prospects, and may increase the risk of yourinvestment.***

 

Our limited operatinghistory may make it difficult to evaluate our current business and our futureprospects. We have encountered and will continue to encounter risks anddifficulties frequently experienced by growing companies in rapidly changingindustries. If we do not address these risks successfully, then our businesswill be harmed.

 

***We may encounter substantial competition in our business andour failure to compete effectively may adversely affect our ability to generaterevenue.***

 

We believe that existingand new competitors will continue to improve the design and performance oftheir products and to introduce new products with competitive price andperformance characteristics. We expect that we will be required to continue toinvest in product development and productivity improvements to competeeffectively in our markets. Our competitors could develop better technology ormore efficient products or undertake more aggressive and costly marketingcampaigns than ours, which may adversely affect our marketing strategies andcould have a material adverse effect on our business, results of operations,and financial condition.

 

Our major competitors maybe better able than us to successfully endure downturns in our markets. Inperiods of reduced demand for our products, we can either choose to maintainmarket share by reducing our selling prices to meet competition or maintainselling prices, which likely would result in sacrifice of our market share.Sales and overall profitability would be reduced and sustained losses maycontinue in either case. In addition, we cannot be assured that additionalcompetitors will not enter our existing markets, or that we will be able tocompete successfully against existing or new competition.

 

***We have a history of losses and we may not achieveprofitability in the future.***

 

We have not beenprofitable on a quarterly or annual basis since our formation. Our operationsresulted in a net loss of $23.8 million for the six months ended June 30, 2008and $4.0 million and $1.5 million for the years 2007 and 2006, respectively. Asof December 31, 2007, our accumulated deficit was $10.4 million and atJune 30, 2008, our accumulated deficit was $15.8 million. We expect to makesignificant future expenditures related to the development and expansion of ourbusiness. In addition, as a public company, we will incur significant legal,accounting, and other expenses that we did not incur as a private company. As aresult of these increased expenditures, we will have to generate and sustainincreased revenue to achieve and maintain future profitability. While ourrevenue has grown somewhat in recent periods, that growth has not beensignificant and future revenue growth may not be sustainable and we may notachieve sufficient revenue to achieve or maintain profitability. We haveincurred and may continue to incur significant losses in the future for anumber of reasons, including due to the other risks described in this report,and we may encounter unforeseen expenses, difficulties, complications, delays,and other unknown factors. Accordingly, we may not be able to achieve ormaintain profitability and we may continue to incur significant losses for theforeseeable future.

 

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***The market for on-demand Web Applications may develop moreslowly than we expect.***

 

Our success will depend,to a large extent, on the willingness of individuals and SMBs to accepton-demand services for Web Applications that they view as critical to thesuccess of their business. Many businesses have invested substantial effort andfinancial resources to integrate traditional enterprise software into theirbusinesses and may be reluctant or unwilling to switch to a differentapplication or to migrate these applications to on-demand Web Applications.

 

Other factors that mayaffect market acceptance of our Web Applications include our ability to:

 

·                    minimizethe time and resources required to implement products from the EtelosMarketplace;

 

·                    maintainhigh levels of customer satisfaction;

 

·                    implementupgrades and other changes to our products without disrupting our service;and/or

 

·                    providerapid response time during periods of intense activity on customer websites.

 

In addition, marketacceptance of our Web Applications may be affected by:

 

·                    thesecurity capabilities, reliability, and availability of on-demand services;

 

·                    customerconcerns with entrusting a third party to store and manage their data,especially confidential or sensitive data;

 

·                    thelevel of customization or configuration we offer; and/or

 

·                    theprice, performance, and availability of competing products and services.

 

The market for ourproducts may not develop further, or it may develop more slowly than we expect,either of which would harm our business.

 

***The market in which we participate is intensely competitive,and if we do not compete effectively, then our operating results may be harmed.***

 

The market for SaaS on-demandWeb Applications for business is new highly competitive and rapidly changingwith relatively low barriers to entry. With the introduction of newtechnologies and new market entrants, we expect competition to intensify in thefuture. In addition, pricing pressures and increased competition generallycould result in reduced sales, reduced margins, or the failure of our productsto achieve or maintain more widespread market acceptance. Often we offer productsin the Etelos Marketplace that compete against existing systems that ourpotential customers have already made significant expenditures to install.Competition in our market is based principally upon service breadth andfunctionality; service performance, security and reliability; ability to tailorand customize services for a specific company, vertical or industry; ease ofuse of the service, speed and ease of deployment, integration and configuration;total cost of ownership, including price and implementation and support costs;professional services implementation; and financial resources of the vendor.

 

We face competition fromboth traditional software vendors and SaaS providers. Many of our actual andpotential competitors enjoy substantial competitive advantages over us, such asgreater name recognition, longer operating histories, more varied products andservices, and larger marketing budgets, as well as substantially greaterfinancial, technical, and other resources. In addition, many of our competitorshave established marketing relationships and access to larger customer bases,and have major distribution agreements with consultants, system integrators,and resellers. If we are not able to compete effectively, then our operatingresults will be harmed.

 

***Our inability to fund our capital to meet our expenditurerequirements may adversely affect our growth and profitability.***

 

Our continued growth isdependent upon our ability to raise capital from outside sources. Our abilityto obtain financing will depend upon a number of factors, including ourfinancial condition and results of operations, the condition of the economy,and conditions in relevant financial markets.  If we are unable to obtainfinancing, as needed, on a timely basis and on acceptable terms, our financialposition, competitive position, growth, and profitability may be adverselyaffected.

 

***We may not be able to effectively control and manage ourgrowth.***

 

If our business andmarkets grow and develop, then it will be necessary for us to finance andmanage expansion in an orderly fashion. In addition, we may face challenges inmanaging expanding product offerings and in integrating acquired businesseswith our own. Such eventualities will increase demands on our existingmanagement, workforce, and facilities. Failure to satisfy such increaseddemands could interrupt or adversely affect our operations and cause longerproduct development time frames and administrative inefficiencies.

 

***We have experienced rapid growth in recent periods. If wefail to manage our growth effectively, then we may be unable to execute ourbusiness plan, maintain high levels of service, or address competitivechallenges adequately.***

 

We have increased ournumber of full-time employees to 46 at June 30, 2008, from 16 at June 30,2007, and have experienced a drop in our revenue for the six months ending June30, to $22 thousand in 2008, from $106 thousand in 2007. Our operating plan hasplaced, and our anticipated growth plan is expected to continue to place, asignificant strain on our managerial, administrative, operational, financial,and other resources. We intend to further expand our overall business, customerbase, headcount, and operations. We will be required to continue to improve ouroperational, financial, and management controls and our reporting proceduresand we may not be able to do so effectively. As such, we may be unable tomanage our expenses effectively in the future, which may negatively impact ourgross margins or operating expenses in any particular quarter.

 

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***Our Customers are individuals, small and medium-sizedbusinesses, and divisions of large companies, which may increase our costs toreach, acquire and retain customers.***

 

We market and sell our products and services and otherofferings in the Etelos Marketplace to individuals, SMBs, and divisions oflarge companies. To grow our revenue quickly, we must add new customers, selladditional services to existing customers, and encourage existing customers torenew their subscriptions. However, selling to and retaining individuals and SMBscan be more difficult than selling to and retaining large enterprises because SMBcustomers tend to be more price sensitive and more difficult to reach withbroad marketing campaigns.  In addition, individuals and SMBs have highchurn rates in part because of the nature of their businesses and often lackthe staffing to benefit fully from our products.  Further, individuals andSMBs often require higher sales, marketing, and support expenditures by vendorsthat sell to them per revenue dollar generated for those vendors.

