UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, DC 20549





FORM 10-K






(Mark One)





xANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the fiscal year ended May 31, 2010






oTRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




For the transition period from ______________ to ______________




Commission file number:  0-27587




ARKADOS GROUP, INC.





(Exact name of registrant as specified in its charter)




Delaware

22-3586087(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)220 Old New Brunswick Road, Piscataway, NJ

08854(Address of principal executive offices)

Zip codeIssuer’s telephone number: (732) 465-9300Securities registered under Section 12(b) of the Exchange Act:Title of each class

Name of each exchange on which registeredNone

NoneSecurities registered under Section 12(g) of the Exchange Act:




Common Stock, $.0001 par value


(Title of class)







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


o Yes    x No




Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.


o Yes    x No




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


Yes x    No o


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 Yes o   No o
 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.


o




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).  (Check one):




Large accelerated filer  o

Non-Accelerated filer   o
Accelerated filero

Smaller reporting company   x




Indicate by check mark wether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes o   No x


Class

Outstanding at September 13, 2010[Common Stock, $0.0001 par value per share]

34,966,761shares










ARKADOS GROUP, INC.


FISCAL 2009 FORM 10-K




INDEX




Item
PagePART IITEM 1: Business
5ITEM 1A:  Risk Factors
22ITEM 1B:  Unresolved Staff Comments
33ITEM 2: Properties
33ITEM 3: Legal Proceedings
33ITEM 4: Submission of Matters to a Vote of Security Holders
33PART IIITEM 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
34ITEM 6: Selected Financial Data
36ITEM 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations
37ITEM 7A:Quantitative and Qualitative Disclosures About Market Risk
41ITEM 8: Financial Statements and Supplementary Data
41ITEM 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
43ITEM 9A:Controls and Procedures
43ITEM 9B: Other Information
44PART IIIITEM 10: Directors, Executive Officers and Corporate Governance
45ITEM 11: Executive Compensation
48ITEM 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
53ITEM 13: Certain Relationships and Related Transactions, and Director Independence
56ITEM 14: Principal Accountant Fees and Services
58PART IVITEM 15: Exhibits and Financial Statement Schedules
59Signatures
67





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As used in this Annual Report on Form 10-K, the terms “we”, “our” or “us” mean Arkados Group, Inc., a Delaware corporation and its consolidated subsidiaries, unless the context indicates otherwise.








NOTE RE: FORWARD LOOKING INFORMATION





All statements in this annual report on Form 10-K that are not historical are forward-looking statements, including statements regarding our “expectations,” “beliefs,” “hopes,” “intentions,” “strategies,” or the like. Such statements are based on management’s current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those set forth or implied by any forward looking statements. Some of these risks are detailed in Part I, Item 1A “Risk Factors” and elsewhere in this report. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, the risk factors discussed in this Annual Report on Form 10-K. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, or circumstances on which any such statements are based.











NOTE RE: CERTAIN MARKS





This Annual Report on Form 10-K contains registered and unregistered trademarks of Arkados Group, Inc and its subsidiaries and other companies, as indicated.  Unless otherwise clear from the context or noted in this Annual Report, marks identified by “® ” and “TM” are registered marks and trademarks of Arkados Group, Inc. or its subsidiaries.  All other trademarks and service marks are the property of their respective owners.  iPod® is a registered trademark of Apple Computer, Inc.  HomePlug® is a registered trademark of the HomePlug Powerline Alliance, of which Arkados is a member.








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PART I





ITEM 1.
BUSINESS.





General





The registrant, Arkados Group, Inc., was incorporated in the State of Delaware in 1998.





We are principally engaged in developing and marketing technology and solutions that enable standard electrical wires to carry digital information, such as broadband communication, multimedia, smart energy and smart grid data, and networking. We conduct these activities principally through Arkados, Inc., which is a wholly owned subsidiary. In September 2006, we changed our corporate name from CDKnet.com, Inc., to its current form to align our corporate identity with the “Arkados” brand developed by our subsidiary. Our Arkados subsidiary is a member of the HomePlug Powerline Alliance, an independent trade organization which has developed global specifications for high-speed powerline communications, and the Institute of Electrical and Electronics Engineers (IEEE), the world's leading professional association for the advancement of technology, and the Smart Grid Interoperability Panel, formed to provide input to NIST (National Institute of Standards and Technology) in coordinating, accelerating and harmonizing standards development for the Smart Grid.





Our executive offices are located at 220 Old New Brunswick Road, Piscataway, NJ 08854. We can be reached at our principal offices by telephone at (732) 465-9300. Arkados maintains a website at www.arkados.com.





Except for the documents on our website that are expressly incorporated by reference into this report, the information contained on our website is not incorporated by reference into this report and should not be considered to be a part of this report. This includes the website referred to in the paragraph above, as well as other websites that we refer to elsewhere in this report. All of these website addresses are included in this document as inactive textual references only.





Available Information





We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all other reports, and amendments to these reports, required of public companies with the SEC. The public may read and copy the materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. Copies of our fiscal 2008 Form 10-K may also be obtained without charge by mailing a request to us at 220 Old New Brunswick Road, Piscataway, NJ 08854 or by calling us at (732) 465-9300.





Overview





Arkados provides both hardware and software engines for a wide variety of products that enable high-speed digital transmission of music, movies, video, voice, smart grid applications, and broadband data over the existing infrastructure of electrical power lines.





By combining our system-on-chip (SoC) semiconductors with software and hardware platform designs, our solutions address diverse target markets in a number of growing market categories. Our turnkey solutions are designed to be used inside products for both consumers and industry. For example, consumer products (such as the Arkados-powered whole-house audio systems from Russound and NuVo Technologies currently being sold to consumers) can use Arkados solutions as part of a connected home entertainment and computing network, while industry can implement Arkados solutions as a part of a utility company’s “smart grid” and “green energy” solutions.





We have operated as a  “fabless” semiconductor company, meaning we design semiconductors without the capital requirements of owning and operating a fabrication facility; Arkados semiconductors are made from our designs by independent fabricators.  We offer our customers complete hardware and software design solutions that allow them to build devices that will distribute audio, video, voice, and data content throughout the whole house, building, or “smart-grid” infrastructure.





