**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 March 31, 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’s telephonenumber)

 

**TripathTechnology, Inc.**

**46560Fremont Blvd., Suite 109, Fremont, CA 94538**

**FormerFiscal Year – September 30**

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

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or For such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirementsfor the 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"large accelerated filer," "accelerated filer," and"smaller reporting company" in Rule 12b-2 of the Exchange Act. (Checkone):

 
| 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 March  31,  2008, the registrant had outstanding 7,540,413 shares of $0.01 par value  common stock, its only class of common equity. |
|---------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

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EXPLANATORY NOTE

 

On April 23, 2008,Tripath Technology Inc., a Delaware corporation (“Tripath”), filed a CurrentReport on Form 8-K announcing, among other things, that Etelos,Incorporated, a Washington corporation (“Etelos-WA”), merged with and intoTripath (the “Merger”), and that the surviving corporation changed its name toEtelos, Inc. and its fiscal year to December 31.  The effectivedate of the Merger was April 22, 2008 and Etelos, Inc., as thesurviving corporation, will conduct the business and operations previouslyconducted by Etelos-WA.  Accordingly, the transaction was accounted for asa reverse merger; the description of the business contained in this report aswell as the one contained in the financial statements reflect the operations ofEtelos-WA for the quarterly period ended March 31, 2008.

 

In connection with theMerger, all outstanding shares of Etelos-WA common stock were converted intoshares of Etelos, Inc. common stock on a three for one ratio: one share ofEtelos Inc. common stock for every three shares of common stock ofEtelos-WA.  Information concerning numberof shares outstanding for Etelos-WA, including the conversion prices and numberof shares issuable upon conversion of preferred stock and other convertiblesecurities, has been adjusted to reflect this conversion ratio as if it hadoccurred at the beginning of the quarterly period.

 

Also in connection withthe Merger, (i) all outstanding shares of preferred stock of Etelos-WAwere converted in to shares of common stock of Etelos, Inc., and (ii) Etelos, Inc.issued an aggregate of 5,010,000 shares of its common stock to the secured andunsecured creditors of Tripath.  These transactionsare treated in this report as subsequent events.

 

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** **

**TABLE OF 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 | 12 |
| Item 3.                                       |       | Quantitative  and Qualitative Disclosure About Market Risk | 22 |
| Item 4.                                       |       | Controls and Procedures | 22 |
|                                          |       |   |
| **Part II — Other  Information**    |       |
|                                          |       |   |
| Item 1.                                       |       | Legal Proceedings | 23 |
| Item 1A.                                      |       | Risk Factors | 23 |
| Item 2.                                       |       | Unregistered  Sales of Equity Securities and Use of Proceeds | 38 |
| Item 3.                                       |       | Defaults  Upon Senior Securities | 38 |
| Item 4.                                       |       | Submission  of Matters to a Vote of Security Holders | 38 |
| Item 5.                                       |       | Other Information | 38 |
| Item 6.                                       |       | Exhibits | 38 |

 

----

 

**PART I - FINANCIAL INFORMATION**

 

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

 

**ETELOS, INC.**

**CONDENSED BALANCE SHEETS**

(inthousands, except share data)

(Unaudited)

 
| ** **                                                                                                                                              | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                                                         |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                              |       | $                        | 916        |                        | $          | 928 |   |
| Accounts  receivable, net                                                                                                                               |       | 12                       |       | —                      |       |
| Prepaid expenses  and other current assets                                                                                                              |       | 311                      |       | 21                          |       |
| Total current  assets                                                                                                                                   |       | 1,239                    |       | 949                         |       |
|                                                                                                                                                    |       |                     |       |                        |       |
| Property and  equipment, net                                                                                                                            |       | 79                       |       | 50                          |       |
| Other assets                                                                                                                                            |       | 119                      |       | 41                          |       |
|                                                                                                                                                    |       |                     |       |                        |       |
| **Total  assets**                                                                                                                                       | ** ** | **$**                    | **1,437**  | ** **                  | **$**      | **1,040** | ** ** |
|                                                                                                                                                    |       |                     |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                                             |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                                   |       |                     |       |                        |       |
| Accounts payable                                                                                                                                        |       | 309                      |       | 249                         |       |
| Accounts payable  related parties                                                                                                                       |       | 2                        |       | 56                          |       |
| Accrued payroll  and related expenses                                                                                                                   |       | 649                      |       | 514                         |       |
| Other accrued  expenses                                                                                                                                 |       | 362                      |       | 244                         |       |
| Current portion  notes payable, net of discounts                                                                                                        |       | 4,713                    |       | 3,166                       |       |
| Current portion  notes payable to related parties                                                                                                       |       | 95                       |       | 187                         |       |
| Current portion  capital leases                                                                                                                         |       | 17                       |       | 16                          |       |
| Total current  liabilities                                                                                                                              |       | 6,147                    |       | 4,432                       |       |
|                                                                                                                                                    |       |                     |       |                        |       |
| Long-term notes  payable, net of discounts                                                                                                              |       | 1,252                    |       | 889                         |       |
| Long-term notes  payable to related parties                                                                                                             |       | 651                      |       | 629                         |       |
| Long-term  capital leases                                                                                                                               |       | 32                       |       | 36                          |       |
|                                                                                                                                                    |       |                     |       |                        |       |
| Total  liabilities                                                                                                                                      |       | 8,082                    |       | 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; 22,167 shares issued and outstanding                                                                            |       | —                   |       | —                      |       |
| Series B:  7,500,000 shares authorized; 40,000 shares issued and outstanding                                                                            |       | —                   |       | —                      |       |
| Series C:  20,000,000 shares authorized; 1,482,604 shares issued and outstanding                                                                        |       | 15                       |       | 15                          |       |
| Common stock,  $0.01 par value: 250,000,000 shares authorized; issued and outstanding -  7,540,413 at March 31, 2008 and 6,791,313 at December 31, 2007 |       | 75                       |       | 68                          |       |
| Additional  paid-in capital                                                                                                                             |       | 5,931                    |       | 5,405                       |       |
| Accumulated  deficit                                                                                                                                    |       | (12,666                  | )          | (10,434                     | )          |
| Total  stockholders’ deficit                                                                                                                       |       | (6,645                   | )          | (4,946                      | )          |
|                                                                                                                                                    |       |                     |       |                        |       |
| **Total  liabilities and stockholders’ deficit**                                                                                                   | ** ** | **$**                    | **1,437**  | ** **                  | **$**      | **1,040** | ** ** |

 

The accompanyingnotes are an integral part of these financial statements.

 

1

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**ETELOS, INC.**

**CONDENSED STATEMENTS OF OPERATIONS**

(inthousands, except per share data) 

(Unaudited)

 
| ** **                                                                                        | ** ** | **Three**          | ** ** | **Three**          | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                        | ** ** | **Months**         | ** ** | **Months**         | ** ** |
| ** **                                                                                        | ** ** | **Ended**          | ** ** | **Ended**          | ** ** |
| ** **                                                                                        | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                                        | ** ** | **2008**           | ** ** | **2007**           | ** ** |
| ** **                                                                                        | ** ** | ** **         | ** ** | ** **         | ** ** |
| Revenue                                                                                           |       | $                  | 24         |               | $          | 105 |   |
| Cost of revenue                                                                                   |       | 101                |       | 55                 |       |
| Gross profit  (loss)                                                                              |       | (77                | )          | 50                 |       |
|                                                                                              |       |               |       |               |       |
| Operating  expenses:                                                                              |       |               |       |               |       |
| Research and  development                                                                         |       | 1,193              |       | 262                |       |
| Sales and  marketing                                                                              |       | 293                |       | 72                 |       |
| General and administrative                                                                        |       | 470                |       | 45                 |       |
| Total operating  expenses                                                                         |       | 1,956              |       | 379                |       |
|                                                                                              |       |               |       |               |       |
| Loss from  operations                                                                             |       | (2,033             | )          | (329               | )          |
|                                                                                              |       |               |       |               |       |
| Interest  expense, net                                                                            |       | (199               | )          | (40                | )          |
| Loss before  taxes                                                                                |       | (2,232             | )          | (369               | )          |
|                                                                                              |       |               |       |               |       |
| Provision for  income taxes                                                                       |       | —             |       | —             |       |
|                                                                                              |       |               |       |               |       |
| **Net loss**                                                                                      | ** ** | **$**              | **(2,232** | **)**              | **$**      | **(369** | **)** |
|                                                                                              |       |               |       |               |       |
| Basic and  diluted net loss per share                                                             |       | $                  | (0.30      | )                  | $          | (0.11 | ) |
|                                                                                              |       |               |       |               |       |
| Weighted average  number of common shares used in computing basic and diluted net loss per  share |       | 7,358              |       | 3,502              |       |

 

The accompanyingnotes are an integral part of these financial statements.

 

2

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**ETELOS, INC.**

**CONDENSED STATEMENTS OF CASH FLOWS**

(inthousands) 

(Unaudited)

 
| ** **                                                                                 | ** ** | **Three**          | ** ** | **Three**          | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                 | ** ** | **Months**         | ** ** | **Months**         | ** ** |
| ** **                                                                                 | ** ** | **Ended**          | ** ** | **Ended**          | ** ** |
| ** **                                                                                 | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                                 | ** ** | **2008**           | ** ** | **2007**           | ** ** |
| ** **                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Cash  flows from operating activities:**                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| Net loss                                                                                   |       | $                  | (2,232     | )                  | $          | (369 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |               |       |               |       |
| Depreciation and  amortization                                                             |       | 5                  |       | 3                  |       |
| Amortization of  notes discount                                                            |       | 65                 |       | —             |       |
| Changes in  operating assets and liabilities:                                              |       |               |       |               |       |
| Accounts  receivable, net                                                                  |       | (12                | )          | 7                  |       |
| Prepaid expenses  and other current assets                                                 |       | (290               | )          | (30                | )          |
| Other assets                                                                               |       | (78                | )          | —             |       |
| Accounts payable                                                                           |       | 89                 |       | (7                 | )          |
| Accounts payable  related parties                                                          |       | (54                | )          | (9                 | )          |
| Accrued payroll  and related expenses                                                      |       | 135                |       | 60                 |       |
| Other accrued  expenses                                                                    |       | 118                |       | (22                | )          |
|                                                                                       |       |               |       |               |       |
| **Net  cash used in operating activities**                                                 | ** ** | **(2,254**         | **)**      | **(367**           | **)**      |
|                                                                                       |       |               |       |               |       |
| **Cash  flows from investing activity:**                                                   |       |               |       |               |       |
| Purchases of  property and equipment                                                       |       | (34                | )          | —             |       |
|                                                                                       |       |               |       |               |       |
| **Net  cash used in investing activities**                                                 | ** ** | **(34**            | **)**      | **—**         | ** ** |
|                                                                                       |       |               |       |               |       |
| **Cash  flows from financing activity:**                                                   |       |               |       |               |       |
| Proceeds from  notes payable                                                               |       | 2,000              |       | 362                |       |
| Payment of notes  payable                                                                  |       | (111               | )          | —             |       |
| Proceeds from  (payments of) notes payable to related parties                              |       | (70                | )          | 33                 |       |
| Payment of  capital leases                                                                 |       | (3                 | )          | (3                 | )          |
| Net change in  line of credit                                                              |       | —             |       | (2                 | )          |
| Proceeds from  issuance of common stock                                                    |       | 460                |       | —             |       |
|                                                                                       |       |               |       |               |       |
| **Net  cash provided by financing activities**                                             | ** ** | **2,276**          | ** ** | **390**            | ** ** |
| ** **                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Net  increase (decrease) in cash and cash equivalents**                                  | ** ** | **(12**            | **)**      | **23**             | ** ** |
| ** **                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Cash,  and cash equivalents, beginning of period**                                       | ** ** | **928**            | ** ** | **15**             | ** ** |
| ** **                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Cash,  and cash equivalents, end of period**                                             | ** ** | **$**              | **916**    | ** **         | **$**      | **38** | ** ** |
|                                                                                       |       |               |       |               |       |
| **Supplemental  disclosure of cash flow information:**                                     |       |               |       |               |       |
| Cash paid for  interest                                                                    |       | $                  | 20         |               | $          | — |   |
|                                                                                       |       |               |       |               |       |
| **Supplemental  disclosure of non-cash financing activities:**                             |       |               |       |               |       |
| Issuance of  detachable warrants                                                           |       | $                  | 76         |               | $          | 42 |   |
| Reclassification  of accounts payable to notes payable                                     |       | $                  | 29         |               | $          | — |   |
| Issuance of  convertible debentures for receivables                                        |       | $                  | —     |               | $          | 200 |   |
| Acquisition of  equipment under capital leases                                             |       | $                  | —     |               | $          | 42 |   |

 

The accompanying notes are an integral part of these financialstatements. 

 

3

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**ETELOS,INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

** **

***1.Organization***

*** ***

On April 23,2008, Tripath Technology Inc., a Delaware corporation (“Tripath”), filed aCurrent Report on Form 8-K announcing, among other things, that Etelos,Incorporated, a Washington corporation (“Etelos-WA”), merged with and intoTripath (the “Merger”), and that the surviving corporation changed its name toEtelos, Inc. and its fiscal year to December 31.  The effective date ofthe Merger was April 22, 2008, and Etelos, Inc., as the surviving corporation,will conduct the business and operations previously conducted byEtelos-WA.  Accordingly, the transaction was accounted for as a reversemerger; the description of the business contained in this report as well as theone contained in the financial statements reflect the operations of Etelos-WAfor the quarterly period ended March 31, 2008.

 

As usedherein, unless the context requires otherwise, the terms the “Company,” “we,”“us,” “our” or “Etelos” refers to Etelos, Inc., the corporation that survivedthe Merger.

 

Etelos-WA wasincorporated in the State of Washington on May 6, 1999. Etelos is aleading provider of software productivity solutions that assist organizationsto effectively use Web Applications.  Etelos provides a revolutionarySoftware-as-a-Service ecosystem for building, distributing and using WebApplications, including a marketplace to deploy and support them; givingbusinesses choices in applications, hosting and support services to costeffectively accomplish their goals. Subsequent to the quarter end, Etelos wasre-incorporated in the state of Delaware (Note 10).

 

***2.Basis of Presentation***

*** ***

The unauditedcondensed interim financial statements included herein have been prepared bythe Company in accordance with accounting principles generally accepted in theUnited States of America and reflect all adjustments, consisting of normalrecurring adjustments, which in the opinion of management are necessary tostate fairly the Company’s financial position, results of operations and cashflows for the periods presented. These interim financial statements should beread in conjunction with the financial statements and footnotes thereto for thefiscal years ending December 31, 2007 and 2006, included on Form 8-K filedApril 23, 2008, and Form 8-K/A filed April 25, 2008 by Tripath. The results ofoperations for the three months ended March 31, 2008, are not necessarilyindicative of the results to be expected for any subsequent quarter or for theentire year.

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates, andsuch differences could affect the results of operations reported in futureperiods and such differences could be material.

 

***3.Going Concern***

*** ***

The financialstatements have been prepared by us with the assumption that we will continueas a going concern.  We have experiencedrecurring losses, which raise substantial doubt about our ability to continueas a going concern. Our financial statements do not include any adjustmentsrelating to the recoverability and classification of asset carrying amounts orthe amount and classification of liabilities that might arise should we beunable to continue as a going concern.

 

Management has supported current operations by raisingadditional operating cash through the private sale of convertible debentures.This has provided us with the cash inflows to continue our business plan, buthave not resulted in significant improvement in our financial position.Alternatives to address the cash flow situation include (1) raising capitalthrough additional sale of common stock and/or debentures and (2) reducing cashoperating expenses to levels that are in line with current revenues.

 

The first alternative could result in substantialdilution to existing shareholders. There can be no assurance that our currentfinancial position can be improved, that we can raise additional workingcapital, or that we can achieve positive cash flows from operations. Ourlong-term viability as a going concern is dependent upon our ability to (1)locate sources of debt or equity funding to meet current commitments andnear-term future requirements and (2) achieve profitability and ultimatelygenerate sufficient cash flow from operations to sustain our continuingoperations.

 

***4.Summary of Significant Accounting Policies***

** **

*Cash and Cash Equivalents*

 

Investmentsecurities with maturity of ninety days or less at the time of purchase areconsidered cash equivalents.

 

*Accounts Receivable*

 

Accountsreceivable are recorded at the invoiced amount and generally do not bearinterest. Amounts collected on trade accounts receivable are included in netcash provided by operating activities in the statements of cash flows.