 

***We depend on a large number of customers.***

 

Our revenue is dependent,in large part, on many orders from a large number of customers. Sales to ourfive largest customers were*de minimus*  during the quarter and six months ended June 30,2008 and 2007, respectively. We believe that revenue derived from the currentand future large number of customers will continue to represent a significantportion of our total revenue.

 

Our inability to secureand maintain a sufficient number of large customers would also have a materialadverse effect on our business, operating results, and financial condition.Moreover, our success will depend in part upon our ability to obtain ordersfrom new customers, as well as the financial condition and success of ourcustomers and general economic conditions.

 

***Our business depends substantially on customers renewing,upgrading, and expanding their subscriptions for products offered in the EtelosMarketplace.***

 

We distribute products inthe Etelos Marketplace pursuant to agreements of varying subscription periods.Our customers have no obligation to renew their subscriptions after theirsubscription period expires, and these subscriptions may not be renewed at thesame or higher levels. Moreover, under specific circumstances, our customersmay have the right to cancel their subscription agreements before they expire.We have limited historical data with respect to rates of customer subscriptionrenewals, upgrades, and expansions so we may not accurately predict futuretrends in customer renewals. Our customers’ renewal rates may decline orfluctuate because of several factors, including their satisfaction ordissatisfaction with the products offered in the Etelos Martketplace, theprices of the service, the prices of services offered by our competitors, orreductions in our customers’ spending levels. If our customers do not renewtheir subscriptions, renew on less favorable terms, or do not purchaseadditional functionality or subscriptions, then our revenue may grow moreslowly than expected or decline and our profitability and gross margins may beharmed.

 

***Many of our customers are price sensitive, and if the pricesthat we or our Marketplace partners charge for subscriptions to products orservices offered in the Etelos Marketplace are unacceptable to our customers,then our operating results will be harmed.***

 

Many of our customers areprice sensitive, and we have limited experience with respect to determining theappropriate prices for our products or services. In addition, we have nocontrol over prices charged by our Marketplace partners for their products orservices offered in the Etelos Marketplace. As the market for our products orservices matures, or as new competitors introduce new products or services thatcompete with ours, we may be unable to renew agreements with existing customersor attract new customers at the same price or based on the same pricing modelas previously used. As a result, it is possible that competitive dynamics inour market may require us to change pricing models or reduce prices, whichcould harm our revenue, gross margin, and operating results.

 

***We may not be able to prevent others from unauthorized useof our patents and other intellectual property, which could harm our businessand competitive position.***

 

Our success depends, inpart, on our ability to protect our proprietary technologies. We own five (5) filedUnited States patent applications covering our technology and we expect to filemore U.S. patent applications in the future. We have filed to protect most ofthose patents in many foreign countries. But the process of seeking patentprotection can be lengthy and expensive and we cannot assure that our patentapplications will result in patents being issued, or that our existing orfuture issued patents will be sufficient to provide us with meaningfulprotection or commercial advantages.

 

We also cannot assurethat our current or potential competitors do not have, and will not obtain,patents that will prevent, limit or interfere with our ability to make, use orsell our technology or operate the Etelos Marketplace.

 

***Our success depends in large part on our ability to protectand enforce our intellectual property rights.***

 

We rely on a combinationof patent, copyright, service mark, trademark, and trade secret laws, as wellas confidentiality procedures and contractual restrictions, to establish andprotect our proprietary rights on a global basis, all of which provide onlylimited protection. We cannot assure you that any patent will issue from ourcurrently pending patent applications in a manner that gives us the protectionthat we seek, if at all, or that any future patents issued to us will not bechallenged, invalidated, or circumvented. Since the filing of some of thesepatent applications may have been, or will be, made after the date of firstsale or disclosure of the subject inventions, patent protection may not beavailable for these inventions outside the United States.  Any patentsthat may issue in the future may not provide sufficiently broad protection orthey may not prove to be enforceable in actions against alleged infringers.Also, we cannot assure you that any future service mark or trademarkregistrations will be issued for pending or future applications or that anyregistered service marks or trademarks will be enforceable or provide adequateprotection of our domestic and foreign proprietary rights.

 

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We have not maintainedoperating controls or logs, or initiated or conducted any forensic, codehistory, ‘genealogy’ or other forms of audit, analysis, processes, training, orcode review of software code incorporated into any Etelos product or in otherproducts offered by others in the Etelos Marketplace. We do not review theintellectual property rights related to products or services offered byMarketplace partners in the Etelos Marketplace. These products may include codesubject to various forms of ‘open source’, ‘copyleft’, or similar licenses thatrequire as a condition of modification or distribution of software subject tosuch license(s) that (i) such software or other software combined ordistributed with such software be disclosed or distributed in source code form,or (ii) such software or other software combined or distributed with suchsoftware, and any related intellectual property,  be licensed on aroyalty-free basis, including for the purposes of making additional copies orderivative works of such software.  This may adversely affect our abilityto patent certain inventions or to license or distribute certain products —whether by open source license or other form of license or right — and mayresult in liability to unknown parties for infringement of their patents orother intellectual property rights. 

 

We require ourMarketplace partners to indemnify us for intellectual property claims but wecannot assure that these agreements will be enforceable.

 

We endeavor to enter intoagreements with our employees and contractors and agreements with parties withwhom we do business to limit access to and disclosure of our proprietaryinformation. The steps we have taken, however, may not prevent unauthorized useor the reverse engineering of our technology. Moreover, others mayindependently develop technologies that are competitive to ours or infringe ourintellectual property. Enforcement of our intellectual property rights alsodepends on our successful legal actions against these infringers, but theseactions may not be successful, even when our rights have been infringed. In addition, the legal standards relating to the validity, enforceability, andscope of protection of intellectual property rights in Internet-relatedindustries are uncertain and still evolving.

 

***Assertions by third parties that we infringe theirintellectual property, whether successful or not, could subject us to costlyand time-consuming litigation or expensive licenses.***

 

The software andtechnology industries are characterized by the existence of a large number ofpatents, copyrights, trademarks, and trade secrets and by frequent litigationbased on allegations of infringement or other violations of intellectualproperty rights. As we face increasing competition, the possibility ofintellectual property rights claims against us may grow; the costs of defendingagainst such claims can be very large. Our technologies may not be able towithstand any third-party claims or rights against their use. Additionally,many of our partner and product agreements require us to indemnify our customersfor certain third-party intellectual property infringement claims, which couldincrease our costs as a result of defending such claims and may require that wepay damages or purchase expensive licenses, if there were an adverse rulingrelated to any such claims. These types of claims could harm our relationshipswith our customers, may deter future customers from subscribing to ourservices, or could expose us to litigation for these claims. Even if we are nota party to any litigation between a customer and a third party, an adverseoutcome in any such litigation could make it more difficult for us to defendour intellectual property in any subsequent litigation in which we are a namedparty.