We began the transition from development stage company in fiscal year ended May 31, 2008 by generating revenue of $855,676 and generated $763,040 of revenue in the fiscal year ended May 31, 2009. During Fiscal 2009, we obtained a second extension of convertible subordinated notes which expired June 30, 2009, obtained a limited waiver of anti-dilution rights held the holders of





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secured convertible notes to facilitate equity financing, and added Harris Cohen to our board of directors.  As of May 31, 2010, $18,426,377 of secured debt, of which $5,205,617 is held by related parties is in default, as is $1,043,748 in principal and interest on unsecured notes due June 29, 2009.  In addition, as of May 31, 2010, $4,167,522 of salary remains due to our employees and our accounts payable was approximately $1,959.636 of which $1,656,244 was over 90 days.









We continue to negotiate with the holders of each class of debt to fashion a forbearance agreement, compromise or convert outstanding debt into equity and thereby facilitate raising additional investor capital and are exploring restructuring alternatives including selling assets and refocusing Arkados’ business in the powerline networking space.  We have also received indications of interest from potential private and strategic investors concerning the terms and conditions upon which they would make an investment in Arkados, including the terms upon which the secured debt and other debt would have to be compromised and converted for them to make such investments, but there is no binding commitment on anyone’s part to complete the transactions.  Finally, without commitment on anyone’s part, we have discussed converting a substantial portion of past due compensation with our employees if the restructuring of our debt can be completed and financing can be obtained for the continuing business.  Pending the completion of these transactions, we are financing operations by issuing bridge notes to investors that would participate in an equity financing if the debt can be restructured.  If the debt can be restructured and the financing proceeds, these investors would be able to make the equity investment in Arkados at a discount of 33% from the price other investors are offered.  In the event the financing is not completed, the bridge notes are due with interest at the annual rate of 8% on December 1, 2010, however it is unlikely that such note would be paid as the amount of our secured debt outstanding to which the bridge notes are subordinated, far exceeds the fair value of our assets.





Recent Announcements





Despite the extraordinary challenges of our financial position, Fiscal 2010 brought a number of significant announcements which relate to our relationships with STMicroelectronics and Tatung. Also, Arkados customers Russound and NuVo Technologies made announcements of products based on our chip.





In October 2008, we announced an agreement with STMicroelectronics to develop and manufacture a 200 Mbit per second, HomePlug AV wideband powerline modem System-on-Chip (SoC). Planned for availability in 2010, the world’s first HomePlug AV SoC to be interoperable with three established powerline standards (TIA-1113/HomePlug 1.0, HomePlug AV, and the recently confirmed IEEE 1901 Standard) is designed to power applications ranging from simple Ethernet-to-powerline bridges to full-featured products as wide ranging as HDTV distribution, digital set-top boxes, IPTV, whole-house audio, networked digital picture frames, surveillance systems, and also industrial and commercial applications, especially targeting the Smart Grid and Green Energy segments. STMicroelectronics, with its significant experience in developing and marketing powerline communications solutions, is largest semiconductor manufacturer to announce plans to bring a HomePlug AV chip to market. Both Arkados and STMicroelectronics participated in the HomePlug alliance exhibit at this year’s Consumer Electronics Show (January 2010).





In August 2008, we announced a relationship with the $7B global Original Design Manufacturer (ODM) Tatung. The collaborative relationship between Tatung and Arkados constitutes a one-stop shop for the industry’s technology and manufacturing needs for distributing digital content in homes. Together, the companies deliver complete product solutions to consumer product manufacturers – from audio input/output devices, to integrated speakers, to control units, to smart grid and smart meter products. By coupling Tatung’s product design and manufacturing with the Arkados technology platform, the companies can deliver turnkey products to brand-name manufacturers. In June 2009, we announced how we have built on this relationship by demonstrating the capability to connect Smart Grid applications and in-home consumer applications over one network. The demonstration at Computex featured Tatung's smart meter connected to an Electricity Control Center via a WiMAX network, and a number of in-home entertainment applications connected via an Arkados powered HomePlug powerline network. In January at the 2010 Consumer Electronics Show, both Arkados and Tatung participated in the exhibit of the HomePlug Powerline Alliance to display a number of smart grid devices that are based on Arkados’ technology platform. Devices residing on the HomePlug network enable home video surveillance, control of electricity usage, and home entertainment.





Arkados has been recognized through awards given to the products of our customers:




·
Checkolite International received a “CES Best of the Best” award from G4 Television for a system that combines whole-house audio with lighting control


·
Russound’s Collage and NuVo’s Renovia systems were each recognized as Honorees in the 2009 CES Innovations awards.


·
Both the NuVo and Russound systems were displayed at the 2009 Electronic House Expo (EHX) and were singled out by CE Pro magazine in a list of Ten Products to Watch for in 2009. Both companies are now shipping products and have begun significant marketing campaigns.





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The recognition of our customers’ products follows a major award received by Arkados in January 2008 from G4 Television. The Arkados HomePlug system-on-chip and software solution won the award on the strength of its embedded solution powering the IOGEAR Powerline Stereo Audio System which creates whole-house music at a fraction of the cost of dedicated installed systems. The IOGEAR product is now on sale and has received very positive reviews, including a 4-star rating from About.com that called the product “a giant step forward in multiroom audio.”1





Russound’s Collage Powerline Media and Intercom System has received significant positive reviews from Home Entertainment magazine2, Home Theater magazine3, and CePro magazine4 which said, “It’s not often that something lives up to the hype this industry tends to create for products but, in the case of the Collage, I think Russound’s enthusiasm for the product is founded in reality.” The Collage system was also named as one of the Top 15 products by E-Gear magazine5 (February 2010) alongside products from LG, Yamaha, Steinway-Lyngdorf, Marantz, and Toshiba.




Dependence on Financing Activities





Although we have started to generate revenue during the past three years, we continue to be dependent on outside sources of financing to continue the development of our semiconductors and software, and to further support sales. During fiscal 2008, we completed a series of debt financings in the aggregate principal amount of $855,000; we also issued notes in the amount of $125,000 which were converted into equity in August 2008.  Andreas Typaldos, our Chairman and one other Director loaned the Company $177,700.  From June 1, 2008 to May 31, 2009, we received advances from related parties of approximately $649,000 which was converted into equity in August 2008.  In addition, we received an additional $20,000 which represents borrowings from related parties. All aspects of the business are challenged by the lack of funding and in the event we are unable to adequately fund our operations and restructure our existing debt, we will have to suspend operations.