 

4

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*Allowance for Doubtful Accounts*

 

We provide,when appropriate, an allowance for doubtful accounts to ensure tradereceivables are not overstated due to un-collectability. The collectability of ourreceivables is evaluated based on a variety of factors, including the length oftime receivables are past due, indication of the customer’s willingness to pay,significant one-time events, and historical experience. As of March 31,2008, and December 31, 2007, there was no allowance for doubtful accounts.

 

*Deferred Revenue*

 

Deferredrevenue represents money received but not recognized as revenue because thework has not been completed or the software subscription has not been fullydelivered, and therefore is deferred until the work is completed or thesoftware subscription is fully delivered when it is then recognized.  Wedo not have a concentration of risk in any one account as subscriptions tend tobe subscribed to by many individual subscribers as compared to a small numberof large enterprises.

 

*Property and Equipment*

 

Property andequipment are stated at historical cost less accumulated depreciation.Depreciation is computed on a straight-line basis over the estimated usefullives of the assets, which we currently believe to be three years. Fixed assetsare composed of computer equipment with accumulated depreciation of $26.0thousand and $20.0 thousand as of March 31, 2008, and December 31, 2007,respectively.

 

*Fair Value of Financial Instruments*

 

Our balancesheets include the following financial instruments: cash, accounts receivable,accounts payable, and accrued liabilities. We consider the carrying amount ofworking capital items to approximate the fair value for these financialinstruments because of the relatively short period of time between originationof the instruments and their expected realization.

 

*Internal Use Software*

 

We capitalizeinternally developed software costs in accordance with the Statement ofPosition 98-1, “*Accounting for Costs ofComputer Software Developed or Obtained for Internal Use*” (SOP98-1).  We also capitalize software development costs in accordance withSFAS NO. 86, “*Accounting for Costs ofComputer Software to be Sold, Leased or Otherwise Marketed*” (SFAS 86)under which certain software development costs incurred subsequent to theestablishment of the technological feasibility may be capitalized and amortizedover the estimated useful life of the related products.   Theintangible asset costs, if any, are amortized on a straight-line basis over theestimated useful life of the software, once it is available for its intendeduse.  We had fully amortized all internally developed software costs as ofDecember 31, 2006. No expenditures during the three months ending March 31,2008 and 2007 qualified for capitalization.

 

*Revenue Recognition*

 

Revenues arerecognized on licensing transactions and product sales using the criteria inSecurities and Exchange Commission Staff Accounting Bulletin 104, “*Revenue Recognition in Financial Statements*”(SAB 104).  For revenue transactions that involve software or softwarerelated products, we recognize revenue under the guidance established byStatement of Position No. 97-2,**“*Software Revenue Recognition*” (SOP97-2).  Both SAB 104 and SOP 97-2 state that revenue must be recognizedwhen persuasive evidence of an arrangement exists, delivery of the product orperformance of the service has occurred, no significant obligations with regardto implementation or integration exist, the fee is fixed or determinable andcollectability is reasonably assured.  Arrangements for which the fees arenot deemed reasonably assured for collection are recognized upon cashcollection.

 

We provideWeb Applications as a subscription service using the Software-as-a-Service(SaaS) or software-on-demand business model.  Revenues from subscriptionsare generally collected and recognized in the period invoiced.  However,if the subscription collected upon be for more than one period in advance, therevenue is deferred and recognized ratably over the number of excess periodsreflected by the advance payment.

 

5

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* *

*Research and Development*

 

Research anddevelopment expenses consist primarily of salaries, payroll taxes, benefits,and related expenditures for technology, software development, projectmanagement, and support personnel. Costs related to the development of newproducts and enhancements to existing products are expensed as incurred.

 

*Stock Based Compensation*

 

On January 1,2006, we adopted SFAS No. 123 (revised 2004), “*Share-Based Payment*” (FAS 123R), thataddresses the accounting for share-based payment transactions in which anenterprise receives employee services in exchange for equity instruments of theenterprise. The statement eliminates the ability to account for share-basedcompensation transactions, as we formerly did, using the intrinsic value methodas prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock Issued to Employees*,”and generally requires that such transactions be accounted for using afair-value-based method and recognized as expense in our statements ofoperations.

 

Under FAS123(R), we are required to select a valuation technique or option-pricing modelthat meets the criteria as stated in the standard, which includes a latticemodel and the Black-Scholes Merton model. For all new stock based compensationawards granted starting January 1, 2006, and for any modification,cancellation, or repurchase of awards granted prior to January 1, 2006, werecorded compensation cost in the statement of operations based on the fairvalue of the award for the requisite service period. We adopted theBlack-Scholes Merton model. The adoption of FAS 123(R), applying the “modifiedprospective method,” as elected by us, requires us to value stock options as ofJanuary 1, 2006, the first day of our fiscal year 2006. FAS123(R) requires us to estimate forfeitures in calculating the expenserelating to share-based compensation as opposed to only recognizing theseforfeitures and the corresponding reduction in expense as they occur. Thisresulted in $128 and $0 of expense for the quarters ending March 31, 2008 and2007, respectively.

 

FAS123(R) requires the cash flows resulting from the tax benefits resultingfrom tax deductions in excess of the compensation cost recognized for thoseoptions to be classified as financing cash flows. Due to our loss position,there were no such tax benefits during the quarters ended March 31, 2008and 2007. Prior to the adoption of FAS 123(R), those benefits would have beenreported as operating cash flows had we received any tax benefits related tostock option exercises.

 

*Share-Based Compensation Information under FAS No. 123(R)*

* *

Theweighted-average fair value of stock-based compensation is based on the singleoption valuation approach and is estimated on the date of grant using a Black-ScholesMerton based option valuation model. The fair value of forfeitures is anestimate and no dividends have been declared. The fair value of options grantedduring the three months ended March 31, 2008, were calculated based on thefollowing average assumptions:

 

| Estimated fair value     |   | $    | 0.23    |   |
|--------------------------|--------|------|---------|--------|
| Expected lives  in years |   | 7    |    |
| Volatility               |   | 55   | %  |
| Risk-free  interest rate |   | 3.19 | %       |
| Dividend yield           |   | 0    | %       |

 

We used estimatedvolatility of comparable public companies to estimate the expected volatility usedfor the Black-Scholes Merton model. The risk-free interest rate assumption isbased upon the US Treasury yield. We historically have not declared dividendsand therefore the dividend yield was assumed to be zero in the model.

 

*Income Taxes*

 

We accountfor income taxes in accordance with SFAS No. 109, “*Accounting for Income Taxes*” (FAS 109) whichutilizes the liability method of accounting for income taxes. Deferred taxassets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amount of existing assets and liabilities and their respective taxbases. Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. Valuation allowances areestablished when necessary to reduce deferred tax assets to the amountsexpected to be realized.

 

6

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*Net Loss per Share*

 

Basic netloss per share is computed by dividing the net loss available to commonstockholders for the period by the weighted average number of common stockoutstanding during the period. Diluted net loss per share is computed based onthe weighted average number of common stock and dilutive potential common stockoutstanding. The calculation of diluted net loss per share excludes potentialcommon stock if the effect is anti-dilutive. Potential common stock consists ofincremental common stock issuable upon the exercise of stock options, sharesissuable upon conversion of convertible preferred stock, common stock issuableupon the exercise of common stock warrants, and common stock issuable upon theconversion of convertible debentures. As their effect is antidilutive,4,717,333 options and 222,222 warrants have been excluded from thiscalculation.

 

The followingtable sets forth the computation of basic and diluted net loss per share forthe periods presented (in thousands, except per share amounts):

 

| ** **                     | ** ** | **For the three months ended** | ** ** |
|--------------------------------|------------|----------------------------------------------------|------------|
| ** **                     | ** ** | **March 31,**                                 | ** ** |
| ** **                     | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| ** **                     | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Numerator:                     |       |                                               |       |   |   |
| Net loss                       |       | $                                                  | (2,232     | )  | $ | (369 | ) |
|                           |       |                                               |       |   |   |
| Denominator:                   |       |                                               |       |   |   |
| Weighted average  common stock |       | 7,358                                              |       | 3,502 |   |
|                           |       |                                               |       |   |   |
| Net loss per  share:           |       |                                               |       |   |   |
| Basic and  dilubted            |       | $                                                  | (0.30      | ) | $ | (0.11 | ) |

 

*Use of Estimates*

 

Thepreparation of the financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

*Segment Reporting*

* *

We have oneoperating segment because we are not organized into multiple segments for thepurpose of making operating decisions or for assessing performance. The chiefoperating decision maker evaluates performance, makes operating decisions, andallocates resources based on financial data consistent with the presentation inthe accompanying financial statements.

 

***5.Recently Issued Accounting Standards***

*** ***

InJune 2006, the Financial Accounting Standards Board (FASB) issued FASBInterpretation (FIN) No. 48, “*Accountingfor Uncertainty in Income Taxes,*” (FIN 48) which supplementsStatement of Financial Accounting Standard No. 109, “*Accounting for Income Taxes,*” (FAS 109)by defining the confidence level that a tax position must meet in order to berecognized in the financial statements. FIN 48 requires the tax effect of aposition to be recognized only if it is “more-likely-than-not” to be sustainedbased solely on its technical merits as of the reporting date. If a taxposition is not considered more-likely-than-not to be sustained based solely onits technical merits, then no benefits of the position are recognized. If the taxposition is considered more-likely-than-not to be sustained, then the amount torecord is measured at the largest amount of benefit that is greater than 50 percentlikely of being realized upon ultimate settlement. This is a different standardfor recognition than was previously required. The more-likely-than-notthreshold must continue to be met in each reporting period to support continuedrecognition of a benefit. At adoption, companies must adjust their financialstatements to reflect only those tax positions that are more-likely-than-not tobe sustained as of the adoption date. Any necessary adjustment is recordeddirectly to opening retained earnings in the period of adoption and reported asa change in accounting principle. We have not yet adopted FIN 48 but do notexpect it to have a material impact.

 

7

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InSeptember 2006, the Securities and Exchange Commission published StaffAccounting Bulletin No. 108, “*Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*” (SAB 108). The interpretations inSAB 108 are being issued to address diversity in practice in quantifyingfinancial statement misstatements and the potential under current practice tobuild up improper amounts on the balance sheet. This guidance applies to fiscalyears ending after November 15, 2006 and early application in interimperiods is encouraged. The adoption of SAB 108 did not have an effect on the ourfinancial statements.

 

InSeptember 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements,*” (FAS 157) whichdefines fair value, establishes guidelines for measuring fair value, andexpands disclosures regarding fair value measurements. FAS 157 does notrequire any new fair value measurements but rather eliminates inconsistenciesin guidance found in various prior accounting pronouncements. FAS 157 iseffective for fiscal years beginning after November 15, 2007. Earlieradoption is permitted, provided the company has not yet issued financialstatements, including for interim periods, for that fiscal year. We arecurrently evaluating the impact of FAS 157, but do not expect the adoptionof FAS 157 to have a material impact our financial position, results ofoperations, or cash flows.

 

InFebruary 2007,theFASBissuedSFASNo. 159,“*The**Fair**Value**Option**for**Financial**Assets**and**Financial**Liabilities* ” (FAS 159) which permitsentities to choose to measure many financial assets and financial liabilitiesat fair value. Unrealized gains and losses on items for which the fair valueoption has been elected are reported in earnings. FAS 159 is effective forfiscal years beginning after November 15, 2007. We do not expect theadoption of FAS 159 to have a material impact on our financial statements.

 

In December 2007, the FASB issued SFAS No. 141(R), “*Business Combinations”* (FAS 141R), which requires anacquirer to measure the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest in the acquiree at their fair values on theacquisition date, with goodwill being the excess value over the netidentifiable assets acquired, FAS 141R is effective for financial statementsissued for fiscal years beginning after December 15, 2008. We have not yetdetermined the effect on our financial statements, if any, upon adoption of FAS141R.

 

In December 2007, the FASB issued SFAS No. 160, “*Noncontrolling Interests in Consolidated Financial Statements,”*an notital amendment of *ARB No. 51* (FAS160), which clarifies that a noncontrolling interest in a subsidiary should bereported as equity in the consolidated financial statements. The calculation ofearnings per share will continue to be based on income amounts attributable tothe parent. FAS 160 is effective for financial statements issued for fiscalyears beginning after December 15, 2008. We have not yet determined the effecton our financial statements, if any, upon adoption of FAS 160.

 

***6.Stock-based compensation***

** **

The followingtable summarizes stock option activity under the Company’s stock option plans:

 

| Outstanding at  December 31, 2007 |   | 4,097,083 |   |
|-----------------------------------|--------|-----------|--------|
| Granted                           |   | 627,000   |   |
| Exercised                         |   | (3,750    | )      |
| Cancelled                         |   | (3,000    | )      |
| Outstanding at  March 31, 2008    |   | 4,717,333 |   |

 

Total cashreceived as a result of options exercised during the quarter ended March 31,2008 was $225 dollars. There were no equity instruments granted undershare-based payment arrangements and therefore there was no cash used to settleany equity instrument. We do not plan to repurchase any shares during the remainderof 2008.

 

***7.Convertible Debt and Warrant Liability***

 

During the period October 2006 to June 2007, we issued20 percent convertible notes with detachable warrants with a value of $850.0thousand. The notes mature on June 1, 2008, with interest due and payable onOctober 1, 2007, and the last day of each calender quarter thereafter, throughthe maturity date. At our option, upon the closing of a Series D preferred stockoffering having aggregate gross proceeds not less than $7.0 million, excludingthe proceeds collected in connection with this financing, note holders mayelect to convert the outstanding principal and the accrued and unpaid interestinto Series E preferred stock at the purchase price per Series E 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. To supportthis, we are required to reserve, at all the times, the number of authorizedunissued shares such that we have enough shares to issue in the event that theconversion right is exercised.

 

In addition to the notes, the investors receivedwarrants to purchase up to 283,333 shares of our common stock. The warrantscarry an exercise price of $0.09, and terminate upon the earlier of (i) 3 yearsfrom the date of issuance; (ii) a public offering; or (iii) the closing of anacquisition of the Company. As of March 31, 2008, 283,333 of the warrants hadbeen exercised. The warrants were determined to have *de minimus*value at the issuance date.

 

During the period August 2007 to October 2007, weissued 6 percent convertible notes at an original issue discount of 10 percentwith detachable warrants and a face value of $3,326,400. These notes mature onMarch 31, 2009, with interest due and payable on February 1, 2008, and on thelast day of each calendar quarter thereafter. We are required to make paymentson the outstanding principal balance beginning September 1, 2008 and on the 1stday of each calendar quarter thereafter. The default interest rate is 8 percent.There are 1,008,000 detachable warrants, each of which carry an exercise priceof $1.20 and a term of 5 years. At March 31, 2008, 974,667 of the warrants havebeen exercised. The warrants were determined to have *de minimus*value at the issuance date. The notes have the following conversion featuresinto our capital stock: (i) at the our option upon the closing of a referredSeries D round at $0.75 per share, and (ii) mandatory conversion upon; (a)closing of Series E Preferred Stock offering, no later than January 31, 2008,having aggregate gross proceeds to the Company of not less than $5.0 million,(b) closing of public offering at a conversion rate of $0.75 per preferredshare, or (c) a change of 40 percent of the control, at a conversion rate of $0.75per preferred share. The conversion price on these notes has an anti-dilutionprovision and adjustments for stock splits or stock dividends. The conversionfeature also has a reset provision upon a future sale or issuance of equityinstruments at a lower price. The Company analyzed this provision under ETTF 05-04and, although the debt is unconventional, the reset provision is deemed withintheir control and therefore it qualified as equity under ETTF 00-19. TheCompany is obligated to reserve, at all the times, a sufficient number ofauthorized unissued conversion shares. 

 

In addition the investors received 1,008,000 warrantsat an exercise price of $0.12 with a term of 60 months and termination at theearlier of: (i) 5 years, or automatically terminated upon the Company, (ii)public offering, (iii) sale of the Company, or (v) change in control.

 

8

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Theconversion features for both convertible notes issued in the October 2006 andthe August 2007 Private Placements have been evaluated under FAS 150, FAS 133,and EITF 00-19 and are deemed not to be an imbedded derivative and any valueattributable to these features would be classified as equity.

 

Immediately prior to the effective time of the Merger,substantially all of the notes and warrants issued by the Company in the October 2006 and the August 2007Private Placements were converted or exercised, as the case maybe, into shares of common stock of the Company. See Subsequent Events in Note 10 below.

 

January 2008Private Placement

 

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 this transaction as our January 2008 Private Placement.  In this transaction we issued an aggregate of$2.0 million principal amount of debentures and warrants to purchase anaggregate of 222,222 shares of our common stock.  This transaction resulted in net proceeds of$1.9 million. Debt issuance costs of $85.2 thousand were capitalized and areamortized using the effective interest method.