 

***Any intellectual property rights claim against us or ourcustomers, with or without merit, could be time-consuming, expensive tolitigate or settle, and could divert management attention and financialresources. An adverse determination also could prevent us from offering ourproducts to our customers and may require that we procure or develop substituteservices that do not infringe.***

 

For any intellectualproperty rights claim against us or against our Marketplace partners or customers,we may have substantial direct and indirect costs.  Direct costs caninclude a requirement to pay damages or stop using technology found to be inviolation of a third party’s rights. We may have to purchase a license for thetechnology, which may not be available on reasonable terms, if at all, maysignificantly increase our operating expenses, or may require us to restrictour business activities in one or more respects. As a result, we may also berequired to develop alternative non-infringing technology, which could requiresignificant effort and expense.  Substantial indirect costs also may beexpected in the form of diversion of development and management resources instrategic planning for legal, technology, and business defenses to such claims.

 

***We rely on our management team and need additional personnelto grow our business, and the loss of one or more key employees or ourinability to attract and retain qualified personnel could harm our business.***

*** ***

Our success and futuregrowth depends to a significant degree on the skills and continued services ofour management team, especially Daniel J.A. Kolke, our Chief Technology Officerand Chairman of the Board, and Jeffrey L. Garon, our President and ChiefExecutive Officer. We do not maintain key man insurance on any members of ourmanagement team, including Messrs. Garon or Kolke. Our future success alsodepends on our ability to attract, retain and motivate highly skilledtechnical, managerial, sales, marketing and service and support personnel,including members of our management team. Competition for sales, marketing, andtechnology development personnel is particularly intense in the software andtechnology industries. As a result, we may be unable to successfully attract orretain qualified personnel. Our inability to attract and retain the necessary personnelcould harm our business.

 

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***We do not have key man insurance on our key officers, onwhom we rely for the management of our business.***

 

We depend, to a largeextent, on the abilities and participation of our current management team, buthave a particular reliance upon Daniel J. A. Kolke, our Chief TechnologyOfficer and Chairman of the Board, and Jeffrey L. Garon, our President andChief Executive Officer. The loss of the services of either or both ofMessrs. Kolke or Garon for any reason may have a material adverse effecton our business and prospects. We cannot assure you that the services of eitherMessrs. Kolke or Garon will continue to be available to us, or that wewill be able to find a suitable replacement for either of them. We do not carrykey man life insurance for any key personnel.

 

***We may not be able to hire and retain qualified personnel tosupport our growth and if we are unable to retain or hire such personnel in thefuture, our ability to improve our products and implement our businessobjectives could be adversely affected.***

 

If one or more of oursenior executives or other key personnel are unable or unwilling to continue intheir present positions, we may not be able to replace them easily or at all,and our business may be disrupted and our financial condition and results ofoperations may be materially and adversely affected. Although both Messrs. Kolkeand Garon are under employment agreements, their continued employment cannot beassured.  In addition, competition for senior management and seniortechnology personnel is intense, the pool of qualified candidates is verylimited, and we may not be able to retain the services of our senior executivesor senior technology personnel, or attract and retain high-quality seniorexecutives or senior technology personnel in the future. Such failure couldmaterially and adversely affect our future growth and financial condition.

 

***If we do not effectively expand and train our sales forceand our services and support teams, then we may be unable to add new customersand retain existing customers.***

 

We plan to continue toexpand our sales force and our services and support teams to increase ourcustomer base and revenue. We believe that there is significant competition forsales, service, and support personnel with the skills and technical knowledgethat we require. Our ability to achieve significant revenue growth will depend,in large part, on our success in recruiting, training, and retaining sufficientnumbers of personnel to support our growth. New hires require significanttraining and, in most cases, take significant time before they achieve fullproductivity. Our recent hires and planned hires may not become as productiveas we expect and we may be unable to hire or retain sufficient numbers ofqualified individuals in the markets where we do business. If these expansionefforts are not successful or do not generate a corresponding increase inrevenue, then our business will be harmed.

 

If we are unable tocost-effectively market and sell our products to our target customers, then ourability to grow our revenue quickly and become profitable will be harmed.

 

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***Our quarterly operating results may fluctuate in the future.As a result, we may fail to meet or exceed the expectations of researchanalysts or investors, which could cause our stock price to decline.***

 

Our quarterly operatingresults may fluctuate as a result of a variety of factors, many of which areoutside of our control. Fluctuations in our quarterly operating results may bedue to a number of factors, including the risks and uncertainties discussedelsewhere in this report. Fluctuations in our quarterly operating results couldcause our stock price to decline rapidly, may lead analysts to change theirlong-term model for valuing our common stock, could cause us to face short-termliquidity issues, may impact our ability to retain or attract key personnel, orcause other unanticipated issues. If our quarterly operating results orguidance fall below the expectations of research analysts or investors, thenthe price of our common stock could decline substantially.

 

We believe that ourquarterly revenue and operating results may vary significantly in the futureand that period-to-period comparisons of our operating results may not bemeaningful. You should not rely on the results of one quarter as an indicationof future performance.

 

***We use third-party data centers to support our services. Anydisruption of service at these facilities could interrupt or delay our abilityto deliver our service to our customers.***

 

We host many of ourservices and serve a significant number of our customers from either of twothird-party data center facilities with Network OS and with ServePath, bothlocated in the greater Seattle Washington area. We do not control the operationof these facilities. These facilities may be vulnerable to damage orinterruption from earthquakes, hurricanes, floods, fires, terrorist attacks,power losses, telecommunications failures, and similar events. These facilitiesalso could be subject to break-ins, computer viruses, sabotage, intentionalacts of vandalism and other misconduct. The occurrence of a natural disaster oran act of terrorism, a decision to close the facilities without adequatenotice, or other unanticipated problems could result in lengthy interruptionsin our services.

 

Our data center facilityproviders have no obligation to renew their agreements with us on commerciallyreasonable terms, or at all. If we are unable to renew our agreements with anyfacility provider on commercially reasonable terms, then we may experienceincreased costs or downtime in connection with the transfer to a new datacenter facility.

 

Any errors, defects,disruptions, or other performance problems with our services could harm ourreputation and may damage our customers’ businesses. Interruptions in ourservices might reduce our revenue, cause us to issue credits to customers,subject us to potential liability, cause customers to terminate theirsubscriptions, and harm our renewal rates.

 

***Any significant fluctuation in price of servers or relatedsupport may have a material adverse effect on the cost of our products andservices.***

 

The prices of servers andrelated support are subject to market conditions and generally we do not, anddo not expect to, have long-term contracts with our suppliers for those items.While these items are generally available and we have not experienced anyshortage in the past, we cannot assure you that the necessary servers orsupport will continue to be available to us at prices currently in effect oracceptable to us. The prices for these items have varied significantly in thepast and may vary significantly in the future. Numerous factors, most of whichare beyond our control, influence prices of servers and related support. Thesefactors include general economic conditions, industry capacity utilization,vendor backlogs and delays and other uncertainties.

 

We may not be able toadjust our product prices, especially in the short-term, to recover costincreases in these items. Our future profitability may be adversely affected tothe extent we are unable to pass on higher server and support related costs toour customers.

 

***We may become liable to our customers and lose customers ifwe have defects or disruptions in our products and services or if we providepoor service.***

 

Because we deliverproducts as a service through the Etelos Marketplace, errors or defects in theWeb Applications underlying the service, or a failure of our hostinginfrastructure may make the service unavailable to our customers. Because ourcustomers use the products to manage critical aspects of their business, anyerrors, defects, disruptions in service, or other performance problems with theproducts, whether in connection with the day-to-day operation of the products,upgrades or otherwise, could damage our customers’ businesses. If we have anyerrors, defects, disruptions in service, or other performance problems with theproducts, then customers could elect not to renew their subscriptions or delayor withhold payment to us. As a result, we could lose future sales or customersmay make warranty claims against us or our Marketplace partners, which couldresult in an increase in our provision for doubtful accounts, an increase incollection cycles for accounts receivable, or costly litigation.