We have sought and will continue to seek various sources of financing but there are no binding commitments from anyone to provide us with financing. In addition, there is $18,426,377 in principal and interest amount of 6% Secured Convertible Debentures due June 28, 2009 (initially due December 28, 2008) issued during the period from December 2004 to August 31, 2008 outstanding, which has been an impediment to obtaining equity financing.   The documents were amended in January 2007 to eliminate the requirement that the holders of 60.1% of the outstanding principal amount consent to our issuance of shares, debt or fixed convertible securities to finance our operations, continue to contain a full “ratchet down” provision which has a dilutive effect, which is triggered by future financing at an effective price lower than the conversion and warrant exercise price.





In July 2008, we reached an agreement with the holders of the Secured Debentures which extended the due date to June 28, 2009 capitalizing interest until the Secured Debentures are due and waiving the ratchet down anti-dilution adjustment for certain equity financings completed before October 31, 2008.  The Company exchanged the following for these amendments:





·
new debentures for 25% of the outstanding principal amount of Secured Debentures ($2,845,815.25) having identical rights as the Secured Debentures, except that the conversion price is $0.25 rather than $0.85 and





·
new warrants for 25% of the existing warrants held by the holders of the Secured Debentures (2,332,131), identical to the warrants surrendered, except that the warrant exercise price is  $0.25 rather than $0.85 and the new warrants are only exercisable for cash until December 1, 2008.





On August 7, 2008, we issued 1,690,080 units (each consisting of two shares of our common stock and one warrant) to 18 accredited investors for aggregate consideration of $845,038.47.  Of this consideration $762,593.66 was cash or cash advances made to us after April 15, 2008 and the balance was in exchange for prior obligations for borrowed money and other accounts payable.  The warrants are exercisable until June 30. 2013 and entitle the holder to acquire one additional share of our common stock for $0.25 per share.





On July 2, 2009 we received notice from a law firm representing approximately 45% of our outstanding 6% secured convertible debentures due June 28, 2009 (the “Debentures”) were in default by reason of non-payment. This event triggers an “Event of Default” under the terms of the Debentures on July 8, 2009, absent payment in full. The Event of Default entitles the holders of the Debentures to redemption at the rate of 130% of the principal and accrued interest outstanding, interest on unpaid interest and principal at the rate of 18% per annum commencing on July 8, 2009 and reimbursement for expenses incurred enforcing the obligations.





We have been negotiating for an infusion of equity capital, restructuring of our secured and unsecured debt, as well as exploring restructuring alternatives that include a sale of assets and refocusing our niche in the powerline networking space.  Although there can be no assurance that the forbearance, financing, sale of assets or restructuring of our debt or business can be achieved, nor are there any binding agreements in any of the areas that have been reached, we continue to work closely with representatives of the holders of the Debentures to maintain the company as an ongoing business, which includes preserving our current operations and relationships with existing customers, partners and suppliers. 
 As of July 6, 2009 , $1,066,500 principal amount of 6% Convertible Subordinated Notes (the “Notes”) due June 30, 2009 were also in default by reason on non-payment. Under the terms of the Notes, the interest rate increases to 12% during the period the Notes are in default and the holders are entitled to the costs of collection. We plan to discuss forbearance or extension of the due dates of the Notes, as well as conversion of the Notes into equity with the holders and their representatives, as part of our restructuring, but there can be no assurance that any such agreement can be reached.


Arkados Products





Our highly integrated semiconductors provide the internet or network connections over existing electric lines for new consumer electronic products (such as stereo systems, television sets, intercoms and personal iPods®) and smart grid applications. Our solutions can also be used for bridging legacy products with newer home networking and broadband communications technologies.





Arkados solutions offer a completely different approach than our competitors.  Our solutions incorporate a processor and multiple interfaces into the same chip that houses HomePlug communication technology, as well as provide application-level software that runs on the chip.  We believe this “system-on-a-chip” approach provides a more cost-effective and more flexible strategy to bring products to market for our customers.





·
Comprehensive platform solutions.


Our platform solutions consist of an integrated package of hardware, firmware and software designed to enable our customers to develop differentiated products in a cost-effective manner with a short time-to-market. In addition to a high-performance SoC, we plan to provide our customers with customizable, high functionality firmware, and software development kits to allow them to rapidly develop and differentiate their products. As a result, we would be able to reduce our customers’ investment in costly and time-consuming internal firmware and software development for their products, and from having to source different firmware and software for their end products from multiple suppliers.


·
Customizable firmware and software.


Our firmware, which is sold as a bundled solution with our SoCs, includes a real-time operating system and a set of application specific modules that support a wide range of functions including Web-based management, audio distribution, traffic classifications, etc. Our software platform includes a comprehensive suite of components, such as device link libraries and drivers, tools, sample code and documentation to create applications that would allow a wide range of networking devices and networked multimedia appliances.


·
Targeted, high-performance SoCs.


Our SoC solutions are specifically designed for the powerline communication market.  They are driven by function-specific blocks that allow simultaneous execution of complex operations, such as transmission of data over power lines and MPEG audio decoding and playback. Our SoCs support most major peripheral connection protocols, including USB, Ethernet, Infrared, I2S, and a number of specialized and general purpose interfaces. This support enables connectivity to a variety of playback, display and content creation devices including cameras, PCs, televisions and car and home audio systems.