 

The warrants arethree year warrants to purchase shares of our common stock at a price of $1.80per share, subject to adjustment, including full-ratchet anti-dilutionprotection.  As of April 23, 2008, noneof these warrants had been exercised. The warrants were determined to have avalue of $72.5 thousand at issuance, using a Black-Scholes valuation model witha 55 percent volatility and 3.3 percent risk free rate.

 

The following summarizes the terms of the January debentures:

·                                          *Term*. The debentures are due and payable on January 31, 2010.

 

·                                          *Interest*. Interest accrues at the rate of 6 percent per annum and is payablesemiannually on January 1 and July 1, commencing on July 1,2008.

 

·                                          *Monthly Principal Payments*. Monthly principal payments equal to 1/18th of the principal amount beginon the earlier of (i) the 1st of the month that follows the effective dateof the registration statement we filed to cover the resale of the common stockunderlying the debentures, and (ii) November 1, 2008.

 

·                                          *Payments of Principal andInterest*.  We have the right to pay interest and monthlyprincipal payments in cash, or upon notice to the holders and compliance withcertain equity conditions, including having a currently effective registrationstatement covering the shares of common stock issuable upon conversion of thedebentures, we can pay all or a portion of any such payment in common stockvalued at a price equal to the lesser of the then effective conversion price(currently $1.35) or 85 percent of the average of the volume weighted averageprice, or VWAP, per share for our common stock for the 10 consecutive tradingdays immediately prior to the applicable payment date.

 

·                                          *Early Redemption.*  Wehave the option to redeem the debentures before their maturity by payment incash of 120 percent of the then outstanding principal amount plus accruedinterest and other charges.  To redeemthe debentures we must meet certain equity conditions, including having acurrently effective registration statement covering the shares of common stockissuable upon conversion of the debentures. The payment of the debentures would occur on the 10th dayfollowing the date we gave notice to the holders of our intent to redeem thedebentures.  We agreed to honor anynotices of conversion that we receive from a holder before the date we pay offthe debentures.

 

·                                          *Voluntary Conversion by Holder.* The debentures are convertible at anytime at the discretion of theholder at a conversion price per share of $1.35, subject to adjustment includingfull-ratchet anti-dilution protection, and subject to a cap on the beneficialownership of our shares of common stock by the holder and its affiliatesfollowing such conversion.

 

·                                          *Forced Conversion.* Subject to compliance with certain equity conditions, including having acurrently effective registration statement covering the shares of common stockissuable upon conversion of the debentures and subject to the applicable cap onthe beneficial ownership of our shares of common stock by the holder and itsaffiliates following such conversion, we also have the right to forceconversion of the debt if the average of the VWAP for our common stock exceeds$3.39 for 20 trading days out of a consecutive 30 trading day period.

 

9

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The January 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 debentures definecertain events of default, including, without limitation, failure to make apayment obligation, failure to observe other covenants of the debenture or relatedagreements (subject to applicable cure periods), breach of representation orwarranty, bankruptcy, default under another significant contract or creditobligation, delisting of our common stock, a change in control, failure tosecure and maintain an effective registration statement covering the resale ofthe common stock underlying the debentures and the warrants, or failure todeliver share certificates in a timely manner. In the event of default, the holders of the debentures have the right toaccelerate all amounts outstanding under the debenture and demand payment of amandatory default amount equal to 130 percent of the amount outstanding plusaccrued interest and expenses.

 

Inconnection with our January 2008 Private Placement, we also entered into aregistration rights agreement with the institutional investors, pursuant towhich we agreed to file a registration statement covering the resale of theshares of common stock that may be issued to such investors upon the conversionof the debentures, payment in kind, and the exercise of the relatedwarrants.  We agreed to maintain theeffectiveness of the registration statement (subject to certain limitations)for a period of time until the holders can sell the underlying common stockwithout volume restrictions under Rule 144 of the Securities Act of 1933,or the Securities Act. If the registration statement is not declared effectiveby an agreed to date, or if we fail to maintain the effectiveness of theregistration statement, we are required to pay to each investor, as partialliquidated damages, cash equal to 1.0 percent of the aggregate purchase pricepaid by such investor for the securities purchased in the financing and thenheld by such investor, and must pay to such investor 1.0 percent for eachsubsequent 30-day period that the default remains uncured, up to a maximumaggregate liquidated damages amount of 10 percent of the aggregate purchaseprice paid by such investor in our January 2008 Private Placement.  We have determined that it is not probablethat there will be any damages and accordingly have not estimated any provisionfor default.

** **

The conversion featuresfor the convertible notes have been evaluated under FAS 150, FAS 133, and EITF00-19 and have been deemed not to be embedded derivatives. Therefore, any valueattributable would be classified as equity.

*** ***

***8. Notes Payable 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 secured by certain presently unidentified assets of theCompany if and when Daniel J.A. Kolke is no longer an employee nor a member of ourboard 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 $745,500 as of March  31,2008.

 

***9. Credit Facility***

 

In October 2007, weentered into a one year credit facility with Bridge Bank which provides forborrowing of up to $250.0 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 12 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.  There was no borrowing underthis facility during the quarter ending March 31, 2008.

 

***10. Subsequent Events***

 

April 2008Private Placement

 

On April 22, 2008, weentered into a securities purchase agreement with two unaffiliatedinstitutional investors for the sale of 6 percent convertible debentures andcommon stock purchase warrants.  We refer to this transaction as our April 2008Private Placement.  In this transaction we issued $3.5 million ofdebentures plus warrants to purchase an aggregate of up to 129,630 shares of ourcommon stock.  The warrants have a term of three years and an exerciseprice of $1.80 per share, subject to adjustment, including full-ratchetanti-dilution protection.  This transaction resulted in net proceeds to usof $3.4 million.

 

10

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In this report we mayrefer to the debentures we issued in our April 2008 Private Placement as ourApril debentures.  The following summarizes the terms of our April debenturesand is qualified by reference to a copy of the debenture which is filed as anexhibit to our registration statement on Form S-1 filed with the SEC on May 8,2008:

 
| · | * * | *Term*.  The debentures are due and payable on April 30, 2010.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Interest*.  Interest accrues at the rate of 6 percent per annum and is payable  semiannually on January 1 and July 1, commencing on July 1,  2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Monthly  Principal Payments*. Monthly principal payments equal to  1/18th of the principal amount due under each debenture begin on the earlier  of (i) the 1st of the month that follows the effective date of the  registration statement we filed to cover the resale of the common stock  underlying the debentures, and (ii) November 1, 2008.                                                                                                                                                                                                                                                                                                                                                                              |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Payments  of Principal and Interest*. We have the right to pay  interest and monthly principal payments in cash or, upon notice to the  holders and compliance with certain equity conditions, we can pay all or a  portion of any such payment in common stock valued at a price equal to the  lesser of the then effective conversion price (currently $1.35) or 85 percent  of the average of the volume weighted average price, or VWAP, per share for our  common stock for the 10 consecutive trading days immediately prior to the  applicable payment date.                                                                                                                                                              |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Early  Redemption*. We have the option to redeem the debentures  before their maturity by payment in cash of 120 percent of the then  outstanding principal amount plus accrued interest and other charges. To  redeem the debentures we must meet certain equity conditions, including  having an effective registration statement covering the sale by the investors  of the shares of our common stock issued upon conversion of the debentures.  The payment of the debentures would occur on the 10th day following the date  we gave notice to the holders of our intent to redeem the debentures. We  agreed to honor any notices of conversion that we receive from a holder  before the date we pay off the debentures. |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Voluntary  Conversion by Holder*. The debentures are convertible at  anytime at the discretion of the holder at a conversion price per share of  $1.35, subject to adjustment including full-ratchet anti-dilution protection,  and subject to a cap on the beneficial ownership of our shares of common  stock by the holder and its affiliates following such conversion.                                                                                                                                                                                                                                                                                                                                                      |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Forced  Conversion*. Subject to compliance with certain equity  conditions, including having an effective registration statement covering the  sale by the investors of the shares of our common stock issued upon  conversion of the debentures, and subject to the applicable cap on the  beneficial ownership of our shares of common stock by the holder and its  affiliates following such conversion, we also have the right to force  conversion if the average of the VWAP for our common stock exceeds $3.39 for  20 trading days out of a consecutive 30 trading day period.                                                                                                                                           |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Security*.  The debentures are secured by all of our assets under the terms of a security  agreement we entered into with the investors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

The April debenturesimpose certain covenants on us, including restrictions against incurringadditional indebtedness, creating any liens on its property, amending itscertificate of incorporation or bylaws, redeeming or paying dividends on sharesof our outstanding common stock, and entering into certain related partytransactions.  The 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 to 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, the holders of the debentureshave the right to accelerate all amounts outstanding under the debenture anddemand payment of a mandatory default amount equal to 130 percent of the amountoutstanding plus accrued interest and expenses.

 

The warrants we issued inour April 2008 Private Placement, none of which have been exercised to date,are substantially identical to the warrants we issued in our January 2008Private Placement.

 

We have also entered intoan amendment to the registration rights agreement we entered into in connectionwith our January 2008 Private Placement to provide that the registrationstatement we would file to cover the resale of the shares of our common stockthat may be issued upon the conversion of the debentures, payment in kind, andthe exercise of the warrants issued in our January 2008 Private Placement wouldalso include the shares of our common stock that may be issued upon theconversion of the April debentures, payment in kind, and the exercise of therelated warrants. A registration statement was filed May 8, 2008.

 

EquityTransactions

 

During April, 2008 weconverted (i) $750 thousand of convertible notes issued in our October 2006Private Placement into 3,000,000 shares of common stock at a conversion priceof $0.25 per share and (ii) $1,540,911 of 6 percent convertible debtissued in our August 2007 Private Placement into 6,163,644 shares ofcommon stock at $0.25 per share.

 

In connection with theMerger discussed below, in April 2008, 22,167 shares of Series APreferred, 40,000 shares of Series B Preferred and 1,482,604 shares of Series CPreferred were converted into our common stock as follows:

 
| Series A |   | 22,167    |   |
|---------------|--------|-----------|--------|
| Series B |   | 40,000    |   |
| Series C |   | 1,482,604 |   |

 

11

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Reverse MergerTransaction

 

On April 23, 2008,Etelos, Incorporated, a Washington corporation (“Etelos-WA”), merged with andinto Tripath Technology, Inc., a Delaware corporation (the “Merger”).  Prior to the Merger, Tripath Technology, Inc.had been a debtor-in-possession in a Chapter 11 bankruptcy proceeding in theUnited States Bankruptcy Court for the Northern District of California.  In connection with the bankruptcy proceeding,all assets of Tripath were transferred to a trustee for liquidation and allliabilities of Tripath were discharged. Accordingly, at the time of the Merger, Tripath had no assets orliabilities.

 

The surviving corporationin the Merger changed its name to Etelos, Inc. and its fiscal year to December 31. Etelos, Inc., as the surviving corporation, will conduct the business andoperations previously conducted by Etelos-WA.

 

In connection with theMerger, all outstanding shares of Etelos-WA common stock were converted intoshares of Etelos, Inc. common stock on a one for three ratio; one share ofEtelos Inc. common stock for every three shares of common stock ofEtelos-WA.  Also in connection with theMerger, (i) all outstanding shares of preferred stock of Etelos-WA wereconverted in to shares of common stock of Etelos, Inc. and (ii) Etelos, Inc.issued an aggregate of 5,010,000 shares of its common stock to the secured andunsecured creditors of Tripath Technology, Inc. After the transaction,there are 22,719,634 shares of Etelos, Inc. common stock outstanding. As theshareholders of Etelos-WA received the majority of the outstanding shares afterthe transaction, the transaction was accounted for as a reverse merger.Accordingly, the historical financial statement, are those of Etelos-WA.

 

**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF 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, andelsewhere in this report.  In some cases, you can identify forward lookingstatements by terms such as “may,” “intend,” “might,” “should,” “could,” “would,”“expect,” “believe,” “anticipate,” “estimate,” “predict,” “potential,” or thenegative of these terms, and similar expressions are intended to identifyforward-looking statements.  Such statements are subject to certain risksand uncertainties, which could cause actual results to differ materially fromthose projected.  Readers are cautioned not to place undue reliance onthese forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release the result of any revisions tothese forward-looking statements, which may be made to reflect events orcircumstances 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 March 31, 2008.  This discussion and analysisshould be read with the financial statements and financial statement footnotesincluded in this report.

 

**Business**

 

We area leading provider of software solutions that assist organizations toeffectively use Web Applications 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.

 

Wehave developed products for Web Applications, which include openstandards-based tools for Web developers, businesses and individual users suchas the Etelos Application ServerÔ (EASÔ) andthe Etelos Development EnvironmentÔ (EDEÔ).  EAS and EDE support many common programminglanguages and also 

 

12

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supportthe English Application Scripting Engine (EASEÔ), asimple-to-use open standards-based scripting language developed by us.  In order to support broader adoption of ourproducts, EASE and other components of the EDE are provided to developers andusers at market appropriate pricing. This is done to support the development of new Web Applications and themigration of existing Web Applications into the EtelosTM ecosystem where thereare tools and other support mechanisms for the marketing, distribution, salesand support of these applications.  Wegenerally receive a transaction fee, subscription fee or a license fee fortransactions that occur within the Etelos ecosystem via the Etelos MarketplaceÔ.

 

TheEtelos Marketplace supports and encourages communities of developers,distributors, and consumers to expand their offerings, collaborate on new ideasand improvements, and provide scalable solutions using Web Applicationsavailable to others.

** **

**CriticalAccounting Policies Involving Management Estimates and Assumptions**

 

Our discussion andanalysis of our financial condition and results of operations is based on our financialstatements.  In preparing our financial statements in conformity withaccounting principles generally accepted in the United States, we must make avariety of estimates and assumptions that affect the reported amounts of assetsand liabilities, the disclosure of contingent assets and liabilities, and thereported 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.

 

*Allowancefor Doubtful Accounts*

 

We provide, whenappropriate, an allowance for doubtful accounts to ensure that our tradereceivables are not overstated due to un-collectibility. The collectibility of ouraccounts receivables is evaluated based on a variety of factors, including thelength of time receivables are past due, indication of the customer’swillingness to pay, significant one-time events and historical experience.

 

*RevenueRecognition*

 

We recognize revenue inaccordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104,or SAB 104, “*Revenue Recognition inFinancial Statements* “. We recognize revenue when all of thefollowing criteria are met: 1) there is persuasive evidence that anarrangement exists, 2) delivery of goods has occurred, 3) the salesprice is fixed or determinable, and 4) collectibility is reasonablyassured.

 

***InternalUse Software***

 

The Company capitalizesinternally developed software costs in accordance with the Statement ofPosition 98-1, “*Accounting for Costs of Computer SoftwareDeveloped or Obtained for Internal Use*” (SOP 98-1). The Company alsocapitalizes software development costs in accordance with SFAS NO.86, “*Accounting for Costs of Computer Software to be Sold, Leased orOtherwise Marketed*” (FAS 86) under which certain softwaredevelopment costs incurred subsequent to the establishment of the technologicalfeasibility may be capitalized and amortized over the estimated useful life ofthe related products. The intangible asset costs, if any, are amortized on astraight-line basis over the estimated useful life of the Software, once it isavailable for its intended use.

 

Our significantaccounting policies are described in more detail in the notes to financialstatements included elsewhere in this filing.  If actual results differsignificantly from our estimates and projections, then there could be amaterial effect on our financial statements.  Please see “Note 4. Summaryof Significant Accounting Policies” to our financial statements included inthis report.

 

**Resultsof Operations**

 

**Fluctuationsin Operating Results**

 

We are in the earlystages of our operations. Our results of operations are likely to fluctuatefrom period to period.  We anticipate that our quarterly and annualresults of operations will be impacted for the foreseeable future by severalfactors, including the timing and volume of sales of our products.  Due tothese factors, each of which will have a substantial impact on our futureoperations, we believe that the period-to-period comparisons of our operatingresults are not a good indication of our future performance.

 

**ThreeMonths Ended March 31, 2008 Compared with Three Months Ended March 31,2007**

 

**Revenues**

 

Revenues were $23.6thousand and $104.8 thousand for quarters ending March 31, 2008 and 2007,respectively. Revenues decreased by $81.2 thousand, or 77.1 percent, in thethree months ending March 31, 2008, compared to same period in 2007.  The decrease in revenues is due in part toreductions in revenues generated from the sale of newsletters and relatedhosting services.  In addition, as thequarter ending March 31, 2007, was the first quarter of our sales of ourcustomer resource management product, we expected a spike of activity during thatquarter, which was not repeated in the quarter ending March 31, 2008.