 

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***If our security measures are breached and unauthorizedaccess is obtained to a customer’s data, then we may incur significantliabilities, our service may be perceived as not being secure, and customersmay curtail or stop using our products.***

 

The products and serviceswe offer in the Etelos Marketplace involve the storage of large amounts of ourcustomers’ sensitive and proprietary business information. If our securitymeasures are breached as a result of third-party action, employee error,malfeasance, or otherwise, and someone obtains unauthorized access to ourcustomers’ data, then we could incur significant liability to our Marketplacepartners, our customers, and to individuals or businesses whose information wasbeing stored by our customers, our business may suffer and our reputation maybe damaged. Because techniques used to obtain unauthorized access to, or tosabotage, systems change frequently and generally are not recognized untillaunched against a target, we may be unable to anticipate these techniques orto implement adequate preventive measures. If an actual or perceived breach ofour security occurs, then the market perception of the effectiveness of oursecurity measures could be harmed and we could lose sales and customers.

 

***If we are unable to develop new products or services,  sell our products or services into newmarkets, or add Marketplace partners to offer their products or services in theEtelos Marketplace, then our revenue growth will be harmed and we may not beable to achieve profitability.***

 

Our ability to attractnew customers and to increase revenue from existing customers will depend inlarge part on our ability to enhance and improve our existing products and toadd new Marketplace partners to offer these products and services introduce newproducts and services and sell into new markets. The success of any enhancementor new product or service depends on several factors, including the timelycompletion, introduction, and market acceptance of the enhancement, product orservice. Any new product or service offered by a Marketplace partner or that wedevelop or acquire may not be introduced in a timely or cost-effective mannerand may not achieve the broad market acceptance necessary to generatesignificant revenue. Any new markets into which we attempt to sell our productsor services may not be receptive. If we are unable to successfully develop oracquire new products or services, enhance our existing products and services tomeet customer requirements, or sell our products and services into new markets,then our revenue will not grow as expected and we may not be able to achieveprofitability.

*** ***

***When we become subject to Section 404 of theSarbanes-Oxley Act of 2002, if we fail to maintain proper and effectiveinternal controls or are unable to remediate the material weakness in ourinternal controls, then our ability to produce accurate and timely financialstatements could be impaired and investors’ views of us could be harmed.***

 

Ensuring that we haveadequate internal financial and accounting controls and procedures in place sothat we can produce accurate financial statements on a timely basis is a costlyand time-consuming effort that needs to be re-evaluated frequently. Ourinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements in accordance with generally acceptedaccounting principles. We are in the process of documenting, reviewing, andimproving our internal controls and procedures for compliance with Section 404of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, which requiresannual management assessment of the effectiveness of our internal control overfinancial reporting and a report by our independent auditors addressing thisassessment. We will be testing our internal controls for the year ending December 31,2008, and, as part of that documentation and testing, identifying areas forfurther attention and improvement.

 

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During our review for theyear ended December 31, 2007, we identified a material weakness in ourinternal controls. The material weakness relates to the need for accountingpersonnel who possess the skill sets necessary to operate and report as apublic company, and specifically the skills necessary to ensure that adequatereview of critical account reconciliations is performed and that supportingdocumentation is complete, accurate, and in accordance with generally acceptedaccounting principles. We have recruited and are continuing to recruitadditional finance and accounting personnel to address this observation. Webelieve we have made progress in addressing this material weakness and expectto complete the remediation in the next six to fifteen months. If ourremediation efforts are insufficient to address the material weakness or takelonger than we expect, or if additional material weaknesses in our internalcontrols are discovered in the future, then we may fail to meet our futurereporting obligations, our financial statements may contain materialmisstatements and the price of our common stock may decline.

 

Implementing anyappropriate changes to our internal controls may distract our officers andemployees, entail substantial costs to modify our existing processes, and addpersonnel and take significant time to complete. These changes may not,however, be effective in maintaining the adequacy of our internal controls, andany failure to maintain that adequacy, or consequent inability to produceaccurate financial statements on a timely basis, could increase our operatingcosts and harm our business. In addition, investors’ perceptions that ourinternal controls are inadequate or that we are unable to produce accuratefinancial statements on a timely basis may harm our stock price and make itmore difficult for us to effectively market and sell our service to new andexisting customers.

 

***Because we recognize subscription revenue over the term ofthe applicable agreement, the lack of subscription renewals or new serviceagreements may not be reflected immediately in our operating results.***

 

The majority of ourquarterly revenue is attributable to subscription agreements entered intoduring the current and previous quarters. A decline in new or renewed serviceagreements in any one quarter may not be fully reflected in our revenue in thatquarter but will harm our revenue in future quarters. As a result, the effectof significant downturns in sales and market acceptance of our products andservices in a particular quarter may not be fully reflected in our operatingresults until future periods. Our subscription model also can make it difficultfor us to rapidly increase our revenue through additional sales in any period,because revenue from new customers must be recognized over the applicablesubscription term.

 

***Material defects or errors in the software we use to deliverour products and services and the offerings by our Marketplace partners couldharm our reputation, result in significant costs to us, and impair our abilityto sell our services.***

 

The Web Applicationsunderlying the products and services offered in the Etelos Marketplace areinherently complex and may contain material defects or errors, particularlywhen first introduced or when new versions or enhancements are released. Wehave, from time to time, found defects in our products and services, and newerrors in our existing software and services may be detected in the future. Wehave no actual knowledge, but we reasonably expect that the products andservices offered by our Marketplace partners may have similar errors and/ordefects. Any errors or defects that cause interruptions to the availability ofour services could result in:

 

·                                               a reduction in sales or delay in marketacceptance of our services;

 

·                                               sales credits or refunds to ourcustomers;

 

·                                               loss of existing customers and difficultyin attracting new customers;

 

·                                               diversion of development resources;

 

·                                               harm to our reputation; and/or

 

·                                               increased warranty and insurance costs.

 

After the release of ourservices, defects or errors may also be identified from time to time by ourinternal team our Marketplace partners, and by our customers. The costsincurred in correcting any material defects or errors in such products or servicesmay be substantial and could harm our operating results.

*** ***

***Government regulation of the Internet and e-commerce isevolving, and unfavorable changes or our failure to comply with regulationscould harm our operating results.***

 

As Internet commercecontinues to evolve, increasing regulation by super-national, federal, state orlocal government agencies becomes more likely. Increased regulation in the areaof data privacy, and laws and regulations applying to the solicitation,collection, processing, or use of personal or consumer information could affectour customers’ ability to use and share data, potentially reducing demand forWeb-based applications and restricting our ability to store, process, and shareour customers’ data. In addition, taxation of services provided over theInternet or other charges imposed by government agencies or by privateorganizations for accessing the Internet may also be imposed. Any regulationimposing greater fees for Internet access or use or restricting informationexchange over the Internet could result in a decline in the use of the Internetand the viability of Web-based services, which could harm our business andoperating results.