Technology





Arkados is committed to building standards-based solutions.  Currently, Arkados SoCs are based on the specifications developed by the HomePlug Powerline Alliance and TIA-1113 standards (these SoCs are used inside products being shipped by Russound





1 ©2009 by Gary Altunian (http://stereos.about.com/od/reviewsandrecommendations/fr/Powerline.htm).  Used with permission of About, Inc. which can be found online at www.about.com.  All rights reserved.
 2 Complete article: http://www.hemagazine.com/Russound+Collage?page=0%2C0
 3 Complete article: http://www.hometheatermag.com/wholehousesystems/russound_collage_powerline_media_and_intercom_system/
 4 Complete article: http://www.cepro.com/article/hands_on_does_russound_collage_live_up_to_hype/
 5 Complete article: http://www.e-gear.com/slideshow/15-best-products#5


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and NuVo).  Our planned HomePlug® AV based AI-2100 SoC, which is being developed and manufactured under an agreement with STMicroelectronics, is designed to be interoperable with three established powerline standards: TIA-1113/HomePlug 1.0, HomePlug AV, and the recently confirmed IEEE 1901 Baseline Standard. The chip also designed to offer support for the Inter PHY Communication Protocol (IPP) as defined by the IEEE P1901 Working Group, and which is scheduled to be included in the upcoming ITU-T G.hn standard.





System-on-Chip Semiconductors





Arkados has a number of design wins that employ our first SoC, the Arkados AI-1100, which we started marketing in Fiscal 2007.  The device supports applications such as whole-house music streaming, whole-house internet access, and can be used in IPTV set-top boxes designed to decode and display standard definition video content -- from sources as varied as surveillance cameras and YouTube -- on regular TVs throughout the home. This turnkey solution features a programmable MAC and an on-chip ARM 9 application processor. Its fully HomePlug 1.0 compliant MAC/PHY and Arkados extensions and software provide increased performance and future proofing. The whole-house audio systems currently shipping from Russound, NuVo and IOGEAR take advantage of these features.





Our next generation SoC, the AI-2100, will be backwards compatible with our current chip and it will feature an enhanced embedded Quality of Service (QoS) engine which supports video flows for low jitter, lip synch and low latency delivery. The chip is being developed and manufactured under an agreement with STMicroelectronics.





Software





In our view, today’s digital products are incomplete without an array of software components that enable both device-to-device communications and robust product features.  We provide our customers with a host of software components that run directly on our chips, further reducing development time.  These software components include application-level features (such as our Direct-to-SpeakerTM multi-channel audio synchronization, networking and internet, online gaming, etc.) embedded application support software (audio compression/decompression, internet radio support, GUI support, video drivers, etc.), Quality of Service engine, traffic management, and TCP/IP components. We developed custom software components for NuVo, IOGEAR, and Russound in the whole-house audio systems that these companies are now shipping.





Market Opportunities





Arkados solutions are offered to the following markets:





·
the retail consumer electronics market and the whole-home custom installation market


·
the smart grid market


·
the subscription services market.


The Growing Digital Home: Networked Consumer Electronics





As broadband access to the home is becoming ubiquitous, home networking and connectivity demands for digital home applications continue to grow – extending the internet, and the services that travel on it, to every corner of the house.





The promise of sending digital communications over common power lines is now being realized, and Arkados’ products serve several large and growing markets: retail consumer electronic products, whole-house audio installations, smart-grid utility company applications, broadband-over-powerline internet access, and the distribution of internet-based services. Specifically, Arkados customers Russound and NuVo are shipping audio systems that incorporate Arkados solutions to combine whole-house music with features such as intercom, online access to services such as Rhapsody and Sirius, iPod connectivity, and DLNA-based media discovery and playback from locally networked devices.





The Arkados AI-1100 is the first HomePlug 1.0 compliant system-on-chip targeted for the retail consumer electronics market. Coupled with software to create full turnkey solutions, the Arkados AI-1100 has already received a number of design wins, and is the engine behind the creation of reasonably-priced multi-room audio and video distribution products for the retail consumer market. Products in the market now feature iPod® docking stations and multimedia in-home systems that can be placed anywhere in the home, with no additional wiring needed.





As a subset of this market, the whole-house audio market category has been particularly active. Arkados’ solutions offer a way to create both retail and custom audio systems with features and functionality heretofore available only in multi-thousand dollar custom audio installations.  Arkados’ customers include Checkolite, Devolo AG, IOGEAR, Gigafast, NuVo Technologies, Russound, Tatung, and Zinwell.





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Two customers in particular, Russound and Nuvo have begun shipping their whole-house systems that use the Arkados chips and software. Both whole-house audio systems have won major industry awards from CEDIA, CePRO, and CES. Russound selected the AI-1100 chip and Arkados software for use in both its iBridge Power Dock, and its Collage Powerline Media and Intercom System, and NuVo selected Arkados solutions for multiple components of its Renovia system. Both systems are shipping to custom installers worldwide.





These high-end custom audio systems, which address the existing home market (expanding from their primary market target of newly constructed homes), can feature up to 12 separate audio zones and can process a wide range of sources of audio content which can be streamed from any digital or legacy analog source.





Russound is a leading custom multi-room audio distribution system manufacturer that selected the AI-1100 for use in a number of products. Arkados has received initial volume commitments and NREs (Non-Recurring Engineering) valued over $1.2 million from customers in this area, of which over $212,595 has been recognized through May 31, 2010.  Arkados’ chips can also power cameras, video endpoints, and sensors for other installed home systems, such as for surveillance systems.





Smart Energy and Utility Company Applications





Another large potential market for Arkados’ solutions relates to energy conservation, the “green” applications that help utility companies and their customers save both money and energy.  For example, “Smart Grid” applications (Green Energy, demand response, energy efficiency and grid modernization – i.e., reduction of carbon emissions) and home/building automation (such as controlling air conditioner thermostats remotely) represent large and attractive opportunities given today’s surging energy costs. Arkados has registered design wins at MainNet and Corporate Systems Engineering.





Services





An additional immediate potential market for the Arkados platform is for subscription music services. Arkados software and chips enable the distribution of Internet music services (e.g., Rhapsody, Yahoo!Music, AOL Music, Shoutcast services), and Russound’s Collage, with its access to the Rhapsody music service, is the first Arkados-powered solution to implement this feature. The Company is actively working on reference designs and business strategies to address this rapidly developing market.





Corporate Background





On May 24, 2004, we filed a merger certificate completing the acquisition of Miletos, Inc., a previously unaffiliated Delaware corporation (the “Merger”). The consideration for this Merger was 16,090,577 restricted shares of our common stock and the assumption of certain liabilities of Miletos’ predecessor and former controlling equity holders. The merger was completed according to the terms of an Agreement and Plan of Merger dated as of May 7, 2004. Miletos merged into a wholly owned subsidiary we formed for the merger which then changed its name to “Arkados, Inc.”.