 

13

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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 $100.8 thousand and $54.8 thousandfor the quarters ending March 31, 2008 and 2007, respectively. Cost ofrevenue for the first quarter of 2008 increased by $46.0 thousand, or by 83.6percent.  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 quarter of 2008 was 420.8percent and for the corresponding period of 2007 was 52.4 percent.

 

**OperatingExpenses**

 

*Researchand Development.*** **Research and development expenses include primarily employee and employeerelated expenses. Research and development expenses were $1.2 million and $261.5thousand for the quarters ending March 31, 2008 and 2007, respectively.Stated as a percentage of revenues, research and development expense for thecorresponding periods was 5,000 percent and 249.5 percent, respectively. Research and development expenses increased by $938.5 thousand or by 355.3percent, in the first quarter of 2008 compared to the same period in2007.  This increase was primarily due to additional hiring of engineersfor 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 $293.4 thousand and $72.0 thousand for thequarters ending March 31, 2008 and 2007, respectively. The $221.4 thousand,or 306.9 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 122.1 percent and 68.5 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 $469.5 thousand and $45.4 thousand for the quarters ending March 31,2008 and 2007, respectively. The $424.1 thousand, or 931.6 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 1,958.3 percent and 42.9 percent,respectively.

 

**InterestExpense**

 

Net interest expense was$198.8 thousand for the quarter ending March 31, 2008 compared to $40.4thousand for  the comparable period of2007.  The increase in interest expensewas primarily due to multiple rounds of convertible debt financing completedduring 2007.

 

**NetLoss**

 

Our net loss was $2.2million and $368.6 thousand for the quarters ending March 31, 2008  and 2007, respectively, an increase of $1.8million, or 504.9 percent.  The increase in net loss from 2007 to 2008 wasprimarily due to decreased revenue and increased  salaries and otheremployee-related costs incurred during a period of transition in which we weredeeply involved in preparations for completing the reverse merger process.

 

**RecentFinancings**

 

*January 2008Private Placement.*

 

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 this transaction as our January 2008 PrivatePlacement.  In this transaction we issuedan aggregate of $2.0 million principal amount of debentures and warrants topurchase an aggregate of 222,222 shares of our common stock.  This transaction resulted in net proceeds tous of $1.9 million.

 

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Thewarrants are three year warrants to purchase shares of our common stock at aprice of $1.80 per share, subject to adjustment, including full-ratchetanti-dilution protection.  As of April 23,2008, none of these warrants had been exercised.

 

Thefollowing summarizes the terms of our January debentures and is qualifiedby reference to a copy of the debenture which is filed as an exhibit to ourCurrent Report on Form 8-K filed with the Securities and ExchangeCommission, or SEC, on April 23, 2008:

 

·                                          *Term*. The debentures are due and payable on January 31, 2010.

 

·                                          *Interest*. Interest accrues at the rate of 6 percent per annum and is payablesemiannually on January 1 and July 1, commencing on July 1,2008.

 

·                                          *Monthly Principal Payments*. Monthly principal payments equal to 1/18th of the principal amount beginon the earlier of (i) the 1st of the month that follows the effective dateof the registration statement we filed to cover the resale of the common stockunderlying the debentures, and (ii) November 1, 2008.

 

·                                          *Payments of Principal andInterest*.  We have the right to pay interest and monthlyprincipal payments in cash, or upon notice to the holders and compliance withcertain equity conditions, including having a currently effective registrationstatement covering the shares of common stock issuable upon conversion of thedebentures, we can pay all or a portion of any such payment in common stockvalued at a price equal to the lesser of the then effective conversion price(currently $1.35) or 85 percent of the average of the volume weighted averageprice, or VWAP, per share for our common stock for the 10 consecutive tradingdays immediately prior to the applicable payment date.

 

·                                          *Early Redemption.* We have the option to redeem the debentures before their maturity bypayment in cash of 120 percent of the then outstanding principal amountplus accrued interest and other charges. To redeem the debentures we must meet certain equity conditions,including having a currently effective registration statement covering theshares of common stock issuable upon conversion of the debentures.  The payment of the debentures would occur onthe 10th day following the date we gave the holders notice of ourintent to redeem the debentures.  We haveagreed to honor any notices of conversion that we receive from a holder beforethe date we pay off the debentures.

 

·                                          *Voluntary Conversion by Holder.* The debentures are convertible at anytime at the discretion of theholder at a conversion price per share of $1.35, subject to adjustmentincluding full-ratchet, anti-dilution protection, and subject to a cap on thebeneficial ownership of our shares of common stock by the holder and itsaffiliates following such conversion.

 

·                                          *Forced Conversion.* Subject to compliance with certain equity conditions, including having acurrently effective registration statement covering the shares of common stockissuable upon conversion of the debentures and subject to theapplicable cap on the beneficial ownership of our shares of common stock by theholder and its affiliates following such conversion, we also have the right to force conversion if theaverage of the VWAP for our common stock exceeds $3.39 for 20 trading days outof a consecutive 30 trading day period.

 

The January 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 debentures definecertain events of default, including without limitation failure to make apayment obligation, failure to observe other covenants of the debenture orrelated agreements (subject to applicable cure periods), breach ofrepresentation or warranty, bankruptcy, default under another significantcontract or credit obligation, delisting of our common stock, a change incontrol, failure to secure and maintain an effective registration statementcovering the resale of the common stock underlying the debentures and thewarrants, or failure to deliver share certificates in a timely manner.  In the event of default, the holders of thedebentures have the right to accelerate all amounts outstanding under thedebenture and demand payment of a mandatory default amount equal to 130 percentof the amount outstanding plus accrued interest and expenses.

 

Inconnection with our January 2008 Private Placement, we also entered into aregistration rights agreement with the institutional investors, pursuant towhich we agreed to file a registration statement covering the resale of theshares of common stock that may be issued to such investors upon the conversionof the debentures, payment in kind, and the exercise of the relatedwarrants.  We agreed to maintain theeffectiveness of the registration statement (subject to certain limitations)for a period of time until the holders can sell the underlying common stockwithout volume restrictions under Rule 144 of the Securities Act of 1933,or the Securities Act. If the registration statement is not declared effectiveby an agreed to date, or if we fail to maintain the effectiveness of theregistration statement, we are required to pay to each investor, as partialliquidated 

 

15

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damages,cash equal to 1.0 percent of the aggregate purchase price paid by such investorfor the securities purchased in the financing and then held by such investor,and must pay to such investor 1.0 percent for each subsequent 30-day periodthat the default remains uncured, up to a maximum aggregate liquidated damagesamount of 10 percent of the aggregate purchase price paid by such investor inour January 2008 Private Placement.

 

*April 2008Private Placement*

 

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 tothis transaction as our April 2008 Private Placement.  In this transactionwe issued an aggregate of $3.5 million principal amount of debentures andwarrants to purchase an aggregate of up to 388,889 shares of our commonstock.  The warrants have a term of five years and an exercise price of$1.80 per share, subject to adjustment, including full-ratchet anti-dilutionprotection.  This transaction resulted in net proceeds to us of $3.4million.

 

In this report we mayrefer to the debentures we issued in our April 2008 Private Placement asour April debentures.  The following summarizes the terms of our April debenturesand is qualified by reference to a copy of the debenture which is filed as anexhibit to our registration statement on Form S-1 filed with the SEC on May 8,2008:

 
| · | * * | *Term*.  The debentures are due and payable on April 30, 2010.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Interest*.  Interest accrues at the rate of 6 percent per annum and is payable  semiannually on January 1 and July 1, commencing on July 1,  2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Monthly  Principal Payments*. Monthly principal payments equal to  1/18th of the principal amount due under each debenture begin on the earlier  of (i) the 1st of the month that follows the effective date of the  registration statement we filed to cover the resale of the common stock  underlying the debentures, and (ii) November 1, 2008.                                                                                                                                                                                                                                                                                                                                                                              |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Payments  of Principal and Interest*. We have the right to pay  interest and monthly principal payments in cash or, upon notice to the  holders and compliance with certain equity conditions, we can pay all or a  portion of any such payment in common stock valued at a price equal to the  lesser of the then effective conversion price (currently $1.35) or 85 percent  of the average of the volume weighted average price, or VWAP, per share for  our common stock for the 10 consecutive trading days immediately prior to the  applicable payment date.                                                                                                                                                              |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Early  Redemption*. We have the option to redeem the debentures  before their maturity by payment in cash of 120 percent of the then  outstanding principal amount plus accrued interest and other charges. To  redeem the debentures we must meet certain equity conditions, including  having an effective registration statement covering the sale by the investors  of the shares of our common stock issued upon conversion of the debentures.  The payment of the debentures would occur on the 10th day following the date  we gave notice to the holders of our intent to redeem the debentures. We  agreed to honor any notices of conversion that we receive from a holder  before the date we pay off the debentures. |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Voluntary  Conversion by Holder*. The debentures are convertible at  anytime at the discretion of the holder at a conversion price per share of  $1.35, subject to adjustment including full-ratchet anti-dilution protection,  and subject to a cap on the beneficial ownership of our shares of common  stock by the holder and its affiliates following such conversion.                                                                                                                                                                                                                                                                                                                                                      |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Forced  Conversion*. Subject to compliance with certain equity  conditions, including having an effective registration statement covering the  sale by the investors of the shares of our common stock issued upon  conversion of the debentures, and subject to the applicable cap on the  beneficial ownership of our shares of common stock by the holder and its  affiliates following such conversion, we also have the right to force  conversion if the average of the VWAP for our common stock exceeds $3.39 for  20 trading days out of a consecutive 30 trading day period.                                                                                                                                           |
|   | * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| · | * * | *Security*.  The debentures are secured by all of our assets under the terms of a security  agreement we entered into with the investors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

The debentures imposecertain covenants on us, including restrictions against incurring additionalindebtedness, creating any liens on our property, amending our certificate ofincorporation or bylaws, redeeming or paying dividends on shares of ouroutstanding common stock, and entering into certain related partytransactions.  The 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 to 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, the holders of the debentureshave the right to accelerate all amounts outstanding under the debenture anddemand payment of a mandatory default amount equal to 130 percent of the amountoutstanding plus accrued interest and expenses.

 

The warrants we issued inour April 2008 Private Placement, none of which have been exercised to date,are substantially identical to the warrants we issued in our January 2008Private Placement.

 

We also entered into anamendment to the registration rights agreement we entered into in connectionwith our January 2008 Private Placement to provide that the registrationstatement we would file to cover the resale of the shares of common stock thatmay be issued upon the conversion of the debentures, payment in kind, and theexercise of the warrants issued in our January 2008 Private Placement wouldalso include the shares of common stock that may be issued upon the conversionof the April debentures, payment in kind, and the exercise of the relatedwarrants.

 

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As further discussedunder “Liquidity and Capital Resources,” below, we believe our cash balance at March 31,2008, plus the net proceeds derived from our April 2008 Private Placement,is sufficient to fund our operations through at least December 2008. If cash reserves are not sufficient to sustain operations, we plan to raiseadditional capital by selling shares of capital stock or other debt or equitysecurities.  However, there are no commitments or arrangements for futurefinancings in place at this time, and there can be no assurance that suchcapital will be available on favorable terms to us or at all.

 

**Liquidityand Capital Resources**

 

On March 31, 2008,we had $916.4 thousand in cash and cash equivalents, and prepaid expenses andother current assets of $311.0 thousand. Our working capital deficit at March 31,2008 was $4.9 million, compared to a deficit of $3.9 million at March 31,2007.

 

Net cash used byoperating activities during the quarter ended March 31, 2008 was $2.3million, compared to $367.0 thousand during the quarter ended March 31,2007. The primary use of cash from operating activities during the firstquarter of 2008 was operating expenses of $2.0 million.

 

Net cash provided byfinancing activities for first quarter of 2008 was $2.3 million, primarily fromthe issuance of notes.  During the quarter ended March  31,2008, we closed our January private placement further discussed in “Note 7 – Convertible Debt and WarrantLiability”.

 

We believe our cashbalance, including the net proceeds from our April 2008 Private Placement,is sufficient to fund our operations through at least December 2008. If cash reserves and our credit facility are not sufficient to sustainoperations, then we plan to raise additional capital by selling shares of our capitalstock or other securities.  However, there are no commitments orarrangements for future financings in place at this time and we can give noassurance that such capital will be available on favorable terms, or atall.  We may need additional financing thereafter until we can achieveprofitability.  If we cannot, then we will be forced to curtail ouroperations or possibly be forced to evaluate a sale or liquidation of ourassets.  Even if we are successful in raising additional funds, there isno assurance regarding the terms of any additional investment.  Any futurefinancing may involve substantial dilution to existing investors.

 

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**Commitmentsand Contingencies**

 

January Debentures

 

In January 2008, weissued our January debentures with an aggregate principal amount of $2.0million.  As of March 31, 2008, theentire principal amount ($2.0 million) is outstanding and no payments ofprincipal or interest have become due or paid. Under the terms of these debentures, we are to begin making monthlyredemption payments upon the earlier of (i) the 1st of the month thatfollows the effective date of the registration statement we filed to cover theresale of the shares of common stock underlying our January debentures, and (ii) November 1,2008.  The maturity date of thesedebentures is January 31, 2010.  Thetotal monthly principal payment amounts on our January debentures arescheduled to be paid as follows, assuming such payments begin on September 1,2008:

 

**Monthly Principal PaymentAmount**

 
| **Date**  | ** ** | **January  Debentures** | ** **   |
|-----------|------------|-------------------------|--------------|
| 9/1/2008  |       | $                       | 111,111.12   |   |
| 10/1/2008 |       | $                       | 111,111.12   |   |
| 11/1/2008 |       | $                       | 111,111.12   |   |
| 12/1/2008 |       | $                       | 111,111.12   |   |
| 1/1/2009  |       | $                       | 111,111.12   |   |
| 2/1/2009  |       | $                       | 111,111.12   |   |
| 3/1/2009  |       | $                       | 111,111.12   |   |
| 4/1/2009  |       | $                       | 111,111.12   |   |
| 5/1/2009  |       | $                       | 111,111.12   |   |
| 6/1/2009  |       | $                       | 111,111.12   |   |
| 7/1/2009  |       | $                       | 111,111.12   |   |
| 8/1/2009  |       | $                       | 111,111.12   |   |
| 9/1/2009  |       | $                       | 111,111.12   |   |
| 10/1/2009 |       | $                       | 111,111.12   |   |
| 11/1/2009 |       | $                       | 111,111.12   |   |
| 12/1/09   |       | $                       | 111,111.12   |   |
| 1/1/2010  |       | $                       | 111,111.12   |   |
| 1/31/2010 |       | $                       | 111,111.12   |   |
|      |       | $                       | 2,000,000.00 |   |

 

Assumingmonthly principal payments are made in accordance with the schedule set forthabove, the amount of interest to be paid through the January 31, 2010,maturity date is $240 thousand with respect to our January debentures, oron average, $13.3 thousand per month.

 

April Debentures

 

In April 2008,we issued our April debentures with an aggregate principal amount of $3.5million. Under the terms of these debentures, we are to begin making monthlyredemption payments upon the earlier (i) the 1st of the month that followsthe effective date of the registration statement we filed to cover the resale ofthe shares of common stock underlying our April debentures, and (ii) November 1,2008.  The maturity date of thesedebentures is April 30, 2010.  Theaggregate face value of our outstanding debentures is $3.5 million at April 23,2008.  The total monthly principalpayment amounts on our April debentures are scheduled to be paid asfollows, assuming such payments begin on November 1, 2008:

**Monthly Principal PaymentAmount**

 
| **Date**  | ** ** | **April  Debentures** | ** **   |
|-----------|------------|-----------------------|--------------|
| 11/1/2008 |       | $                     | 194,400.00   |   |
| 12/1/2008 |       | $                     | 194,400.00   |   |
| 1/1/2009  |       | $                     | 194,400.00   |   |
| 2/1/2009  |       | $                     | 194,400.00   |   |
| 3/1/2009  |       | $                     | 194,400.00   |   |
| 4/1/2009  |       | $                     | 194,400.00   |   |
| 5/1/2009  |       | $                     | 194,400.00   |   |
| 6/1/2009  |       | $                     | 194,400.00   |   |
| 7/1/2009  |       | $                     | 194,400.00   |   |
| 8/1/2009  |       | $                     | 194,400.00   |   |
| 9/1/2009  |       | $                     | 194,400.00   |   |
| 10/1/2009 |       | $                     | 194,400.00   |   |
| 11/1/2009 |       | $                     | 194,400.00   |   |
| 12/1/09   |       | $                     | 194,400.00   |   |
| 1/1/2010  |       | $                     | 194,400.00   |   |
| 2/1/2010  |       | $                     | 194,400.00   |   |
| 3/1/2010  |       | $                     | 194,400.00   |   |
| 4/1/2010  |       | $                     | 194,400.00   |   |
|      |       | $                     | 3,500,000.00 |   |

 

Assumingmonthly principal payments are made in accordance with the schedule set forthabove, the amount of interest to be paid through the April 30, 2010,maturity date is $420 thousand with respect to our April debentures, or onaverage, $23.3 thousand per month.