 

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***Privacyconcerns and laws or other regulations may reduce the effectiveness of ourproducts and services and harm our business.***

*** ***

Our customers can use theproducts and services offered in the Etelos Marketplace to store personal oridentifying information regarding their customers and contacts. Super-national,federal, state and other government bodies and agencies have adopted or areconsidering adoption of laws and regulations regarding the collection, use, anddisclosure of personal information obtained from consumers and otherindividuals. The costs of compliance with, and other burdens imposed by, suchlaws and regulations that are applicable to the businesses of our customers maylimit the use and adoption of our products and services and reduce overalldemand.

 

In addition to governmentactivity, privacy advocacy groups and the technology and other industries areconsidering various new, additional, or different self-regulatory standardsthat may place additional burdens on us and our Marketplace partners. If thegathering of personal information were to be curtailed, then Web-basedapplications would be less effective, which may reduce demand for the products andservices offered in the Etelos Marketplace and harm our business.

 

***Our operating results may be harmed if we are required tocollect taxes for our subscription services in jurisdictions where we have nothistorically done so.***

*** ***

We have not collected anysales or other taxes from our customers or remitted any such taxes to anytaxing jurisdiction where we may be required to do so. We have begun ananalysis of this issue but to date have not made any accrual for any potentialliability.  In addition, additional taxing jurisdictions at various local,national and super-national levels may seek to impose sales or other taxcollection obligations on us.  We have not recorded sales or other taxliabilities for the years ended December 31, 2007 or 2006, in respect ofsales or other tax liabilities in any jurisdiction. A successful assertion thatwe should be collecting sales or other taxes on our service could result insubstantial tax liabilities for past sales, discourage customers frompurchasing our products, or otherwise harm our business and operating results.

 

***Changes in financial accounting standards or practices maycause adverse, unexpected financial reporting fluctuations, and harm ouroperating results.***

*** ***

A change in accountingstandards or practices could harm our operating results and may even affect ourreporting of transactions completed before the change is effective. Newaccounting pronouncements and varying interpretations of accountingpronouncements have occurred and may occur in the future. Changes to existing rules orthe questioning of current practices may harm our operating results or the waywe conduct our business.

 

***We may expand by acquiring or investing in other companies,which may divert management’s attention, result in additional dilution to ourstockholders, and consume resources that are necessary to operate and sustainour business.***

*** ***

Although we have noongoing negotiations or current agreements or commitments for any acquisitions,our business strategy may include acquiring complementary products, services,technologies, or businesses. We also may enter into relationships with otherbusinesses to expand our product or service offerings or our ability to provideservice in foreign jurisdictions, which could involve preferred or exclusivelicenses, additional channels of distribution, discount pricing, investments inother companies, or other strategies. Negotiating these transactions can betime-consuming, difficult, and expensive, and our ability to close thesetransactions may often be subject to approvals that are beyond our control.Consequently, these transactions, even if undertaken and announced, may notclose.

 

An acquisition,investment, or business relationship may result in unforeseen operatingdifficulties and expenditures. In particular, we may encounter difficultiesassimilating or integrating the businesses, technologies, products, servicesofferings, personnel, or operations of the acquired companies, particularly ifthe key personnel of the acquired company choose not to work for us, thetarget’s software is not easily adapted to work with ours, or we are unable toretain the customers of any acquired business due to changes in management orotherwise. Acquisitions may also disrupt our business, divert our resources, andrequire significant 

 

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management attention thatwould otherwise be available for operation and development of our business.Moreover, the anticipated benefits of any acquisition, investment, or businessrelationship may not be realized or we may be exposed to unknown liabilities.For one or more of those transactions, we may:

 

·                                               issueadditional equity securities that would dilute our stockholders;

 

·                                               usecash that we may need in the future to operate our business;

 

·                                               incurdebt on terms unfavorable to us or that we are unable to repay;

 

·                                               incurlarge charges or substantial liabilities;

 

·                                               encounterdifficulties retaining key employees of the acquired company or integratingdiverse software codes or business cultures; and/or

 

·                                               becomesubject to adverse tax consequences, substantial depreciation, or deferredcompensation charges.

 

Any of these risks couldharm our business and operating results.

 

***Wemay be subject to taxes and penalties regarding past tax years.***

 

To date, we have notfiled all required federal or state income and franchise tax returns or paid oraccrued any amounts for taxes that might be due on such returns.  Although we believe the amounts due in thisrespect are *de minimus*, because we have incurredsubstantial operating losses which we believe will exceed, in the aggregate,all operating income, no assurances can be given in this regard.  Further, we are in arrears in payment ofemployment related taxes to various tax authorities. We are in contact withthose authorities and are making payments to bring these matters current. Theamounts due in this respect have been accrued and are included in our auditedfinancial statements for the period ending December 31, 2007. However, noassurances can be given that we will not be assessed additional penalties orinterest for failing to make these payments when due.

 

***We maybe subject to other legal claims.***

 

In July 2008, KaufmanBros. L.P. filed suit against us in the United States District Court for theSouthern District of New York (Case No. 08 CV 5716). The complaint arises outof an advisory services agreement, pursuant to which Kaufman Bros. was toprovide us with advisory services in connection with financings and strategictransactions. We notified Kaufman Bros. that we believed it had failed toprovide the required services under the agreement, and that we were thereforeentitled to terminate the agreement for cause. In the suit, Kaufman Bros. wasseeking (i) monetary damages of $400,000 for anticipatory breach of theagreement; (ii) $73,800 in fees allegedly owed in connection with a previouslyclosed financing transaction; (iii) an injunction prohibiting us fromcancelling any shares issued to Kaufman Bros. us Compensation, (iv) adeclaration from the court that we are not entitled to a refund of any feespreviously paid to Kaufman Bros., and (v) a declaration that we are obligatedto pay Kaufman Bros. a commission on any financing or transaction that we enterinto within 18 months following the termination of the agreement. On July 15,2008, Kaufman Bros. voluntarily filed a notice of dismissal without prejudice. Settlementdiscussions were unsuccessful and Kaufman Bros. has re-filed substantially thesame claims in the Supreme Court of New York-County of New York (Index No.08-602239). The Company has been served and is developing its defense plan.

 

**Risks Related to an Investment in our Common Stock.**

** **

***Our officers, directors, and affiliates control us throughtheir positions and stock ownership and their interests may differ from otherstockholders.***

*** ***

As of June 30, 2008,our officers, directors, and affiliates beneficially own approximately 75.5percent of our common stock. As a result, if they act together, they are ableto influence the outcome of stockholder votes on various matters, including theelection of directors and extraordinary corporate transactions, includingbusiness combinations. This concentration could also have the effect ofdelaying or preventing a change in control that could otherwise be beneficialto our stockholders. The interests of our officers, directors, and affiliatesmay differ from other stockholders. Furthermore, the current ratios ofownership of our common stock reduce the public float and liquidity of ourcommon stock which can in turn affect the market price of our common stock.

 

***We are responsible for the indemnification of our officersand directors.***

 

Our articles ofincorporation and bylaws provide for the indemnification of our directors,officers, employees, and agents, and, under certain circumstances, againstcosts and expenses incurred by them in any litigation to which they become aparty arising from their association with or activities on our behalf.Consequently, we may be required to expend substantial funds to satisfy theseindemnity obligations.