Simultaneously with the merger, we completed a private placement of 883,334 shares of our common stock for aggregate proceeds of $1,060,000, of which approximately $950,000 were subscriptions for cash, $50,000 (41,667 shares) was for outstanding debt of Arkados, and $59,800 (49,834 shares) was in lieu of consulting fees. The sale was made to 10 accredited investors (“Investors”) directly by us without any general solicitation or broker. The offering is claimed to be exempt from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended. In addition, we settled liabilities relating to outstanding convertible notes and payables for 700,000 common shares.





Prior to the Merger, on March 23, 2004, Miletos acquired the assets and business of Enikia, LLC, a Delaware limited liability company at a public foreclosure sale, including the intellectual property upon which Arkados’ development efforts are based. Miletos was formed in February 2004, by control affiliates of Enikia. These control affiliates were both secured creditors of Enikia and holders of the controlling equity interest in Enikia. They contributed a secured promissory note to Miletos in the initial principal amount of $9,221,000, dated June 1, 2002. The promissory note also represents obligations to the lender for additional advances to Enikia by the control group which brought the aggregate principal due at the time of foreclosure to approximately $11,100,000. At the foreclosure sale, Miletos forgave $4,000,000 of the secured obligation in exchange for substantially all of the assets of Enikia. The merger has been treated as a reorganization of Arkados, Inc. via a reverse merger with Arkados Group, Inc. The assets acquired at the foreclosure sale and certain liabilities assumed by Arkados Group, Inc. have been recorded as historical cost.





On March 3, 2007 we completed the merger of Arkados Wireless Technologies, Inc., our wholly owned subsidiary (“Merger Sub”) with Aster Wireless, Inc. a Delaware corporation (“Aster”) pursuant to an Agreement and Plan of Merger dated February 13, 2007 by and among Merger Sub and Arkados Group, Inc. In this merger, we acquired synergistic talent and technology which has helped improve the reliability and quality of audio streaming in our current generation chipset and we believe may help deliver our next-generation chips to market more quickly, with richer capabilities. This will translate to a better competitive





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position in the marketplace.  The technology enhances the reliable distribution of multimedia content, potentially over multiple distribution media, and is designed to be embedded in new consumer electronics products and accessories for audio, video distribution, set-top boxes and other multimedia entertainment appliances.





Industry Background





Music, movies, the electrical “smart grid”, and a wide range of communication services are experiencing a fundamental shift. The distribution of content to products, and in some cases the products themselves, is transitioning from traditional methods. Digital content is requires a new digital distribution model.





Arkados’ Standards-based Solutions





Arkados’ solutions are designed to directly address this opportunity by enabling electrical power sockets to be turned into high-speed network ports, thereby providing a high-speed pathway through which digital information can travel inside a home, to the home, and on the smart grid. We believe that this shift creates demand for new products, and new products will require new types of advanced semiconductors that incorporate digital technologies, supporting such functions as communication, application processing, and media rendering.





Our ArkTIC® family of turnkey hardware and software solutions is designed to address these requirements. In particular, Arkados has implemented a method that uses power lines as a pathway for digital information, allowing end users to truly achieve “plug-and-play” simplicity without the hassles of custom-installed networks, or the problems associated with wireless solutions such as dropouts, unreliable coverage, and security issues.





Standards-compliance Creates Market and Product Confidence





Members of the Arkados team have been active in establishing standards for the powerline communications industry since the year 2000.





Standards are important for a number of reasons, but especially when both consumers and service providers or utility companies may be installing different pieces of the ecosystem. This is the case within the powerline communications and smart grid industries. Wireless standards, for example, have brought about a ubiquitous, interoperable and affordable standard for portable data communication, which resulted in greatly accelerated market growth.





Members of the Arkados team participated in the creation of the HomePlug Powerline Alliance, an independent industry association.  The Alliance’s mission is to enable and promote rapid availability, adoption and implementation of cost effective, interoperable and standards-based home powerline networks and products.  Formed in 2000, the Alliance developed the HomePlug 1.0 specification that unified product vendors in support of a single powerline solution for home networking. In 2008, the technology of the HomePlug 1.0 specification was adopted by the Telecommunication Industry Association as TIA-1113 standard. In 2005, the Alliance ratified HomePlug AV specification that enables 200Mbps class communication over power lines.





In April 2010, the IEEE (the world’s leading standards-setting body) announced that the P1901 Working Group passed the initial sponsor ballot, paving the way for a global standard for powerline networking. The ballot passed with over 80 percent affirmative votes, demonstrating the overwhelming industry support behind the technology. Arkados HomePlug AV chips will be interoperable with the IEEE 1901 standard.





Market Analyst In-Stat believes that powerline communication will be a potentially important technology for multimedia networking, as the technology could provide a home network backbone. Arkados has worked in significant ways to develop the HomePlug specifications including in-home technologies (HomePlug 1.0, HomePlug AV, and HomePlug AV2), to-the-home technologies ( HomePlug BPL for broadband over powerline), and HomePlug Command &Control (C&C) and HomePlug GP (“Green PHY”) for low-speed command and control and Smart Grid applications.





Arkados is a Contributing Member of the HomePlug alliance. Members of the Arkados team were recently elected to several leadership positions in the Alliance. Oleg Logvinov, our president and CEO, currently serves as the Chief Technical Officer of the HomePlug Alliance, and chair of the Standards and Liaison working group. Mr. Logvinov is also a past president of the Alliance, having been succeeded by Matthew Theall of Intel. Additionally, Jim Reeber, our Director of Marketing served as Chair of the





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Worldwide Marketing Working Group from 2003 to 2010, and currently remains as Vice Chair of the group; Grant Ogata, our Executive Vice President of Worldwide Operations, has served as the Chairman of HomePlug Command and Control Working Group and was instrumental in spearheading the alliance’s efforts to develop a specification for a low-cost command and control technology. Jim Allen, our Vice President of Standardization and Advance Planning, was re-elected as the chair of the HomePlug Smart Energy Technical Working Group.