 

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Wehave the right to pay interest and monthly principal payments due in respect ofour January and April debentures in cash, or upon notice to theholders and compliance with certain equity conditions, we can pay all or aportion of any such payment in common stock valued at a price equal to thelesser of the then effective conversion price (currently $1.35) or 85 percentof the average of the VWAP per share for our common stock for the 10consecutive trading days immediately prior to the applicable payment date.  On the other hand, if the holders voluntarilyelect to convert all or a portion of the debentures into common stock, then theconversion price will be the then-effective conversion price.  The conversion of these debentures couldresult in substantial dilution to our existing stockholders.

 

Subjectto compliance with certain equity conditions, and subject also to theapplicable cap on the beneficial ownership of our shares of common stock by theholder and its affiliates following such conversion, we have the right to forceconversion of the entire amount of principal and accrued interest of thedebentures if the average of the VWAP for our common stock exceeds $3.39 for 20trading days out of a consecutive 30 trading day period.  If the price of our common stock is below$3.39 per share but is substantially above $1.35 per share, then we anticipatethat the holders of these debentures will elect to convert monthly payments ofinterest and principal into shares of common stock rather than receive cash. If the price of our common stock is below $1.35, the current conversionprice, then we intend to make principal and interest payments in cash to theextent that our cash flows from operations provide sufficient ability to do so.

 

If ourcash flows from operations are not sufficient to make principal and interestpayments in cash, then we will evaluate other equity financing opportunities,the proceeds of which could be used to repay the debentures.  If we areunable to pay the principal and interest in cash, or elect not to do so topreserve working capital, then we will make the payments with our common stockpursuant to the terms of the agreements including a conversion price based onthe lower of the then effective conversion price or 85 percent of the averageof the VWAP per share for our common stock for the 10 consecutive trading days.

 

Operatingand Capital Leases

 

Wehave non-cancelable leases for corporate facilities and equipment.  Rent expense under the leases totaled $66.1thousand and $24.2 thousand for the quarters ending March 31, 2008 and 2007,respectively.  Future minimum rentalpayments required under non-cancelable leases are as follows for the twelvemonths ending March 31:

 
| ** **                              | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|---------------------|------------|
| 2009                                    |       | $                     | 235        |                | $          | 25,895 |   |
| 2010                                    |       | 97                    |       | 17,417              |       |
| 2011                                    |       | 48                    |       | 13,286              |       |
| 2012                                    |       | —                |       | 12,179              |       |
| Total minimum lease payments            |       | $                     | 380        |                | $          | 68,777 |   |
| Less amount representing interest       |       |                  |       | 20,184              |       |
| Present value of minimum lease payments |       |                  |       | 48,593              |       |
| Less current portion                    |       |                  |       | 16,931              |       |
| Total long term portion                 |       |                  |       | $                   | 31,662     |   |

 

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**RecentFinancings**

 

January and April  2008Private Placements

 

The table below provides the following informationrelative to our January 2008 and April 2008 Private Placements: (i) thegross proceeds to us from the private placements (ii) each payment we madeor may be required to make to the investors, any affiliate of the investors orany person with whom the investors have a contractual relationship regardingthe private placement (other than principal and interest payments we will berequired to make under the terms of the debentures issued in the privateplacements, which are discussed below), and (iii) the net proceeds to usfrom the private placement.

 
| **Investor Name**                                          | ** ** | **January 2008  Private Placement** | ** ** | **April  2008  Private Placement** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------|------------|
|                                                            |       |                                          |       |                                              |       |
| Enable Growth  Partners LP                                      |       | $                                             | 1,000,000  |                                              | 3,000,000  |   |
| Hudson Bay Fund  LP                                             |       | 470,000                                       |       | —                                            |       |
| Hudson Bay  Overseas Fund LTD.                                  |       | 530,000                                       |       | 500,000                                           |       |
| Gross proceeds                                                  |       | $                                             | 2,000,000  |                                              | 3,500,000  |   |
|                                                            |       |                                          |       |                                              |       |
| Less fees and  expenses:                                        |       |                                          |       |                                              |       |
| Payment to  Kaufman Bros., L.P. and investor relations firm (1) |       | (85,000                                       | )          | (148,750                                          | )          |
| Payment to  Enable Capital Management, LLC (2)                  |       | (10,000                                       | )          | —                                            |       |
|                                                            |       | $                                             | (95,000    | )                                                 | (148,750   | ) |
|                                                            |       |                                          |       |                                              |       |
| Net proceeds                                                    |       | $                                             | 1,905,000  |                                              | 3,351,250  |   |

 

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| (1) Kaufman Bros.  acted as our advisors                                           |
|-----------------------------------------------------------------------------------------|
| (2) Reimbursement of  legal fees and due diligence costs incurred by the investor. |

 

Thefollowing table sets forth the (i) gross proceeds we received from eachinvestor in our January 2008 and April 2008 Private Placement and (ii) amountof payments that we may be required to make under the terms of our January andApril debentures assuming all such payments are made in cash when due andmonthly redemption payments begin September 1, 2008 (dollar amounts inthousands).

 
| ** **                    | ** ** | **Gross**    | ** ** | **Payments through December 31, 2008** | ** ** | **Payments from January 1, 2009 through  January 31, 2010** | ** ** |
|-------------------------------|------------|--------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|
| **Investor Name**        | ** ** | **Proceeds** | ** ** | **Principal**                                              | ** ** | **Interest**                                                                                   | ** ** | **Total (1)** | ** ** | **Principal** | ** ** | **Interest** | ** ** | **Total (2)** | ** ** |
| Enable Growth  Partners LP    |       | $            | 4,000      |                                                       | $          | 889                                                                                            |       | $ | 73 |   | $ | 962 |   | $ | 3,111 |   | $ | 117 |   | $ | 3,228 |   |
| Hudson Bay Fund  LP           |       | $            | 970        |                                                       | $          | 216                                                                                            |       | $ | 18 |   | $ | 234 |   | $ | 754 |   | $ | 14 |   | $ | 768 |   |
| Hudson Bay  Overseas Fund LTD |       | $            | 530        |                                                       | $          | 118                                                                                            |       | $ | 10 |   | $ | 128 |   | $ | 412 |   | $ | 15 |   | $ | 427 |   |
|                          |       | $            | 5,500      |                                                       | $          | 1,223                                                                                          |       | $ | 101 |   | $ | 1,324 |   | $ | 4,277 |   | $ | 146 |   | $ | 4,423 |   |

 

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(1) Averagesto $330 thousand per month from September 1, 2008, through December 31,2008.

(2) Averagesto $340 thousand per month from January 1, 2009, through January 31,2010.

 

Theconversion price for the debentures is currently $1.35 and the exercise priceof these warrants is currently $1.80 per share. Assuming that we pay all future principal and interest payments in cashon their respective due dates, the total principal and interest payments forsuch debentures will aggregate to $5.8 million over their respectiveterms.  We received net proceeds afterexpenses of $5.3 million from our January 2008 and April 2008 PrivatePlacements.  The ratio of (i) thetotal amount of payments over the term of the debentures to (ii) net proceedsis 109 percent.

 

**Off-Balance Sheet Arrangements**

 

We did not have any off-balance sheet arrangements asof the quarter ending March 31, 2008, nor do we have any as of May 14,2008.

 

**Going Concern Issue**

 

We remain dependent on outside sources of fundinguntil our results of operations provide positive cash flows.  Ourindependent auditors issued a going concern qualification in their report datedApril 22, 2008. With our current level of funding, substantial doubt existsabout our ability to continue as a going concern.

 

During the quarter ended March 31, 2008, we havebeen unable to generate cash flows sufficient to support our operations andhave been dependent on debt and equity raised from qualified individualinvestors.

 

These factors raise substantial doubt about ourability to continue as a going concern.  The financial statementscontained herein do not include any adjustments relating to the recoverabilityand classification of recorded asset amounts or amounts and classification of liabilitiesthat might be necessary should we be unable to continue inexistence.  Our ability to continue as a going concern is dependentupon our ability to generate sufficient cash flows to meet our obligations on atimely basis, to obtain additional financing as may be required, and ultimatelyto attain profitable operations.  However, there is no assurance thatprofitable operations or sufficient cash flows will occur in the future.

 

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We have supported current operations by raisingadditional operating cash through the private sale of our convertibledebentures.  This has provided us with the cash inflows to continue ourbusiness plan, but has not resulted in significant improvement in our financialposition. We are considering alternatives to address our cash flow situationthat include: (1) raising capital through additional sale of our commonstock and/or debentures and (2) reducing cash operating expenses to levelsthat are in line with current revenues.

 

The first alternative could result in substantialdilution of existing stockholders. There can be no assurance that our currentfinancial position can be improved, that we can raise additional workingcapital, or that we can achieve positive cash flows from operations. Ourlong-term viability as a going concern is dependent upon our ability to (i) locatesources of debt or equity funding to meet current commitments and near-termfuture requirements and (ii) achieve profitability and ultimately generatesufficient cash flow from operations to sustain our continuing operations.

 

**Recent Accounting Pronouncements**

 

In June 2006, the Financial Accounting StandardsBoard (FASB) issued FASB Interpretation (FIN) No. 48,*“Accounting for Uncertainty in Income Taxes*”**(FIN48), which supplements Statement of Financial Accounting Standard No. 109,*  “Accountingfor Income Taxes”*, by defining the confidence level that a taxposition must meet in order to be recognized in the financial statements. FIN48 requires the tax effect of a position to be recognized only if it is “more-likely-than-not”to be sustained based solely on its technical merits as of the reporting date.If a tax position is not considered more-likely-than-not to be sustained basedsolely on its technical merits, no benefits of the position are recognized. Ifthe tax position is considered more likely than not to be sustained, the amountto record is measured at the largest amount of benefit that is greater than 50percent likely of being realized upon ultimate settlement. This is a differentstandard for recognition than was previously required. The more-likely-than-notthreshold must continue to be met in each reporting period to support continuedrecognition of a benefit. At adoption, companies must adjust their financialstatements to reflect only those tax positions that are more-likely-than-not tobe sustained as of the adoption date. Any necessary adjustment is recordeddirectly to opening retained earnings in the period of adoption and reported asa change in accounting principle. We adopted FIN 48 starting January 1,2007. The adoption of FIN 48 did not have a material effect on our financialstatements.

 

In September 2006, the Securities and ExchangeCommission published Staff Accounting Bulletin No. 108, “*Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements* “(SAB 108). The interpretations in SAB 108 are being issued to address diversityin practice in quantifying financial statement misstatements and the potentialunder current practice to build up improper amounts on the balance sheet. Thisguidance applies to fiscal years ending after November 15, 2006 and earlyapplication in interim periods is encouraged. The adoption of SAB 108 did nothave an effect on our financial statements.

 

In September 2006, the FASB issued SFAS No. 157,“*Fair Value Measurements*,” (FAS 157)which defines fair value, establishes guidelines for measuring fair value, andexpands disclosures regarding fair value measurements. FAS 157 does notrequire any new fair value measurements but rather eliminates inconsistenciesin guidance found in various prior accounting pronouncements. FAS 157 iseffective for fiscal years beginning after November 15, 2007. Earlieradoption is permitted, provided the company has not yet issued financialstatements, including for interim periods, for that fiscal year. We arecurrently evaluating the impact of FAS 157, but do not expect the adoptionof FAS 157 to have a material impact on our financial position, results ofoperations, or cash flows.

 

In February 2007, the FASB issued SFAS No. 159,*“The Fair Value Option for Financial Assets andFinancial Liabilities*,” (FAS 159) which permits entities tochoose to measure many financial assets and financial liabilities at fairvalue. Unrealized gains and losses on items for which the fair value option hasbeen elected are reported in earnings. SFAS 159 is effective for fiscal yearsbeginning after November 15, 2007. We do not expect the adoption of FAS159 to have a material impact on our consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141(R), “*Business Combinations”* (FAS 141R). FAS 141R requires anacquirer to measure the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest in the acquiree at their fair values on theacquistion date, with goodwill being the excess value over the net identifiableassets acquired. FAS 141R is effective for financial statements issued forfiscal years beginning after December 15, 2008. We have not yet determined theeffect on our financial statements, if any, upon adoption of FAS 141R.

 

In December 2007, the FASB issued SFAS No. 160, “*Noncontrolling Interests in consolidated Financial Statements”,*an amendment of*ARB No. 51* (FAS 160). FAS 160clarifies that a noncontrolling interest in a subsidiary should be reported asequity in the consolidated financial statements. The calculation of earningsper share will continue to be based on income amounts attributable to theparent. FAS 160 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008. We have not yet determined the effect on ourfinancial statements, if any, upon adoption of FAS 160.

 

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**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

** **

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

** **

**ITEM 4. CONTROLS AND PROCEDURES**

 

(a) Disclosure controls and procedures are controls andother procedures that are designed to ensure that information required to bedisclosed in our reports filed pursuant to the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms and that such information is accumulated and communicatedto our management, including our chief executive officer and chief financialofficer, as appropriate, to allow for timely decisions regarding requireddisclosure.

 

Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within our company have been detected. The design of any system ofcontrols is based in part upon a cost-benefit analysis and certain assumptionsabout the likelihood of future events and any design may not succeed inachieving its stated goals under all potential future conditions. While ourmanagement does not believe that our controls will prevent all errors or allinstances of fraud, our disclosure controls and procedures are designed toprovide a reasonable assurance of achieving their objectives.

 

As required byExchange Act Rule 13a-15(b), we carried out an evaluation, under thesupervision and with the participation of our management, including our chiefexecutive officer and chief financial officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures as of March 31,2008, the end of the period covered by this report. Based on that evaluation,our chief executive officer and chief financial officer concluded that ourdisclosure controls and procedures were effective at the reasonable assurancelevel as of March 31, 2008.

 

(b) We madechanges in our internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) of the Exchange Act) during our most recent fiscal quarter, andsubsequent to that period, that has materially affected, or is likely tomaterially affect, our internal control over financial reporting.  On March 10, 2008, we hired David S. G.MacKenzie as our Chief Financial Officer.

 

(c) Ourcompany (as a “smaller reporting company”) is not now subject to therequirements of Section 404(b) of SOX, which requirements, subject tochange, are now scheduled to be effective for fiscal years ending on or after December 15,2010.  Under Section 404(b), our auditors will be required to performan audit of management’s assessment of the effectiveness of our internalcontrol over financial reporting intended to enable us to issue a report, basedon our audit, containing their opinions on both management’s assessment and onthe effectiveness of our internal control over financial reporting. Section 404(a) ofthe SOX, however, requires management to conduct and report upon its ownassessment of a company’s internal control over financial reporting for fiscalyears ending on or after December 15, 2009, and, accordingly, placessubstantial responsibility on management to perform considerable work inpreparing for this activity, not only in the design and conduct of its testingand other assessment procedures in developing adequate, detailed documentationof the company’s internal control policies and procedures, but also theprocedures applied by management in conducting its assessment and the resultsthereof. With respect to such preparation only, but not with respect toperforming management’s assessment procedures, our auditors are available toprovide only limited assistance in documenting and making recommendations tomanagement regarding internal controls, subject to advance approval of theaudit committee or equivalent financial oversight or governance body, but onlyto the extent that, in their sole judgment, our auditors believe theirindependence will not be impaired.  We will be implementing disclosurecontrols and procedures over the course of the current fiscal year.

 

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**PART II — OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

From time to time, we become subject to various legalproceedings and claims, both asserted and unasserted, that arise in theordinary course of business. Litigation in general, and securities litigationin particular, can be expensive and disruptive to normal business operations.Moreover, the results of legal proceedings are difficult to predict. Anunfavorable resolution of one or more of these lawsuits would materiallyadversely affect our business, results of operations, or financial condition.We cannot estimate the loss or range of loss that may be reasonably possiblefor any of the contingencies described above and accordingly have not recordedany associated liabilities in our consolidated balance sheets. We accrue legalcosts when incurred.