 

***The sale of the shares of our common stock acquired inprivate placements could cause the price of our common stock to decline.***

*** ***

The purchasers of our January 2008and April 2008 Debentures and related warrants may, subject to compliancewith Rule 144, rely on the provisions of Rule 144 to resell theshares of our common stock acquired upon the conversion of the debentures andexercise of the warrants.  We have no way of knowing whether or when suchshares may be sold.  Depending upon market liquidity at the time, a saleof shares by such investors at any given time could cause the trading price ofour common stock to decline.  The sale of a substantial number of sharesof our common stock, or anticipation of such sales, could make it moredifficult for us to sell equity or equity-related securities in the future at atime and at a price that we might otherwise wish to effect sales.

 

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***The sale of the shares of our common stock acquired in privateplacements could cause the price of our common stock to decline.***

*** ***

The purchasers of our January 2008and April 2008 Debentures and related warrants, as well as the holders ofour other outstanding convertible notes, may, subject to compliance with Rule 144,rely on the provisions of Rule 144 to resell the shares of our commonstock acquired upon the conversion and exercise of such securities.  Wehave no way of knowing whether or when such shares may be sold.  Dependingupon market liquidity at the time, a sale of shares by such investors at anygiven time could cause the trading price of our common stock to decline. The sale of substantial number of shares of our common stock, or anticipationof such sales, could make it more difficult for us to sell equity orequity-related securities in the future at a time and at a price that we mightotherwise wish to effect sales.

 

In addition, in connectionwith our January 2008 and April 2008 Debentures, in the aggregate, weissued a total of $5.5 million principal amount of convertible debentures,convertible into 4,074,074 shares of our common stock, and warrants to purchasean additional 611,111 shares of our common stock.  We have agreed toregister for resale by the investors the shares of common stock issuable uponthe conversion of the debentures and the exercise of the warrants we issued inthose private placements.  We are also registering for resale 586,667shares of common stock issuable upon conversion of notes issued in September 2007. The conversion or exercise into our common stock and the registration of thatcommon stock could result in a substantial increase in the number of shares inour public float.  Depending upon market liquidity at the time a resale ofour common stock is made by the investors in such private placements, such salecould cause the trading price of our common stock to decline.  Inaddition, the sale of a substantial number of shares of our common stock, or anticipation of such sales, could make it more difficult for us to sellequity or equity-related securities in the future at a time and at a price thatwe might otherwise wish to effect sales.

 

***We have significant indebtedness and agreed to certainrestrictions as a result of our recent private placement of convertible debentures.***

*** ***

We incurred $5.5 millionin principal amount of indebtedness as a result of the issuance of our January 2008and April 2008 Debentures.  The debentures carry substantialcovenants that impose significant restrictions on us, including restrictions againstincurring additional indebtedness, creating any liens on our property, amendingour certificate of incorporation or bylaws, redeeming or paying dividends onshares of our outstanding common stock, and entering into certain related partytransactions.  The debentures also carry substantial covenants that imposesignificant requirements on us, including, among others, requirements that:

 
| · |   | we pay interest and  other charges on the debentures;                                                                                                                                                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                      |
| · |   | we use the proceeds  from the sale of the debentures only for permitted purposes;                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                      |
| · |   | while the debentures  are outstanding, if we issue equity or equity linked securities at a price  lower than the conversion price of the debentures, then the conversion price  of the debentures will be reduced to the same price of the equity or equity  linked securities so issued; |
|   |   |                                                                                                                                                                                                                                                                                      |
| · |   | we keep reserved out of  our authorized shares of common stock sufficient shares to satisfy our  obligation to issue shares on conversion of the debentures and the exercise  of the related warrants issued in connection with the sale of the debentures;                               |
|   |   |                                                                                                                                                                                                                                                                                      |
| · |   | we may not, directly or  indirectly, redeem, purchase or otherwise acquire any capital stock or set  aside any monies for such redemption, purchase or other acquisition.                                                                                                                 |

 

Our ability to complywith these provisions may be affected by changes in our business condition orresults of our operations, or other events beyond our control.  The breachof any of these covenants could result in a default under the debentures,permitting the holders thereof to accelerate the maturity of the debentures anddemand repayment in full.  Such actions by such holders could impair our abilityto operate or cause us to seek bankruptcy protection.

 

***Certain covenants we agreed to in connection with thedebentures may impair our ability to issue additional debt or equity.***

*** ***

Our January 2008 andApril 2008 Debentures impose significant covenants on us, some of whichmay impair our ability to issue additional debt or equity, if necessary. For example, the investors in our April 2008 Debentures have the right toparticipate in any financing we undertake through the date that is the 12 monthanniversary of the effectiveness of the registration statement we agreed tofile for the re-sale of our shares of common stock issuable upon conversion andexercise of our April 2008 Debentures.

 

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***If we pay interest or principal on the debentures in sharesof common stock when our stock price is low, the holders thereof have theability to negatively affect our stock price and to create a greater dilutionto our stockholders.***

*** ***

We have the right to payinterest and monthly principal payments in cash, or upon notice to the holdersand compliance with certain equity conditions, including having a currentlyeffective registration statement covering the shares of common stock issuableupon conversion of the debentures, we can pay all or a portion of any suchpayment in common stock valued at a price equal to the lesser of the theneffective conversion price or 85 percent of the average of the VWAP per shareas reported on Bloomberg for our common stock for the 10 consecutive tradingdays immediately prior to the applicable payment date.  To the extent thatwe pay principal or interest in common stock during a period when our commonstock price is low, such investor will receive a larger number of shares of ourcommon stock as a result of the conversion, which such investor could sell athigh volumes to drive the VWAP downward.  Downward pressure on the priceof our common stock from consecutive conversions could result in the investorsreceiving payment on the debentures at successively lower conversion rates,thereby causing a successively greater dilution of our stockholders, andcausing a downward spiraling affect on the price of our stock (a so-called “deathspiral”).  Further, to the extent that conversion of the debenturerequires us to issue more shares of common stock, we are obligated to registerthe additional shares of stock under a new registration statement.

 

***Our failure to secure registration of the common stock couldresult in substantial liquidated damages.***

*** ***

Under the terms of theregistration rights agreements we entered into with the investors in connectionwith our January 2008 and April 2008 Debentures, we agreed to file aregistration statement covering the resale of the shares of common stockunderlying the securities we sold in such private placements, and to maintainthe effectiveness of the registration statements (subject to certainlimitations) for a period of time until the holders can sell the underlyingcommon stock without volume restrictions under Rule 144 of the SecuritiesAct.  If the registration statement is not declared effective within anagreed to time period, or if we fail to maintain the effectiveness of theregistration statement, we are required to pay to the investors partialliquidated damages. Since the registration statement was effective on July 31,2008, after the deadline in the registration rights agreement, we may be liablefor liquidated damages, in the amount of $14.7 thousand, which we have accruedas a liability.

 

***Our failure to repay the January 2008 andApril 2008 Debentures could result in substantial penalties against us,and legal action which could substantially impair our operations.***

*** ***

The debentures we issuedrequire monthly principal payments equal to 1/18th of the principal amount dueunder each debenture.  The debentures accrue interest at the rate of 6percent per annum, payable quarterly and on each monthly principal payment. We have the right to pay interest and monthly principal payments in cash, orupon notice to the holders and compliance with certain equity conditions, wecan pay all or a portion of any such payment in common stock.  To repaythe debentures in cash, we will be required to use our limited working capitalor raise additional funds.  If we are unable to repay the debentures whenrequired, either in cash or in common stock, the holders could commence legalaction against us.  Any such action could impose significant costs on usand require us to curtail or cease operations.