The HomePlug technology now dominates the marketplace. Market analyst In-Stat forecasted that in 2010, the technology based on HomePlug specifications will hold 85% of the worldwide market for powerline communications. The HomePlug Powerline Alliance has brought together both personal computer and consumer electronics companies on a global scale. Membership in the Alliance has grown to include nearly 70 industry-leading companies. HomePlug Sponsor companies include Atheros, Cisco; Comcast; Duke Energy, GE Energy, part of General Electric Co.; Gigle Networks; Motorola; Renesas; SPiDCOM Technologies; and STMicroelectronics. Besides Arkados, Corporate Systems Engineering is also a Contributor-level member.





Working with the HomePlug Powerline Alliance, the Arkados team has contributed to the development of a number of specifications that were contributed to standards organizations, such as the Telecommunications Industry Association.





Arkados is also a member of the IEEE P1901 working group that is focused on the development of powerline communication Physical Layer (PHY) and Media Access Control (MAC) specifications. Jim Allen was recently elected to serve as Vice Chair of the Working Group. Mr. Logvinov was recently elected to serve as a member of IEEE SA Standards Board. Arkados is also a member of IEEE P1901.2 working group focused on Low-Frequency Narrow-Band Power Line Communications and Mr. Logvinov was recently appointed as a Vice Chair of this Working Group.





The Strategy behind Arkados Solutions





Arkados is a fabless semiconductor company that develops comprehensive platform solutions, including system-on-chip (SoC) semiconductors, and firmware and software for manufacturers of networked multimedia appliances and feature-rich networking devices. Our platform solutions are designed to enable a systems-based approach to networking and will allow our customers to build products that are simple and intuitive to install, and easy to operate with intuitive and customizable user interfaces.





We believe that many of our customers plan to produce not just one standalone device, but they will introduce many system components that work together. An example is the audio market: Our customers would not just introduce a dock for an MP3 player, but they would also produce a variety of speakers, control units, CD players, adapters, boom-box style rendering points, etc. Our solutions enable greater versatility and value that allows our customers to create each of those components, sometimes with only a single hardware design.





The primary goal of our solutions is to enable our customers’ plan to develop and sell end-user systems. Our customers require a lower Bill of Materials (their cost for manufacturing a product), and better ways to produce a variety of components for end-user systems more quickly. We call our solutions “turnkey” because they enable our customers to create entire product lines without dedicating their resources to long product development cycles, or extensive software design.





Our customers are also aware of our strategy to support a seamless transition to higher-speed technologies as they become available. This promotes long life-span of their development effort, and creates significant re-use of their software components. Our SoC includes a powerful processor that allows applications to be run directly on our chip. Multiple vertical applications can be built by loading different firmware, compared to having to redesign circuitry. This feature can broaden product offerings, and extend the product lifecycle. The Arkados implementation of HomePlug technology offers programmability that enables OEMs to extend the functionality of their products and produce a variety of products from a single design.





In contrast, competitors that do not provide comprehensive platform solutions such as ours may be able to produce a greater variety of customized ICs to more specifically address the particular requirements of an OEM. Solutions which do not include customizable firmware and software like ours may allow OEMs to take advantage of a wider range of third-party developers. While these alternative solutions may be lower in cost for simple data networking devices in comparison to our platform solutions, our solution will be more cost effective and has higher reliability and performance for multi-media networking including distributing audio and video throughout the home and outputting to existing consumer electronic products.





Key Strategic Elements





Provided we are able to continue to finance our operations, our objective is to be the leading supplier of comprehensive platform solutions for high-performance and feature-rich networked multimedia appliances and networking devices.





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Key elements of our strategy are:




·
Maintain a full platform solution approach with industry-leading SoCs, firmware and software.




We plan to continue to commit the resources of each of our hardware, firmware and software teams to drive innovation so that our solutions are at the forefront of the networked multimedia appliances and networking devices industries and capture a leading market share. We intend to continue to devote resources to increase the performance and functionality of our SoCs and expand the features and capabilities of our firmware and software.  This enables great flexibility and value for our customers as they take products to consumer and enterprise markets.




·
Maintain our focus on feature-rich networked multimedia appliances and networking devices.




We intend to build on our experience as a platform provider by continuing to focus primarily on customers that produce feature-rich networked multimedia appliances and networking devices. In addition, we intend to continue to work closely with manufacturers of other media rendering components to ensure that our platform solutions interface with their current and future technology components for optimal performance their end products.




·
Maintain our focus on the integration of powerline and audio rendering functions to secure the leadership position in networked multimedia appliances and networking devices.




We believe that the networked audio markets will continue to represent the largest near-term volume opportunity for networked multimedia appliance and networking device manufacturers. In June 2010, Allied Business Intelligence stated “$10+ billion market is expected by 2015, the result of a 2009-2015 compound annual growth rate of more than 32%”.6 We intend to continue to focus on advancing functionality and promoting our solutions to win designs in this large and growing market. By including these options in our platform, we create a foundation that enables our customers to incorporate new features more quickly.




·
Enable new growth markets, such as photo- and video-enabled networked multimedia appliances.




We intend to build on our existing expertise to be the leading provider of comprehensive platform solutions in new markets. We intend to continue to invest our research and development efforts and engineering resources to develop new platforms and products and to strengthen our technological expertise. One example is our reference design that employs both our solutions as well as Blackfin® Processors by Analog Devices to provide a cost-effective platform for a variety of video applications based on powerline distribution. We believe that our focus in this area creates optimized solutions for our customers and increases the revenue potential for companies throughout the value chain.




·
Expand our customer base while securing additional design wins with existing customers.




We plan to be the leading supplier of new designs to our existing customers, and to secure a high market share with new customers entering this market. We intend to continue the expansion of our customer base by marketing our platform solutions to additional manufacturers of consumer devices. Further, we intend to broaden our reach within our existing customer base into their adjacent product lines that can utilize technologies that we intend to implement in the near future. By providing key hardware and software components to our customers, we believe we can deliver better value and features to our customers, while reducing design and manufacturing costs.




·
Create business arrangements with companies to better serve our common OEM customers.




We plan to go to market together with a number of companies who target specific areas of the marketplace. Since certain companies pursue many of the same customers who approve the products destined for the end-user, we plan to take advantage of this communality and together create solutions and offer even greater turnkey value. This approach offers OEM customers an easier point-of-contact and allows them to take advantage of efficiencies we have already built with our partners.