 

**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.*

 

**Risks Related to our Business**

 

***We have a limited operating history, have experienced significant expendituresrelated to funding our initial product development, and are currently carryinga 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.***

 

Webegan our operations in 1999 but we did not adopt the SaaS on-demand WebApplications delivery model until 2005. As such, we have a limited operatinghistory in the SaaS industry from which to evaluate our business andprospects.  We incurred a net loss of$3.9 million for the year ended December 31, 2007, and have an accumulateddeficit of $10.4 million at December 31, 2007.  We cannot assure you that our future plannedoperations will be implemented successfully or that we will ever haveprofits.  Furthermore, we areexperiencing the initial costs and uncertainties of a young operating company,including start-up expenditures, unforeseen costs and difficulties,complications, and delays, all of which must be resolved and/or paid withoutthe benefit of a predictable revenue stream. We cannot be sure that we will be successful in meeting these challengesand addressing these risks and uncertainties. If we are unable to do so, then our business will not be successful.

 

***Our limited operating history may not serve as an adequate basis tojudge our future prospects and results of operations.***

 

Webegan our operations in 1999 but we did not adopt the SaaS on-demand WebApplication delivery model until 2005. Our limited operating history in theSaaS industry may not provide a meaningful basis on which to evaluate ourbusiness. Since our inception our revenues have not always grown from year toyear.  We cannot assure you that we willachieve our growth targets, or that we will achieve positive cash-flow orprofitability, or that we will not incur negative cash flow or net losses inthe future. We expect that our operating expenses will increase as we expand.Any significant failure to realize anticipated revenue growth could result insignificant operating losses beyond our forecasts. We will continue toencounter risks and difficulties frequently experienced by companies at asimilar stage of development, including our potential failure to:

 

•                                            maintain our technology;

•                                            expand our product offerings and maintainthe high quality of our products;

•                                            manage our expanding operations,including the integration of any future acquisitions;

•                                            obtain sufficient working capital tosupport our expansion and to fill customers’ orders in time;

•                                            maintain adequate control of ourexpenses;

•                                            implement our product development,marketing, sales, and acquisition strategies and adapt and modify them asneeded; and/or

•                                            anticipate and adapt to changingconditions in the markets in which we operate as well as the impact of anychanges in government regulation, mergers and acquisitions involving ourcompetitors, technological developments, and other significant competitive andmarket dynamics.

 

If weare not successful in addressing any or all of these risks, then our businessmay be materially and adversely affected.

 

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

 

Webelieve that existing and new competitors will continue to improve the designand performance of their products and to introduce new products withcompetitive price and performance characteristics. We expect that we will berequired to continue to invest in product development and productivityimprovements to compete effectively in our markets. Our competitors coulddevelop better technology or more efficient products or undertake moreaggressive and costly marketing campaigns than ours, which may adversely affectour marketing strategies and could have a material adverse effect on ourbusiness, results of operations, and financial condition.

 

Ourmajor competitors may be better able than us to successfully endure downturnsin our markets. In periods of reduced demand for our products, we can eitherchoose to maintain market share by reducing our selling prices to meetcompetition or maintain selling prices, which likely would result in sacrificeof our market share. Sales and overall profitability would be reduced and sustainedlosses may continue in either case. In addition, we cannot be assured thatadditional competitors will not enter our existing markets, or that we will beable to compete successfully against existing or new competition.

 

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***Our inability to fund our capital to meet our expenditure requirementsmay adversely affect our growth and profitability.***

 

Ourcontinued growth is dependent upon our ability to raise capital from outsidesources. Our ability to obtain financing will depend upon a number of factors,including our financial condition and results of operations, the condition ofthe economy, and conditions in relevant financial markets.  If we are unable to obtain financing, asneeded, on a timely basis and on acceptable terms, our financial position,competitive position, growth, and profitability may be adversely affected.

 

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

 

If ourbusiness and markets grow and develop, it will be necessary for us to financeand manage expansion in an orderly fashion. In addition, we may face challengesin managing expanding product offerings and in integrating acquired businesseswith our own. Such eventualities will increase demands on our existing management,workforce, and facilities. Failure to satisfy such increased demands couldinterrupt or adversely affect our operations and cause longer productdevelopment time frames and administrative inefficiencies.

 

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

 

Ourrevenue is dependent, in large part, on many orders from a large number ofcustomers. Sales to our five largest customers were *de minimus*during the quarter ended March 31, 2008 and 2007, respectively. We believethat revenue derived from the current and future large number of customers willcontinue to represent a significant portion of our total revenue.

 

Ourinability to secure and maintain a sufficient number of large customers wouldalso have a material adverse effect on our business, operating results, andfinancial condition. Moreover, our success will depend in part upon our abilityto obtain orders from new customers, as well as the financial condition andsuccess of our customers and general economic conditions.

 

***Any significant fluctuation in price of servers or related support mayhave a material adverse effect on the cost of our products and services.***

 

Theprices of servers and related support are subject to market conditions andgenerally we do not, and do not expect to, have long-term contracts with oursuppliers for those items. While these items are generally available and wehave not experienced any shortage in the past, we cannot assure you that thenecessary servers or support will continue to be available to us at pricescurrently in effect or acceptable to us. The prices for these items have variedsignificantly in the past and may vary significantly in the future. Numerousfactors, most of which are beyond our control, influence prices of servers andrelated support. These factors include general economic conditions, industrycapacity utilization, vendor backlogs and delays and other uncertainties.

 

We maynot be able to adjust our product prices, especially in the short-term, torecover cost increases in these items. Our future profitability may beadversely affected to the extent we are unable to pass on higher server andsupport related costs to our customers.

 

***We may not be able to prevent others from unauthorized use of ourpatents and other intellectual property, which could harm our business andcompetitive position.***

 

Oursuccess depends, in part, on our ability to protect our proprietarytechnologies. We own four United States patent applications covering ourtechnology and we expect to file more patents applications in the near future.The process of seeking patent protection can be lengthy and expensive and wecannot assure you that our patent applications will result in patents beingissued, or that our existing or future issued patents will be sufficient toprovide us with meaningful protection or commercial advantages.

 

Wealso cannot assure you that our current or potential competitors do not have,and will not obtain, patents that will prevent, limit or interfere with ourability to make, use or sell our products.

 

***We do not have key man insurance on our key officers, on whom we relyfor the management of our business.***

 

Wedepend, to a large extent, on the abilities and participation of our currentmanagement team, but have a particular reliance upon Daniel J. A. Kolke, ourChief Technology Officer and Chairman of the Board, and Jeffrey L. Garon, ourPresident and Chief Executive Officer. The loss of the services of either orboth of Messrs. Kolke or Garon for any reason may have a material adverseeffect on our business and prospects. We cannot assure you that the services ofeither Messrs. Kolke or Garon will continue to be available to us, or thatwe will be able to find a suitable replacement for either of them. We do notcarry key man life insurance for any key personnel.

 

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***We may not be able to hire and retain qualified personnel to supportour growth and if we are unable to retain or hire such personnel in the future,our ability to improve our products and implement our business objectives couldbe adversely affected.***

 

If oneor more of our senior executives or other key personnel are unable or unwillingto continue in their present positions, we may not be able to replace themeasily or at all, and our business may be disrupted and our financial conditionand results of operations may be materially and adversely affected. Althoughboth Messrs. Kolke and Garon are under employment agreements, theircontinued employment cannot be assured. In addition, competition for senior management and senior technologypersonnel is intense, the pool of qualified candidates is very limited, and wemay not be able to retain the services of our senior executives or seniortechnology personnel, or attract and retain high-quality senior executives orsenior technology personnel in the future. Such failure could materially andadversely affect our future growth and financial condition.

 

***We have a history of losses and we may not achieve profitability in thefuture.***

 

Wehave not been profitable on a quarterly or annual basis since our formation.Our operations resulted in a net loss of $3.9 million for 2007 and $1.5 millionfor 2006.  As of December 31, 2007,our accumulated deficit was $10.4 million. We expect to make significant futureexpenditures related to the development and expansion of our business. Inaddition, as a public company, we will incur significant legal, accounting, andother expenses that we did not incur as a private company. As a result of theseincreased expenditures, we will have to generate and sustain increased revenueto achieve and maintain future profitability. While our revenue has grownsomewhat in recent periods, revenue growth may not be sustainable and we maynot achieve sufficient revenue to achieve or maintain profitability. We mayincur significant losses in the future for a number of reasons, including dueto the other risks described in this report, and we may encounter unforeseenexpenses, difficulties, complications, delays, and other unknown factors.Accordingly, we may not be able to achieve or maintain profitability and we maycontinue to incur significant losses for the foreseeable future.

 

***The market for on-demand Web Applications may develop more slowly thanwe expect.***

 

Oursuccess will depend, to a large extent, on the willingness of SMBs to accepton-demand services for Web Applications that they view as critical to thesuccess of their business. Many companies 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.

 

Otherfactors that may affect market acceptance of our Web Applications include ourability to:

 

•                    minimize the time and resources required to implementproducts from the Etelos Marketplace;

•                    maintain high levels of customer satisfaction;

•                    implement upgrades and other changes to our productswithout disrupting our service; and/or

•                    provide rapid response time during periods of intenseactivity on customer websites.

 

Inaddition, market acceptance of our Web Applications may be affected by:

 

•                    the security capabilities, reliability, andavailability of on-demand services;

•                    customer concerns with entrusting a third party tostore and manage their data, especially confidential or sensitive data;

•                    the level of customization or configuration we offer;and/or

•                    the price, performance, and availability of competingproducts and services.

 

Themarket for our products may not develop further, or it may develop more slowlythan we expect, either of which would harm our business.

 

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***Our customers are small and medium-sized businesses and divisions oflarge companies, which may increase our costs to reach, acquire and retaincustomers.***

 

Wemarket and sell our products to SMBs and divisions of large companies. To growour revenue quickly, we must add new customers, sell additional services toexisting customers, and encourage existing customers to renew theirsubscriptions. However, selling to and retaining SMBs can be more difficultthan selling to and retaining large enterprises because SMB customers tend tobe more price sensitive and more difficult to reach with broad marketingcampaigns.  In addition, SMBs have highchurn rates in part because of the nature of their businesses and often lackthe staffing to benefit fully from our products.  Further, SMBs often require higher sales,marketing and support expenditures by vendors that sell to them per revenuedollar generated for those vendors.

 

If weare unable to cost-effectively market and sell our products to our targetcustomers, then our ability to grow our revenue quickly and become profitablewill be harmed.

 

***Our quarterly operating results may fluctuate in the future. As aresult, we may fail to meet or exceed the expectations of research analysts orinvestors, which could cause our stock price to decline.***

 

Ourquarterly operating results may fluctuate as a result of a variety of factors,many of which are outside of our control. Fluctuations in our quarterlyoperating results may be due to a number of factors, including the risks anduncertainties discussed elsewhere in this report. Fluctuations in our quarterlyoperating results could cause our stock price to decline rapidly, may leadanalysts to change their long-term model for valuing our common stock, couldcause us to face short-term liquidity issues, may impact our ability to retainor attract key personnel, or cause other unanticipated issues. If our quarterlyoperating results or guidance fall below the expectations of research analystsor investors, then the price of our common stock could decline substantially.

 

Webelieve that our quarterly revenue and operating results may vary significantlyin the future and that period-to-period comparisons of our operating resultsmay not be meaningful. You should not rely on the results of one quarter as anindication of future performance.

 

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

 

Ourlimited operating history may make it difficult to evaluate our currentbusiness and our future prospects. We have encountered and will continue toencounter risks and difficulties frequently experienced by growing companies inrapidly changing industries. If we do not address these risks successfully,then our business will be harmed.

 

***We use third-party data centers to support our services. Any disruptionof service at these facilities could interrupt or delay our ability to deliverour service to our customers.***

 

Wehost many of our services and serve a significant number of our customers fromeither of two third-party data center facilities with Network OS and withServePath both located in the greater Seattle Washington area. We do notcontrol the operation of these facilities. These facilities may be vulnerableto damage or interruption from earthquakes, hurricanes, floods, fires,terrorist attacks, power losses, telecommunications failures, and similarevents. These facilities also could be subject to break-ins, computer viruses,sabotage, intentional acts of vandalism and other misconduct. The occurrence ofa natural disaster or an act of terrorism, a decision to close the facilitieswithout adequate notice, or other unanticipated problems could result inlengthy interruptions in our services.

 

Ourdata center facility providers have no obligation to renew their agreementswith us on commercially reasonable terms, or at all. If we are unable to renewour agreements with any facility provider on commercially reasonable terms,then we may experience increased costs or downtime in connection with thetransfer to a new data center facility.

 

Anyerrors, defects, disruptions, or other performance problems with our servicescould harm our reputation and may damage our customers’ businesses.Interruptions in our services might reduce our revenue, cause us to issuecredits to customers, subject us to potential liability, cause customers toterminate their subscriptions, and harm our renewal rates.

 

***We may become liable to our customers and lose customers if we havedefects or disruptions in our service or if we provide poor service.***

 

Becausewe deliver our products as a service, errors or defects in the Web Applicationsunderlying our service, or a failure of our hosting infrastructure may make ourservice unavailable to our customers. Because our customers use our products tomanage critical aspects of their business, any errors, defects, disruptions inservice, or other performance problems with our products, whether in connectionwith the day-to-day operation of our products, upgrades or otherwise, coulddamage our customers’ businesses. If we have any errors, defects, disruptionsin service, or other performance problems with our products, then customerscould elect not to renew, or delay or withhold payment to us. As a result, wecould lose future sales or customers may make warranty claims against us, whichcould result in an increase in our provision for doubtful accounts, an increasein collection cycles for accounts receivable, or costly litigation.

 

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***Our business depends substantially on customers renewing, upgrading,and expanding their subscriptions for our products.***

 

Wesell our products pursuant to agreements of varying subscription periods. Ourcustomers have no obligation to renew their subscriptions after their subscriptionperiod expires, and these subscriptions may not be renewed at the same orhigher levels. Moreover, under specific circumstances, our customers may havethe right to cancel their agreements before they expire. We have limitedhistorical data with respect to rates of customer subscription renewals,upgrades, and expansions so we may not accurately predict future trends incustomer renewals. Our customers’ renewal rates may decline or fluctuatebecause of several factors, including their satisfaction or dissatisfactionwith our products, the prices of our service, the prices of services offered byour competitors, or reductions in our customers’ spending levels. If ourcustomers do not renew their subscriptions, renew on less favorable terms, ordo not purchase additional functionality or subscriptions, then our revenue maygrow more slowly than expected or decline and our profitability and grossmargins may be harmed.

 

***If our security measures are breached and unauthorized access isobtained to a customer’s data, then we may incur significant liabilities, ourservice may be perceived as not being secure, and customers may curtail or stopusing our products.***

 

Theproducts and services we offer 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 customers andto individuals or businesses whose information was being stored by ourcustomers, our business may suffer, and our reputation will be damaged. Becausetechniques used to obtain unauthorized access to, or to sabotage, systems changefrequently and generally are not recognized until launched against a target, wemay be unable to anticipate these techniques or to implement adequatepreventive measures. If an actual or perceived breach of our security occurs,then the market perception of the effectiveness of our security measures couldbe harmed and we could lose sales and customers.

 

***We have experienced rapid growth in recent periods. If we fail tomanage our growth effectively, then we may be unable to execute our businessplan, maintain high levels of service, or address competitive challengesadequately.***

 

Wehave increased our number of full-time employees to 46 at March 31, 2008,from 16 at March 31, 2007, and have experienced a drop in our revenue to $23.6thousand in 2008 from $104.8 thousand in 2007. Our operating plan has placed,and our anticipated growth plan is expected to continue to place, a significantstrain on our managerial, administrative, operational, financial, and otherresources. We intend to further expand our overall business, customer base,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.

 

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

 

Themarket for Web Applications for business is highly competitive and rapidlychanging with relatively low barriers to entry. With the introduction of newtechnologies and 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 compete tosell our products against existing systems that our potential customers havealready made significant expenditures to install. Competition in our market isbased principally upon service breadth and functionality; service performance,security and reliability; ability to tailor and customize services for aspecific company, vertical or industry; ease of use of the service; speed andease of deployment, integration and configuration; total cost of ownership,including price and implementation and support costs; professional servicesimplementation; and financial resources of the vendor.

 

Weface competition from both traditional software vendors and SaaS providers.Many of our actual and potential competitors enjoy substantial competitiveadvantages over us, such as greater name recognition, longer operatinghistories, more varied products and services, and larger marketing budgets, aswell as substantially greater financial, technical, and other resources. Inaddition, many of our competitors have established marketing relationships andaccess to larger customer bases, and have major distribution agreements withconsultants, system integrators, and resellers. If we are not able to competeeffectively, then our operating results will be harmed.