 

In addition, January 2008and April 2008 Debentures define certain events of default, includingwithout limitation failure to make a payment obligation, failure to observeother covenants of the debenture or related agreements (subject to applicablecure periods), breach of representation or warranty, bankruptcy, default underanother significant contract or credit obligation, delisting of our commonstock, a change in control, failure secure and maintain an effectiveregistration statement covering the resale of the common stock underlying thedebentures and the warrants, or failure to deliver share certificates in atimely manner. In the event of default, which is not cured within specified graceperiods, the holders of the debentures have the right to accelerate all amountsoutstanding under the debentures and demand payment of a mandatory defaultamount equal to 130 percent of the amount outstanding under the debenture, plusaccrued interest and expenses.  If we were unable to repay the mandatorydefault amount when required, the holders could commence legal action againstus.  Any such action could impose significant costs on us and require usto curtail or cease operations.

 

***If we need additional financing in the future and arerequired to issue securities which are priced at less than the conversion priceof our debentures or the exercise price of warrants sold in our recent privateplacements, it will result in additional dilution.***

 

Our January 2008 andApril 2008 Debentures and the related warrants contain provisions thatwill require us to reduce the conversion price and exercise price, as the casemay be, if we issue additional securities while such debentures or warrants areoutstanding which contain purchase prices, conversion prices or exercise pricesless than the conversion price of our January 2008 or April 2008 Debenturesor the exercise price of the warrants.  If this were to occur, currentinvestors, other than the investors in our recent private placements, wouldsustain material dilution in their ownership interest.

 

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***The market price of our securities could be adverselyaffected by sales of registered and restricted securities.***

*** ***

Actual sales or theprospect of future sales of shares of our common stock pursuant to a prospectusor under Rule 144 may have a depressive effect upon the price of, andmarket for, our common stock.  As of June 30, 2008, 23,052,624 sharesof our common stock were issued and outstanding, of which 17,695,634 are “restrictedsecurities” and under some circumstances may, in the future, be under aregistration under the Securities Act or in compliance with Rule 144adopted under the Securities Act.  In general, under Rule 144,subject to the satisfaction of other conditions, a person who has beneficiallyowned restricted shares of common stock for at least one year is entitled tosell, within any three month period, a number of shares that does not exceedthe greater of 1 percent of the total number of outstanding shares of the sameclass; or if the common stock is quoted on NASDAQ or a stock exchange, theaverage weekly trading volume during the four calendar weeks immediatelypreceding the sale.  We cannot predict what effect, if any, that sales ofshares of common stock, or the availability of these shares for sale, will haveon the market prices prevailing from time to time.  Nevertheless, thepossibility that substantial amounts of common stock may be sold in the publicmarket may adversely effect prevailing prices for our common stock and couldimpair our ability to raise capital in the future through the sale of equitysecurities.

 

In addition to the17,695,634 shares of “restricted securities” that were issued and outstandingas of June 30, 2008, we have filed a registration statement seeking toregister for resale an aggregate of 1,906,557 shares of our common stock. Theadditional overhang represented by these registered securities could also havea depressive effect on the public trading price of our common stock.

 

***Anti-takeover provisions contained in our amended andrestated certificate of incorporation and amended and restated bylaws, as wellas provisions of Delaware law, could impair a takeover attempt.***

*** ***

Our amended and restatedcertificate of incorporation, amended and restated bylaws and Delaware lawcontain provisions that could have the effect of rendering more difficult ordiscouraging an acquisition deemed undesirable by our board of directors. Ourcorporate governance documents include provisions:

 

·                                               authorizingblank check preferred stock, which could be issued with voting, liquidation,dividend, and other rights superior to our common stock;

 

·                                               limitingthe liability of, and providing indemnification to, our directors and officers;

 

·                                               limitingthe ability of our stockholders to call and bring business before specialmeetings;

 

·                                               requiringadvance notice of stockholder proposals for business to be conducted atmeetings of our stockholders and for nominations of candidates for election toour board of directors;

 

·                                               controllingthe procedures for the conduct and scheduling of board and stockholdermeetings; and

 

·                                               limiting,generally, the filling of vacancies or newly created seats on the board to ourboard of directors then in office.

 

These provisions, aloneor together, could delay hostile takeovers and changes in control or changes inour management.

 

Any provision of ouramended and restated certificate of incorporation or bylaws or Delaware lawthat has the effect of delaying or deterring a change in control could limitthe opportunity for our stockholders to receive a premium for their shares ofour common stock, and could also affect the price that some investors arewilling to pay for our common stock.

*** ***

***Significant amounts of our outstanding common stock will beavailable for resale into the market, which could potentially cause the marketprice of our common stock to drop significantly, even if our business is doingwell.***

*** ***

As of June 30, 2008,we had 23,052,624 shares of common stock issued and outstanding held byapproximately 145 shareholders of record, including 5,010,000 shares that wereissued pursuant to the court approved plan of reorganization.  The sharesissued under the plan of reorganization are freely tradable securities. The market price of our common stock could drop significantly if the holders ofthese shares sell them or are perceived by the market as intending to sell themin an excessive amount relative to the market demand for our shares. Anexcessive sale of our shares may result in a substantial decline in the priceof our common stock and limit our ability to raise capital, even if ourbusiness is doing well.

 

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***We may issue additional shares of our capital stock,including through convertible debt securities, to finance future operations orcomplete a business combination, which would reduce the equity interest of ourstockholders and could cause a change in control of our ownership.***

 

Although we have nocommitments as of the date of this report to issue any additional securities,we may issue a substantial number of additional shares of our common stock orpreferred stock, or a combination of both, including through convertible debtsecurities, to finance future operations.  We may not be able to obtainadditional debt or equity financing on favorable terms, if at all.  If weengage in debt financing, then we may be required to accept terms that restrictour ability to incur additional indebtedness and force us to maintain specifiedliquidity or other ratios.

 

Further, the issuance ofadditional shares of our common stock or any number of shares of preferredstock, including upon conversion of any debt securities, may:

 
| ·                                                                                                              |   | significantly reduce  the equity interest of our current stockholders;                                                                                                                                                                                                                    |
|---------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | cause a change in  control if a substantial number of our shares of common stock or voting  preferred stock are issued, which may affect, among other things, our ability  to use our net operating loss carry-forwards, if any, and could also result  in a change in management; and/or |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | adversely affect  prevailing market prices for our common stock.                                                                                                                                                                                                                          |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| If we need additional  capital and cannot raise it on acceptable terms, we may not be able to, among  other things: |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | develop or enhance our  products and services;                                                                                                                                                                                                                                            |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | continue to expand our  development, sales and marketing organizations;                                                                                                                                                                                                                   |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | acquire complementary  technologies, products or businesses;                                                                                                                                                                                                                              |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | expand operations;                                                                                                                                                                                                                                                                        |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | hire, train and retain  employees; and/or                                                                                                                                                                                                                                                 |
|                                                                                                                |   |                                                                                                                                                                                                                                                                                      |
| ·                                                                                                              |   | respond to competitive  pressures or unanticipated working capital requirements.                                                                                                                                                                                                          |

 

Although we have nocommitments as of the date hereof to issue any additional securities, we mayissue a substantial number of additional shares of our common stock orpreferred stock, or a combination of both, including through convertible debtsecurities, to finance future operations or complete a businesscombination.  The issuance of additional shares of our common stock or anynumber of shares of preferred stock, including upon conversion of any debtsecurities:

 
| · |   | may significantly  reduce the equity interest of our current stockholders;                                                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                        |
| · |   | will likely cause a  change in control if a substantial number of our shares of common stock or  voting preferred stock are issued and could also result in a change in  management; and/or |
|   |   |                                                                                                                                                                                        |
| · |   | may adversely affect  prevailing market prices for our common stock.                                                                                                                        |

 

***The 2007 Stock Incentive Plan and all options issued underthe 2007 Stock Incentive Plan contain provisions for acceleration of allunvested options in the event of a change of control, which might be a disincentiveto acquisition of the Company as a liquidation strategy.***

 

The 2007 Stock IncentivePlan and all options currently issued thereunder and options granted outsidesuch plan provides for accelerated vesting of all unvested options in the eventof a change of control, which is defined as an acquisition by a single personof more than 50 percent of the total combined voting power of all of ouroutstanding securities. This may be regarded as a barrier to retention of keyemployees following a change-of-control acquisition and therefore make such anacquisition more costly or difficult, and therefore an unattractive strategicoption, for a prospective acquiror.