Our Products





We design and develop and are marketing highly integrated SoC semiconductors that are designed to cater to the markets for powerline communications. Our chip designs offer flexible solutions through programmability and remote firmware upgrades. Our customers have responded very favorably to our platform offerings which we call ArkTIC®, which is an acronym for the Arkados Total Integration Concept.





Solutions from our ArkTIC family of converged multimedia and networking solutions targets data-, audio-, photo-, and video-enabled networked multimedia appliances and networking devices.




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The ArkTIC family is a portfolio of turnkey hardware and software solutions that enable OEMs and ODMs to quickly develop digitally networked consumer electronic products with a competitive cost structure to address this rapidly developing market. Among other networking interfaces, the first member of the ArkTIC family supports a powerline communication interface based on the HomePlug Powerline Specification 1.0.1, and our next chip will support HomePlug AV.





Arkados has a number of design wins that employ our first SoC, the Arkados AI-1100.  The device supports applications such as whole-house music streaming, whole-house internet access, and can be used in IPTV set-top boxes designed to decode and display standard definition video content -- from sources as varied as surveillance cameras and YouTube -- on regular TVs throughout the home. Russound and NuVo are currently shipping products that are based on Arkados chip-and-software solutions.





We have announced that our upcoming HomePlug® AV based AI-2100 SoC will likely be the only chip available that will be interoperable with four established powerline standards: TIA-1113/HomePlug 1.0, HomePlug AV, IEEE 1901, and HomePlug GreenPHY (HomePlug GP). The upcoming chip will also offer support for the Inter System Communication Protocol (ISP) as defined by the IEEE P1901 Working Group. Our next generation SoC, the AI-2100, will be backwards compatible with our current chip and it will feature an enhanced embedded Quality of Service (QoS) engine which supports video flows for low jitter, lip synch and low latency delivery. The chip is being developed and manufactured under an agreement with STMicroelectronics.





We started marketing our AI-1100 system-on-chip in Fiscal 2007. It is designed to be embedded into various consumer electronics and multimedia networking devices and deliver high-speed Internet/Networking connectivity and multimedia over the power lines in a home. The AI-1100 chip offers a single-chip integration of HomePlug 1.0.1 powerline technology, an ARM 926-JES CPU operating at 160 MHz, dual Ethernet interfaces, an I2S Audio Interface, and a wide variety of other interfaces designed to support connected home applications. Furthermore, the programmable nature of our implementation allows ODMs/OEMs to extend the functionality of these products and HomePlug technology. This is the silicon-and-software solution embedded inside the IOGEAR, Russound, and NuVo systems are currently shipping into the marketplace.





ArkTICTM AI-1100 system-on-chip features:




·Based on HomePlug 1.0 Specification

-PHY/MAC sub-system is designed to allow for compliance with the

HomePlug specification

-Arkados extensions for increased performance and future-proofing

-Programmable MAC functions for full flexibility

·ARM926 Processor

-16k instruction cache & 4k data cache

-Memory Management Unit

-Embedded Trace Macrocell (ETM9)

·SDRAM Controller

-Supports external parts up to 256Mb

·SRAM Controller/Expansion Bus Interface

-Supports external boot Flash or external SRAM and acts as a general-purpose

interface bus for external logic

·Ethernet controllers

-Standard MII port (802.3u) - or - PHY Emulation Port (PEP) MII (emulates

Ethernet PHY)

·Video/Audio DSP Interface

·USB 1.1 Device

·Serial I/O Controllers

·I2S for direct connection to audio DAC

·IrDA

-6550d compatible UART

·GPIO Controller

·JTAG / Debug Interface

·0.18μ CMOS, 1.8V core, 3.3v I/O

graphic





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Our AI-1100 is the first in a series of devices built around existing and emerging HomePlug Powerline Alliance networking specifications. This device supports the HomePlug 1.0.1 specification along with a variety of multimedia applications. Our Direct to SpeakerTM Internet Radio Reference Design (AI1100-DTS-INTR) and our Direct-to-SpeakerTM MFi iPod Dock have received HomePlug 1.0 certification. Furthermore, the programmable nature of the Arkados implementation allows OEMs to extend the functionality of the HomePlug technology. The AI-2100 and future devices will include, among other enhancements, the implementation of new technologies such as HomePlug AV, HomePlug BPL, HomePlug GP, and IEEE 1901 specifications as they become available.





We have modularized a core Orthogonal Frequency Division Multiplexing (OFDM) and communication platform to rapidly develop customized solutions appropriate for each powerline market. This enables efficient reuse and repurposing of technology blocks, which can be used to create many specific solutions.





We also provide consulting, software, and applications support, thereby facilitating system integration in an effort to reduce our customers’ time-to-market and our customers’ development costs.





In the in-home networking portion of the market, we expect to deliver solutions for both computer-centric and entertainment-centric applications. Inside our chips, we combine the networking blocks with blocks that are capable of supporting end-user applications for consumer electronics products. Our chips are designed to offer a high degree of programmability and may become an attractive solution for a diverse range of home-networking products that merge traditional consumer electronic functions with network-centric features.





In another portion of the market, we expect to deliver highly integrated circuits that combine both networking blocks and blocks that are capable of supporting communications applications in demand from businesses such as hotels, office parks, shopping plazas, apartment buildings, etc. This is sometimes referred to as the multi-dwelling/multi-tenant unit (MDU/MTU) or the “commercial” market. Downloadable firmware management capabilities make this an attractive solution for remote management and service applications.





In the Smart-Grid and Utility Applications portion of the market, we expect to deliver highly integrated circuits that combine both networking blocks and blocks that are capable of supporting the communications applications that are in demand from service providers and utility companies. This portion includes the “Smart Energy” applications that help utility companies to conserve energy and better manage their network (applications such as Automated Meter Reading, Peak Shaving, and others provide a variety of benefits and cost-saving measures for both grid operators and consumers). Downloadable firmware management capabilities would make this an attractive solution for remote management and service applications.





The Application of Arkados Solutions





Listed below are examples of the products that can be built based on the Arkados semiconductors by ODMs and OEMs. Our customers have already developed some of these products and either have or will be bringing them to market. Whole-house audio products from IOGEAR, NuVo, and Russound are shipping to custom installers worldwide.