 

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***Many of our customers are price sensitive, and if the prices we chargefor our products are unacceptable to our customers, then our operating resultswill be harmed.***

 

Manyof our customers are price sensitive, and we have limited experience withrespect to determining the appropriate prices for our products. As the marketfor our products matures, or as new competitors introduce new products orservices that compete with ours, we may be unable to renew our agreements withexisting customers or attract new customers at the same price or based on thesame pricing model as previously used. As a result, it is possible thatcompetitive dynamics in our market may require us to change our pricing modelor reduce our prices, which could harm our revenue, gross margin, and operatingresults.

 

***If we do not effectively expand and train our sales force and ourservices and support teams, then we may be unable to add new customers andretain existing customers.***

 

Weplan to continue to expand our sales force and our services and support teamsto increase our customer base and revenue. We believe that there is significantcompetition for sales, service, and support personnel with the skills andtechnical knowledge that we require. Our ability to achieve significant revenuegrowth will depend, in large part, on our success in recruiting, training, andretaining sufficient numbers of personnel to support our growth. New hiresrequire significant training and, in most cases, take significant time beforethey achieve full productivity. Our recent hires and planned hires may notbecome as productive as we expect and we may be unable to hire or retainsufficient numbers of qualified individuals in the markets where we dobusiness. If these expansion efforts are not successful or do not generate acorresponding increase in revenue, then our business will be harmed.

 

***If we are unable to develop new products or sell our products into newmarkets, then our revenue growth will be harmed and we may not be able to achieveprofitability.***

 

Ourability to attract new customers and increase revenue from existing customerswill depend in large part on our ability to enhance and improve our existingproducts and to introduce new products and services and sell into new markets.The success of any enhancement or new product or service depends on severalfactors, including the timely completion, introduction, and market acceptanceof the enhancement, product or service. Any new product or service we developor acquire may not be introduced in a timely or cost-effective manner and maynot achieve the broad market acceptance necessary to generate significantrevenue. Any new markets into which we attempt to sell our products may not bereceptive. If we are unable to successfully develop or acquire new products orservices, enhance our existing products and services to meet customerrequirements, or sell our products and services into new markets, then ourrevenue will not grow as expected and we may not be able to achieve profitability.

 

***Assertions by third parties that we infringe their intellectualproperty, whether successful or not, could subject us to costly andtime-consuming litigation or expensive licenses.***

 

Thesoftware and technology industries are characterized by the existence of alarge number of patents, copyrights, trademarks, and trade secrets and byfrequent litigation based on allegations of infringement or other violations ofintellectual property rights. As we face increasing competition, thepossibility of intellectual property rights claims against us may grow; thecosts of defending against such claims can be very large. Our technologies maynot be able to withstand any third-party claims or rights against their use.Additionally, many of our partner and product agreements require us toindemnify our customers for certain third-party intellectual propertyinfringement claims, which could increase our costs as a result of defendingsuch claims and may require that we pay damages or purchase expensive licenses,if there were an adverse ruling related to any such claims. These types ofclaims could harm our relationships with our customers, may deter futurecustomers from subscribing to our services, or could expose us to litigationfor these claims. Even if we are not a party to any litigation between acustomer and a third party, an adverse outcome in any such litigation couldmake it more difficult for us to defend our intellectual property in anysubsequent litigation in which we are a named party.

 

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***Any intellectual property rights claim against us or our customers,with or without merit, could be time-consuming, expensive to litigate orsettle, and could divert management attention and financial resources. Anadverse determination also could prevent us from offering our products to ourcustomers and may require that we procure or develop substitute services thatdo not infringe.***

 

Forany intellectual property rights claim against us or against our customers, wemay have substantial direct and indirect costs. Direct costs can include a requirement to pay damages or stop usingtechnology found to be in violation of a third party’s rights. We may have topurchase a license for the technology, which may not be available on reasonableterms, if at all, may significantly increase our operating expenses, or mayrequire us to restrict our business activities in one or more respects. As aresult, we may also be required to develop alternative non-infringingtechnology, which could require significant 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.

 

***Our success depends in large part on our ability to protect and enforceour intellectual property rights.***

 

Werely on a combination of patent, copyright, service mark, trademark, and tradesecret laws, as well as confidentiality procedures and contractualrestrictions, to establish and protect our proprietary rights on a globalbasis, all of which provide only limited protection. We cannot assure you thatany patent will issue from our currently pending patent applications in amanner that gives us the protection that we seek, if at all, or that any futurepatents issued to us will not be challenged, invalidated, or circumvented.Since the filing of some of these patent applications may have been, or willbe, made after the date of first sale or disclosure of the subject inventions,patent protection may not be available for these inventions outside the UnitedStates.  Any patents that may issue inthe future may not provide sufficiently broad protection or they may not proveto be enforceable in actions against alleged infringers. Also, we cannot assureyou that any future service mark or trademark registrations will be issued forpending or future applications or that any registered service marks ortrademarks will be enforceable or provide adequate protection of our domesticand foreign proprietary rights.

 

Wehave not maintained operating controls or logs, or initiated or conducted anyforensic, code history, ‘genealogy’ or other form of audit, analysis,processes, training, or code review of software code incorporated into anyEtelos product or in other products offered by others in the EtelosMarketplace.  These products may includecode subject to various forms of ‘open source’, ‘copyleft’, or similar licensesthat require as a condition of modification or distribution of software subjectto such license(s) that (i) such software or other software combinedor distributed with such software be disclosed or distributed in source codeform, or (ii) such software or other software combined or distributed withsuch software, and any related intellectual property,  be licensed on a royalty-free basis,including for the purposes of making additional copies or derivative works ofsuch software.  This may adversely affectour ability to patent certain inventions or to license or distribute certainproducts — whether by open source license or other form of license or right –and may result in liability to unknown parties for infringement of theirpatents or other intellectual property rights.

 

Weendeavor to enter into agreements with our employees and contractors andagreements with parties with whom we do business to limit access to anddisclosure of our proprietary information. The steps we have taken, however,may not prevent unauthorized use or the reverse engineering of our technology.Moreover, others may independently develop technologies that are competitive toours or infringe our intellectual property. Enforcement of our intellectualproperty rights also depends on our successful legal actions against theseinfringers, but these actions may not be successful, even when our rights havebeen infringed.  In addition, the legalstandards relating to the validity, enforceability, and scope of protection ofintellectual property rights in Internet-related industries are uncertain andstill evolving.

 

***When we become subject to Section 404 of the Sarbanes-Oxley Act of2002, if we fail to maintain proper and effective internal controls or areunable to remediate the material weakness in our internal controls, then ourability to produce accurate and timely financial statements could be impairedand investors’ views of us could be harmed.***

 

Ensuringthat we have adequate internal financial and accounting controls and proceduresin place so that we can produce accurate financial statements on a timely basisis a costly and time-consuming effort that needs to be re-evaluated frequently.Our internal 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 withSection 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act,which requires annual management assessment of the effectiveness of ourinternal control over financial reporting and a report by our independentauditors addressing this assessment. Both we and our independent auditors willbe testing our internal controls in connection with the audit of our internalcontrols for the year ending December 31, 2008 and, as part of thatdocumentation and testing, identifying areas for further attention andimprovement.

 

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Duringour review for the year ended December 31, 2007, we identified a materialweakness in our internal controls. The material weakness relates to the needfor accounting personnel who possess the skill sets necessary to operate andreport as a public company, and specifically the skills necessary to ensurethat adequate review of critical account reconciliations is performed and thatsupporting documentation is complete, accurate, and in accordance withgenerally accepted accounting principles. We have recruited and are continuingto recruit additional finance and accounting personnel to address thisobservation. We believe we have made progress in addressing this materialweakness and expect to complete the remediation in the next six to nine months.If our remediation efforts are insufficient to address the material weakness ortake longer than we expect, or if additional material weaknesses in ourinternal controls are discovered in the future, then we may fail to meet ourfuture reporting obligations, our financial statements may contain materialmisstatements and the price of our common stock may decline.

 

Implementingany appropriate 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 accurate financialstatements on a timely basis may harm our stock price and make it moredifficult for us to effectively market and sell our service to new and existingcustomers.

 

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

 

Themajority of our quarterly revenue is attributable to subscription agreementsentered into during the current and previous quarters. A decline in new orrenewed service agreements in any one quarter may not be fully reflected in ourrevenue in that quarter but will harm our revenue in future quarters. As aresult, the effect of significant downturns in sales and market acceptance ofour products and services in a particular quarter may not be fully reflected inour operating results until future periods. Our subscription model also canmake it difficult for us to rapidly increase our revenue through additionalsales in any period, because revenue from new customers must be recognized overthe applicable subscription term.

 

***Material defects or errors in the software we use to deliver ourservices could harm our reputation, result in significant costs to us, andimpair our ability to sell our services.***

 

TheWeb Applications underlying our services are inherently complex and may containmaterial defects or errors, particularly when first introduced or when newversions or enhancements are released. We have, from time to time, founddefects in our software and services, and new errors in our existing softwareand services may be detected in the future. Any defects that causeinterruptions to the availability of our 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.

 

Afterthe release of our services, defects or errors may also be identified from timeto time by our internal team and by our customers. The costs incurred incorrecting any material defects or errors in our services may be substantialand could harm our operating results.

 

***Government regulation of the Internet and e-commerce is evolving, andunfavorable changes or our failure to comply with regulations could harm ouroperating results.***

 

As Internetcommerce continues to evolve, increasing regulation by super-national, federal,state or local government agencies becomes more likely. Increased regulation inthe area of data privacy, and laws and regulations applying to thesolicitation, collection, processing, or use of personal or consumerinformation could affect our customers’ ability to use and share data,potentially reducing demand for Web-based applications and restricting ourability to store, process, and share our customers’ data. In addition, taxationof services provided over the Internet or other charges imposed by governmentagencies or by private organizations for accessing the Internet may also beimposed. Any regulation imposing greater fees for Internet access or use orrestricting information exchange over the Internet could result in a decline inthe use of the Internet and the viability of Web-based services, which couldharm our business and operating results.

 

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***Privacy concerns and laws or other regulations may reduce theeffectiveness of our products and services and harm our business.***

 

Ourcustomers can use our services to store personal or identifying informationregarding their customers and contacts. Super-national, federal, state andother government bodies and agencies have adopted or are considering adoptionof laws and regulations regarding the collection, use, and disclosure ofpersonal information obtained from consumers and other individuals. The costsof compliance with, and other burdens imposed by, such laws and regulationsthat are applicable to the businesses of our customers may limit the use andadoption of our products and services and reduce overall demand.

 

Inaddition to government activity, privacy advocacy groups and the technology andother industries are considering various new, additional, or differentself-regulatory standards that may place additional burdens on us. If thegathering of personal information were to be curtailed, then Web-basedapplications would be less effective, which may reduce demand for our productsand services and harm our business.

 

***Our operating results may be harmed if we are required to collect taxesfor our subscription services in jurisdictions where we have not historicallydone so.***

 

Wehave not collected any sales or other taxes from our customers or remitted anysuch taxes to any taxing jurisdiction where we may be required to do so. Wehave begun an analysis of this issue but to date have not made any accrual forany potential liability.  In addition, additionaltaxing jurisdictions at various local, national and super-national levels mayseek to impose sales or other tax collection 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 may causeadverse, unexpected financial reporting fluctuations, and harm our operatingresults.***

 

Achange in accounting standards or practices could harm our operating resultsand may even affect our reporting of transactions completed before the changeis effective. New accounting pronouncements and varying interpretations ofaccounting pronouncements have occurred and may occur in the future. Changes toexisting rules or the questioning of current practices may harm ouroperating results or the way we conduct our business.

 

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

 

Althoughwe have no ongoing negotiations or current agreements or commitments for anyacquisitions, our business strategy may include acquiring complementaryservices, technologies, or businesses. We also may enter into relationshipswith other businesses to expand our product or service offerings or our abilityto provide service in foreign jurisdictions, which could involve preferred orexclusive licenses, additional channels of distribution, discount pricing,investments in other companies, or other strategies. Negotiating thesetransactions can be time-consuming, difficult, and expensive, and our abilityto close these transactions may often be subject to approvals that are beyond ourcontrol. Consequently, these transactions, even if undertaken and announced,may not close.

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Anacquisition, investment, or business relationship may result in unforeseenoperating difficulties and expenditures. In particular, we may encounterdifficulties assimilating or integrating the businesses, technologies,products, 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,and require significant management attention that would otherwise be availablefor operation and development of our business. Moreover, the anticipatedbenefits of any acquisition, investment, or business relationship may not berealized or we may be exposed to unknown liabilities. For one or more of thosetransactions, 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 ofthese risks could harm our business and operating results.

 

***We rely on our management team and need additional personnel to growour business, and the loss of one or more key employees or our inability toattract and retain qualified personnel could harm our business.***

 

Oursuccess and future growth depends to a significant degree on the skills andcontinued services of our management team, especially Daniel J.A. Kolke, ourChief Technology Officer and Chairman of the Board, and Jeffrey L. Garon, ourPresident and Chief Executive Officer. We do not maintain key man insurance onany members of our management team, including Messrs. Garon and Kolke. Ourfuture success also depends on our ability to attract, retain and motivatehighly skilled technical, managerial, sales, marketing and service and supportpersonnel, including members of our management team. Competition for sales,marketing, and technology development personnel is particularly intense in thesoftware and technology industries. As a result, we may be unable tosuccessfully attract or retain qualified personnel. Our inability to attractand retain the necessary personnel could harm our business.

 

**RisksRelated to an Investment in our Common Stock.**

 

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

 

As ofApril 23, 2008, our officers, directors, and affiliates beneficially ownapproximately 75.5 percent of our common stock. As a result, if they acttogether, they are able to influence the outcome of stockholder votes onvarious matters, including the election of directors and extraordinarycorporate transactions, including business combinations. This concentrationcould also have the effect of delaying or preventing a change in control thatcould otherwise be beneficial to our stockholders. The interests of ourofficers, directors, and affiliates may differ from other stockholders.Furthermore, the current ratios of ownership of our common stock reduce thepublic float and liquidity of our common stock which can in turn affect themarket price of our common stock.

 

***We are responsible for the indemnification of our officers anddirectors.***

 

Our articlesof incorporation 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 in privateplacements could cause the price of our common stock to decline.***

 

Thepurchasers of our January and April debentures and related warrantsmay, subject to compliance with Rule 144, rely on the provisions ofRule 144 to resell the shares of our common stock acquired upon theconversion of the debentures and exercise of the warrants.  We have no way of knowing whether or whensuch shares may be sold.  Depending uponmarket liquidity at the time, a sale of shares by such investors at any giventime could cause the trading price of our common stock to decline.  The sale of a substantial number of shares ofour common stock, or anticipation of such sales, could make it more difficultfor us to sell equity or equity-related securities in the future at a time and ata 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.***

 

Thepurchasers of our January and April debentures and related warrants, as well asthe holders of our other outstanding convertible notes, may, subject tocompliance with Rule 144, rely on the provisions of Rule 144 to resell theshares of our common stock acquired upon the conversion and exercise of suchsecurities.  We have no way of knowingwhether or when such shares may be sold. Depending upon market liquidity at the time, a sale of shares by suchinvestors at any given time could cause the trading price of our common stock todecline.  The sale of substantial numberof shares of our common stock, or anticipation of such sales, could make itmore difficult for us to sell equity or equity-related securities in the futureat a time and at a price that we might otherwise wish to effect sales.

 

Inaddition, in our January 2008 and April 2008 Private Placements, in theaggregate, we issued a total of $5.5 million principal amount of convertibledebentures, convertible into 4,074,074 shares of our common stock, and warrantsto purchase an additional 611,111 shares of our common stock.  We have agreed to register for resale by theinvestors the shares of common stock issuable upon the conversion of thedebentures and the exercise of the warrants we issued in those private placements.  We are also registering for resale 586,667shares of common stock issuable upon conversion of notes issued in September2007.  The conversion or exercise intoour common stock and the registration of that common stock could reuslt in asubstantial increase in the number of shares in our public float.  Depending upon market liquidity at the time aresale of our common stock is made by the investors in such private placements,such sale could cause the trading price of our common stock to decline.  In addition, the sale of a substantial numberof shares of our common stock,  oranticipation of such sales, could make it more difficult for us to sell equityor equity-related securities in the future at a time and at a price that wemight otherwise wish to effect sales.