 

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***We have never paid dividends on our capital stock and we donot anticipate paying any cash dividends in the foreseeable future.***

 

We have paid no cashdividends on any of our classes of capital stock to date and we currentlyintend to retain our future earnings, if any, to fund the development andgrowth of our business.  In addition, the terms of the Notes prohibit usfrom making any dividend payment or distribution to holders of our common stockwhile any portion of the Notes remain outstanding.  As a result, capitalappreciation, if any, of our common stock will be your sole source of gain forthe foreseeable future.

 

***Our securities may be thinly traded on the Over-the-CounterBulletin Board, which may not provide liquidity for our investors.***

 

Our common stock isquoted on the Over-the-Counter Bulletin Board. The Over-the-Counter BulletinBoard is an inter-dealer, over-the-counter market that provides significantlyless liquidity than the NASDAQ Stock Market or other national or regionalexchanges. Securities traded on the Over-the-Counter Bulletin Board are usuallythinly traded, highly volatile, have fewer market makers, and are not followedby analysts.

 

The SEC’s order handlingrules, which apply to NASDAQ-listed securities, do not apply to securitiesquoted on the Over-the-Counter Bulletin Board. Quotes for stocks included onthe Over-the-Counter Bulletin Board may not be listed in newspapers. Therefore,prices for securities traded solely on the Over-the-Counter Bulletin Board maybe difficult to obtain and holders of our securities may be unable to reselltheir securities at or near their original acquisition price, or at any price.

 

***Investors must contact a broker-dealer to tradeOver-the-Counter Bulletin Board securities. As a result, you may not be able tobuy or sell our common stock at the times that you may wish.***

 

Even though our commonstock is quoted on the Over-the-Counter Bulletin Board, the Over-the-CounterBulletin Board may not permit our investors to sell securities when and in themanner that they wish. Because there are no automated systems for negotiatingtrades on the Over-the-Counter Bulletin Board, they are conducted viatelephone. In times of heavy market volume, the limitations of this process mayresult in a significant increase in the time it takes to execute investororders. Therefore, when investors place market orders to buy or sell a specificnumber of shares at the current market price it is possible for the price of astock to go up or down significantly during the lapse of time between placing amarket order and its execution.

 

***Our stock price may be volatile and you may not be able tosell your shares for more than what you paid.***

 

Our stock price is likelyto be subject to significant volatility and you may not be able to sell sharesof common stock at or above the price you paid for them. The market price ofthe common stock could continue to fluctuate in the future in response tovarious factors including, but not limited to: quarterly variations inoperating results; our ability to control costs and improve cash flow;announcements of technological innovations or new products by us or ourcompetitors; changes in investor perceptions; and new products or produceenhancements by us or our competitors. The stock market in general hascontinued to experience volatility, which may further affect our stock price.As such, you may not be able to resell your shares of common stock at or abovethe price you paid for them.

 

***Our common stock is likely to be subject to penny stockrules.***

 

Our common stock issubject to Rule 15g-1 through 15g-9 under the Securities Exchange Act of1934, as amended, or the “Exchange Act,” which imposes certain sales practicerequirements on broker-dealers which sell our common stock to persons otherthan established customers and “accredited investors” (generally, individualswith net worths in excess of $1 million or annual incomes exceeding $200thousand (or $300 thousand together with their spouses)).  Fortransactions covered by this rule, a broker-dealer must make a specialsuitability determination for the purchaser and have received the purchaser’swritten consent to the transaction prior to the sale.  This rule adverselyaffects the ability of broker-dealers to sell our common stock and purchasersof our common stock to sell their shares of such common stock. Additionally, our common stock is likely to be subject to the SEC regulationsfor “penny stock.”  Penny stock includes any equity security that is notlisted on a national exchange and has a market price of less than $5.00 pershare, subject to certain exceptions.  The regulations require that priorto any non-exempt buy/sell transaction in a penny stock, a disclosure scheduleset forth by the SEC relating to the penny stock market must be delivered tothe purchaser of such penny stock.  This disclosure must include theamount of commissions payable to both the broker-dealer and the registeredrepresentative and current price quotations for the common stock.  Theregulations also require that monthly statements be sent to holders of pennystock which disclose recent price information for the penny stock andinformation of the limited market for penny stocks.  These requirementsadversely affect the market liquidity of our common stock.

 

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***We will incur increased costs and demands upon management asa result of complying with the laws and regulations affecting public companies,which could harm our operating results.***

 

As a public company, wewill incur significant legal, accounting, and other expenses that we did notincur as a private company, including costs associated with public companyreporting requirements. We also have incurred and will incur costs associatedwith current corporate governance requirements, including requirements under Section 404and other provisions of the Sarbanes-Oxley Act, as well as rules implementedby the SEC. The expenses incurred by public companies for reporting andcorporate governance purposes have increased dramatically. We expect these rules andregulations to substantially increase our legal and financial compliance costsand to make some activities more time-consuming and costly. We are unable tocurrently estimate these costs with any degree of certainty. We also expectthese new rules and regulations may make it more difficult and moreexpensive for us to obtain director and officer liability insurance, and we maybe required to accept reduced policy limits and coverage or incur substantiallyhigher costs to obtain the same or similar coverage than used to be available.As a result, it may be more difficult for us to attract and retain qualifiedindividuals to serve on our board of directors or as our executive officers.

 

**ITEM2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

**ITEM5.  OTHER INFORMATION**

 

None

 

**ITEM6.  EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                 |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1*                |       | Certification of  Periodic Report by the Principal Executive Officer, Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                          |
| 31.2*                |       | Certification of  Periodic Report by the Principal Financial Officer, Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                          |
| 32.1*                |       | Certification of  Principal Executive Officer pursuant to 18 U.S.C, Section 1350, adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.            |
| 32.2*                |       | Certification of  Principal Financial Officer pursuant to 18 U.S.C,  Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

 

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*  Filed as an exhibit to this report

 

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**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 

 
| August 18, 2008 | ** ** | **ETELOS,  INC.**                                                                 |
|----------------------|------------|-----------------------------------------------------------------------------------|
|                 |       |                                                                              |
|                 | By:        | /s/ David S.G.  MacKenzie                                                         |
|                 |       | David S.G. MacKenzie                                                              |
|                 |       | Vice  President & Chief Financial Officer and   Chief Accounting Officer |

 

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