 

***We have significant indebtedness and agreed to certain restrictions asa result of our recent private placement of convertible debentures.***

 

Weincurred $5.5 million in principal amount of indebtedness as a result of theissuance of the debentures in our January 2008 and April 2008 PrivatePlacements.  The debentures carrysubstantial covenants that impose significant restrictions on us, includingrestrictions against incurring additional indebtedness, creating any liens onour property, amending our certificate of incorporation or bylaws, redeeming orpaying dividends on shares of our outstanding common stock, and entering intocertain related party transactions.  Thedebentures also carry substantial covenants that impose significant requirementson us, including, among others, requirements that:

 

·                                          wepay interest and other charges on the debentures;

 

·                                          weuse the proceeds from the sale of the debentures only for permitted purposes;

 

·                                          whilethe debentures are outstanding, if we issue equity or equity linked securitiesat a price lower than the conversion price of the debentures, then theconversion price of the debentures will be reduced to the same price of theequity or equity linked securities so issued;

 

·                                          we keep reserved out of our authorizedshares of common stock sufficient shares to satisfy our obligation to issueshares on conversion of the debentures and the exercise of the related warrantsissued in connection with the sale of the debentures;

 

·                                          we must file a registration statementwith the SEC registering the shares of common stock issuable upon theconversion of the debentures and the exercise of the related warrants on atimely basis, and it must be declared effective within a certain period oftime, or else we are required to pay to each investor partial liquidateddamages; and

 

·                                          we may not, directly or indirectly,redeem, purchase or otherwise acquire any capital stock or set aside any moniesfor such redemption, purchase or other acquisition.

 

Ourability to comply with these provisions may be affected by changes in ourbusiness condition or results of our operations, or other events beyond ourcontrol.  The breach of any of thesecovenants could result in a default under the debentures, permitting theholders thereof to accelerate the maturity of the debentures and demandrepayment in full.  Such actions by suchholders could impair our ability to operate or cause us to seek bankruptcyprotection.

 

***Certain covenants we agreed to in connection with the debentures mayimpair our ability to issue additional debt or equity.***

 

OurJanuary and April debentures impose significant covenants on us, someof which may impair our ability to issue additional debt or equity, ifnecessary.  For example, the investors inour April 2008 Private Placement have the right to participate in anyfinancing we undertake through the date that is the 12 month anniversary of theeffectiveness of the registration statement we agreed to file for the re-saleof our shares of common stock issuable upon conversion and exercise of thesecurities we issued in our April 2008 Private Placement.

 

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***If we pay interest or principal on the debentures in shares of commonstock when our stock price is low, the holders thereof have the ability tonegatively affect our stock price and to create a greater dilution to ourstockholders.***

 

Wehave the right to pay interest and monthly principal payments in cash, or uponnotice to the holders and compliance with certain equity conditions, includinghaving a currently effective registration statement covering the shares ofcommon stock issuable upon conversion of the debentures, we can pay all or aportion of any such payment in common stock valued at a price equal to thelesser of the then effective conversion price or 85 percent of the average ofthe VWAP per share as reported on Bloomberg for our common stock for the 10consecutive trading days immediately prior to the applicable payment date.  To the extent that we pay principal or interestin common stock during a period when our common stock price is low, suchinvestor will receive a larger number of shares of our common stock as a resultof the conversion, which such investor could sell at high volumes to drive theVWAP downward.  Downward pressure on theprice of our common stock from consecutive conversions could result in theinvestors receiving payment on the debentures at successively lower conversionrates, thereby causing a successively greater dilution of our stockholders, andcausing a downward spiraling affect on the price of our stock (a so-called“death spiral”).  Further, to the extentthat conversion of the debenture requires us to issue more shares of commonstock, we are obligated to register the additional shares of stock under a newregistration statement.

 

***Our failure to secure registration of the common stock could result insubstantial liquidated damages.***

 

Underthe terms of the registration rights agreements we entered into with theinvestors in connection with our January 2008 and April 2008 PrivatePlacements, we agreed to file a registration statement covering the resale ofthe shares of common stock underlying the securities we sold in such privateplacements, and to maintain the effectiveness of the registration statements(subject to certain limitations) for a period of time until the holders cansell the underlying common stock without volume restrictions underRule 144 of the Securities Act.  Ifthe registration statement is not declared effective within an agreed to timeperiod, or if we fail to maintain the effectiveness of the registrationstatement, we are required to pay to the investors partial liquidated damages.

 

***Our failure to repay the debentures could result in substantialpenalties against us, and legal action which could substantially impair ouroperations.***

 

Thedebentures we issued require monthly principal payments equal to 1/18th of theprincipal amount due under each debenture. The debentures accrue interest at the rate of 6 percent per annum,payable quarterly and on each monthly principal payment.  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.  To repay the debentures incash, we will be required to use our limited working capital or raiseadditional funds.  If we are unable torepay the debentures when required, either in cash or in common stock, theholders could commence legal action against us. Any such action could impose significant costs on us and require us tocurtail or cease operations.

 

Inaddition, the debentures define certain events of default, including withoutlimitation failure to make a payment obligation, failure to observe othercovenants of the debenture or related agreements (subject to applicable cureperiods), 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 specifiedgrace periods, the holders of the debentures have the right to accelerate allamounts outstanding under the debentures and demand payment of a mandatorydefault amount equal to 130 percent of the amount outstanding under thedebenture, plus accrued interest and expenses. If we were unable to repay the mandatory default amount when required,the holders could commence legal action against us.  Any such action could impose significantcosts on us and require us to curtail or cease operations.

 

***If we need additional financing in the future and are required to issuesecurities which are priced at less than the conversion price of our debenturesor the exercise price of warrants sold in our recent private placements, itwill result in additional dilution.***

 

OurJanuary and April debentures and the related warrants containprovisions that will require us to reduce the conversion price and exerciseprice, as the case may be, if we issue additional securities while suchdebentures or warrants are outstanding which contain purchase prices,conversion prices or exercise prices less than the conversion price of ourJanuary or April debentures or the exercise price of thewarrants.  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 adversely affected by salesof registered and restricted securities.***

 

Actualsales or the prospect of future sales of shares of our common stock pursuant toa prospectus or under Rule 144 may have a depressive effect upon the priceof, and market for, our common stock.  Asof April 23, 2008, 22,705,634 shares of our common stock were issued andoutstanding, of which 17,695,634 are “restricted securities” and under somecircumstances may, in the future, be under a registration under the SecuritiesAct or in compliance with Rule 144 adopted under the Securities Act.  In general, under Rule 144, subject tothe satisfaction of other conditions, a person who has beneficially ownedrestricted shares of common stock for at least one year is entitled to sell,within any three month period, a number of shares that does not exceed thegreater 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 predictwhat effect, if any, that sales of shares of common stock, or the availabilityof these shares for sale, will have on the market prices prevailing from timeto time.  Nevertheless, the possibilitythat substantial amounts of common stock may be sold in the public market mayadversely effect prevailing prices for our common stock and could impair ourability to raise capital in the future through the sale of equity securities.

 

Inaddition to the 17,695,634 shares of “restricted securities” that were issuedand outstanding as of April 23, 2008, we have filed a registration statementseeking to register for resale an aggregate of 5,760,741 shares of our commonstock as follows: (i) 4,660,741 shares issuable upon the conversion of theprincipal amount of outstanding debentures and notes, (ii) 488,889 sharesissuable upon conversion of interest accured on the foregoing debentures, and(iii) 611,111 shares issuable upon exercise of warrants.  The additional overhang represented by theseregistered securities could also have a depressive effect on the public tradingprice of our common stock.

 

***Anti-takeover provisions contained in our amended and restatedcertificate of incorporation and amended and restated bylaws, as well asprovisions of Delaware law, could impair a takeover attempt.***

 

Ouramended and restated certificate of incorporation, amended and restated bylawsand Delaware law contain provisions that could have the effect of renderingmore difficult or discouraging an acquisition deemed undesirable by our boardof directors. Our corporate governance documents include provisions:

 

·                                          authorizing blank check preferred stock,which could be issued with voting, liquidation, dividend, and other rightssuperior to our common stock;

·                                          limiting the liability of, and providing indemnificationto, our directors and officers;

·                                          limiting the ability of our stockholdersto call and bring business before special meetings;

·                                          requiring advance notice of stockholderproposals for business to be conducted at meetings of our stockholders and fornominations of candidates for election to our board of directors;

·                                          controlling the procedures for theconduct and scheduling of board and stockholder meetings; and

·                                          limiting, generally, the filling ofvacancies or newly created seats on the board to our board of directors then inoffice.

 

Theseprovisions, alone or together, could delay hostile takeovers and changes incontrol or changes in our management.

 

Anyprovision of our amended and restated certificate of incorporation or bylaws orDelaware law that has the effect of delaying or deterring a change in controlcould limit the opportunity for our stockholders to receive a premium for theirshares of our common stock, and could also affect the price that some investorsare willing to pay for our common stock.

 

***Significant amounts of our outstanding common stock will be availablefor resale into the market, which could potentially cause the market price ofour common stock to drop significantly, even if our business is doing well.***

 

As ofApril 23, 2008, we had 22,705,634 shares of common stock issued andoutstanding held by approximately 145 shareholders of record, including5,010,000 shares that were issued pursuant to the court approved plan ofreorganization.  The shares issued underthe plan of reorganization are freely tradable securities.  The market price of our common stock coulddrop significantly if the holders of these shares sell them or are perceived bythe market as intending to sell them in an excessive amount relative to themarket demand for our shares. An excessive sale of our shares may result in asubstantial decline in the price of our common stock and limit our ability toraise capital, even if our business is doing well.

 

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

 

Althoughwe have no commitments as of the date of this report to issue any additionalsecurities, we may issue a substantial number of additional shares of ourcommon stock or preferred stock, or a combination of both, including throughconvertible debt securities, to finance future operations.  We may not be able to obtain additional debtor equity financing on favorable terms, if at all.  If we engage in debt financing, then we maybe required to accept terms that restrict our ability to incur additionalindebtedness and force us to maintain specified liquidity or other ratios.

 

Further,the issuance of additional shares of our common stock or any number of sharesof preferred stock, including upon conversion of any debt securities, may:

 

·                                          significantly reduce the equity interestof our current stockholders;

·                                          cause a change in control if asubstantial number of our shares of common stock or voting preferred stock areissued, which may affect, among other things, our ability to use our netoperating loss carry-forwards, if any, and could also result in a change inmanagement; and/or

·                                          adversely affect prevailing market pricesfor our common stock.

 

If weneed additional capital and cannot raise it on acceptable terms, we may not beable to, among other things:

 

·                                          develop or enhance our products andservices;

·                                          continue to expand our development, salesand marketing organizations;

·                                          acquire complementary technologies,products or businesses;

·                                          expand operations;

·                                          hire, train and retain employees; and/or

·                                          respond to competitive pressures orunanticipated working capital requirements.

 

Althoughwe have no commitments as of the date hereof to issue any additionalsecurities, we may issue a substantial number of additional shares of our commonstock or preferred stock, or a combination of both, including throughconvertible debt securities, to finance future operations or complete abusiness combination.  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 equityinterest of our current stockholders;

·                                          will likely cause a change in control ifa substantial number of our shares of common stock or voting preferred stock areissued and could also result in a change in management; and/or

·                                          may adversely affect prevailing marketprices for our common stock.

 

***The 2007 Stock Incentive Plan and all options issued under the 2007Stock Incentive Plan contain provisions for acceleration of all unvestedoptions in the event of a change of control, which might be a disincentive toacquisition of the Company as a liquidation strategy.***

 

The2007 Stock Incentive Plan and all options currently issued thereunder andoptions granted outside such plan provides for accelerated vesting of allunvested options in the event of a change of control, which is defined as anacquisition by a single person of more than 50 percent of the total combinedvoting power of all of our outstanding securities. This may be regarded as abarrier to retention of key employees following a change-of-control acquisitionand therefore make such an acquisition more costly or difficult, and thereforean unattractive strategic option, for a prospective acquiror.

 

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*** ***

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

 

Wehave paid no cash dividends on any of our classes of capital stock to date and wecurrently intend to retain our future earnings, if any, to fund the developmentand growth of our business.  In addition,the terms of the Notes prohibit us from making any dividend payment ordistribution to holders of our common stock while any portion of the Notesremain 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-Counter BulletinBoard, which may not provide liquidity for our investors.***

 

Ourcommon stock is quoted on the Over-the-Counter Bulletin Board. TheOver-the-Counter Bulletin Board is an inter-dealer, over-the-counter marketthat provides significantly less liquidity than the NASDAQ Stock Market or nationalor regional exchanges. Securities traded on the Over-the-Counter Bulletin Boardare usually thinly traded, highly volatile, have fewer market makers, and arenot followed by analysts.

 

TheSEC’s order handling rules, which apply to NASDAQ-listed securities, do notapply to securities quoted on the Over-the-Counter Bulletin Board. Quotes forstocks included on the Over-the-Counter Bulletin Board may not be listed innewspapers. Therefore, prices for securities traded solely on theOver-the-Counter Bulletin Board may be difficult to obtain and holders of oursecurities may be unable to resell their securities at or near their originalacquisition price, or at any price.

 

***Investors must contact a broker-dealer to trade Over-the-CounterBulletin Board securities. As a result, you may not be able to buy or sell ourcommon stock at the times that you may wish.***

 

Eventhough our common stock is quoted on the Over-the-Counter Bulletin Board, theOver-the-Counter Bulletin Board may not permit our investors to sell securitieswhen and in the manner that they wish. Because there are no automated systemsfor negotiating trades on the Over-the-Counter Bulletin Board, they areconducted via telephone. In times of heavy market volume, the limitations ofthis process may result in a significant increase in the time it takes toexecute investor orders. Therefore, when investors place market orders to buyor sell a specific number of shares at the current market price it is possiblefor the price of a stock to go up or down significantly during the lapse oftime between placing a market order and its execution.

 

***Our stock price may be volatile and you may not be able to sell yourshares for more than what you paid.***

 

Ourstock price is likely to be subject to significant volatility and you may notbe able to sell shares of common stock at or above the price you paid for them.The market price of the common stock could continue to fluctuate in the futurein response to various factors including, but not limited to: quarterly variationsin operating 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 stock rules.***

 

Ourcommon stock is subject to Rule 15g-1 through 15g-9 under the SecuritiesExchange Act of 1934, as amended, or the “Exchange Act,” which imposes certainsales practice requirements on broker-dealers which sell our common stock topersons other than established customers and “accredited investors” (generally,individuals with net worths in excess of $1 million or annual incomes exceeding$200,000 (or $300,000 together with their spouses)).  For transactions covered by this rule, abroker-dealer must make a special suitability determination for the purchaserand have received the purchaser’s written consent to the transaction prior tothe 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 tobe subject to the SEC regulations for “penny stock.”  Penny stock includes any equity security thatis not listed on a national exchange and has a market price of less than $5.00per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/selltransaction in a penny stock, a disclosure schedule set forth by the SECrelating to the penny stock market must be delivered to the purchaser of suchpenny stock.  This disclosure mustinclude the amount of commissions payable to both the broker-dealer and theregistered representative and current price quotations for the commonstock.  The regulations also require thatmonthly statements be sent to holders of penny stock which disclose recentprice information for the penny stock and information of the limited market forpenny stocks.  These requirements adverselyaffect the market liquidity of our common stock.

 

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***We will incur increased costs and demands upon management as a resultof complying with the laws and regulations affecting public companies, whichcould harm our operating results.***

 

As a publiccompany, we will incur significant legal, accounting, and other expenses thatwe did not incur as a private company, including costs associated with publiccompany reporting requirements. We also have incurred and will incur costsassociated with current corporate governance requirements, includingrequirements under Section 404 and other provisions of the Sarbanes-OxleyAct, as well as rules implemented by the SEC. The expenses incurred bypublic companies for reporting and corporate governance purposes have increaseddramatically. We expect these rules and regulations to substantiallyincrease our legal and financial compliance costs and to make some activitiesmore time-consuming and costly. We are unable to currently estimate these costswith any degree of certainty. We also expect these new rules andregulations may make it more difficult and more expensive for us to obtaindirector and officer liability insurance, and we may be required to acceptreduced policy limits and coverage or incur substantially higher costs toobtain the same or similar coverage than used to be available. As a result, itmay be more difficult for us to attract and retain qualified individuals toserve 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**

 

On March 13, 2008, Etelos, Incorporated, aWashington corporation, held a meeting of stockholders in connection with theapproval of the Merger.  In connectionwith the vote, the Merger was approved by all classes of its outstandingpreferred and common stock.

 

**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 the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
| May 15, 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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