·
CONSUMER ELECTRONICS - Devices that bridge current devices and content with existing and new consumer electronic products throughout the home.  These devices allow users to easily distribute multimedia content, allowing them to enjoy music from iPod, internet, or PC throughout the whole house; to view videos downloaded from the internet on a big screen TV; to access the digital photos stored on a PC and display them on a digital photo frame, or to share new photos with loved ones via the internet by displaying them directly on a digital photo frame located thousands of miles away. This is a growing market that includes audio & video devices with embedded powerline technology. We expect this market to grow over the next few years as more video and audio products are released with networking technologies built-in. Televisions, stereos, powered speakers, receivers, DVD and CD players, digital picture frames, home intercom systems, and other products are targeted applications for powerline networking technology. Internet streaming content and home content servers should greatly increase the demand for HomePlug 1.0 and AV products. In particular, our solutions offer advanced features such as synchronized whole-house audio which, combined with its new ease of installation, may significantly broaden the marketplace for such applications.·
NETWORK HARDWARE - New types of routers, switches, gateways, network attached storage, surveillance cameras, and other devices that offer various types of services to the SOHO (Small Office Home Office) network.





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·
INTERNET TELEPHONY - As companies like Vonage, Comcast, Verizon and other service providers begin to roll-out new voice services to the home, an easy-to-use and reliable home network is needed. VoIP (Voice-over-IP) phones are currently produced by several vendors and we expect to see such products with HomePlug technology embedded into them.





·
HOME SECURITY - Many companies have created home security cameras that are networked through various means. Early market entrants GigaFast, Logitech, ST&T, and Asoka have already created powerline networked security cameras with embedded web servers that allow direct access to the camera’s feed.





·
SMART GRID – Many utility companies may implement applications that could provide benefits such as saving money due to automated operation, the ability to predict maintenance issues, implementing a self-healing grid architecture, reducing power outages, and making better use of their assets; managing the grid more intelligently to prevent blackouts and power disruptions; recovering more quickly after a power disruption; increasing security; implementing real-time monitoring of the state of the network, and managing a response; managing the quality of the power (to deliver differentiated services for businesses with sensitive electronics and computers); implementing “green power” programs that allow consumers to manage their electricity use and costs; and integrating control systems, power electronics, and distributed resources.





Sales & Customers





Our solutions are designed to bridge entertainment and internet content to devices around the home, and to bridge between communications technologies, such as WiFi and powerline, Ethernet and powerline, and even to-the-home, in-the-home, and smart grid powerline technologies. We believe the use of digital communications technologies will increase beyond the world of computing, until a large percentage of devices in the home seamlessly connect to some form of digital content or communications. Currently shipping, two systems that use Arkados solutions, Russoud’s Collage and NuVo’s Renovia, are prime examples of these types of connected multimedia systems.





Many of our existing and potential customers are also in a specific marketplace that is being affected by digital convergence and networking technologies. We believe traditional networking companies are moving into traditional consumer electronics areas, while the reverse is happening to consumer electronics companies. Arkados provides platform solutions that allow those companies to enter the new market space with ease and speed.





We recently counted 34 design wins for our chip, and 26 separate products that our customers have publically announced. Arkados and our customers have publicly displayed and announced a wide variety of potential products that include whole-house audio solutions (including music player docking stations, audio bridges, powered speakers, computer drivers for whole-house networked distribution of sound, and internet radio), and whole-house video distribution systems (including Internet-based TV adapters, surveillance systems, and digital picture frames).





Arkados solutions have been shown in a number of public venues, including the 2008/2009/2010 International Consumer Electronics Show, Computex 2009, CeBIT 2009, CEDIA Expo 2009, Electronic House Expo 2009, and other conferences. The Company’s prototypes or products have been publicly announced and/or demonstrated by Analog Devices, Channel Vision, Checkolite, Corporate Systems Engineering, devolo AG, Freescale, GigaFast, GoodWay, IOGEAR, NuVo, Meiloon, PAC Electronics, Russound, Tatung, Zinwell, and Zylux. Many of these companies are suppliers to top-tier brands in the market place. Several of these relationships, among others, have progressed into sales of chips, software development services, and related revenue.





We have also been involved with our customers in projects related to Smart Grid applications. Smart Grids have received increased attention due to the recently enacted American Recovery and Reinvestment Act (ARRA) of 2009. The act includes $4.5 billion focused on smart grid related activities and smart meters, and $7.3 billion to support expanding access to broadband in underserved communities. Arkados has already reported service revenue related to smart grid development projects. As early as October 2007, Arkados and MainNet Communications announced plans to jointly develop applications to improve the reliability and efficiency of electrical grids, connect consumer electronic devices over power lines, enable energy-saving initiatives, and deliver Broadband content to homes and offices. Arkados has also provided solutions for components intended to implement energy-saving programs (such as temperature control, smart thermostats, and demand-driven load control) that were used in trials of a “green power” application with Corporate Systems Engineering.





We are working closely with many of the leading communications, digital entertainment and consumer electronics companies





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some of which may result in design wins and orders for our integrated circuits. There are multiple OEMs that are sampling and testing our AI-1100 SoC chips, and one has announced a product incorporating our chip, but factors such as design issues, compatibility issues and manufacturing errors could delay the functioning of the products and prevent us from making sales. As is evidenced by the HomePlug certification of several of our reference designs for an Internet Radio and for a whole-house connected iPod dock, we are focused on delivering a wide array of reference designs that can help guide our customers through the product-to-market cycle.





We believe our solutions create easy-to-install and easy-to-use products since connectivity occurs through the existing electrical outlets and electrical wires. For the end user, products that use Arkados solutions connect to each other by simply plugging in, while also being reliable and secure.





Strategic Relationships





Arkados and STMicroelectronics have announced an agreement to develop and manufacture a 200 Mbit per second, HomePlug AV wideband powerline modem System-on-Chip (SoC). STMicroelectronics is largest semiconductor manufacturer to announce plans to bring a HomePlug AV chip to market, and, based on announced product plans of other HomePlug members, we believe this chip will be the only chip available in the near term that will be interoperable with four established powerline standards: TIA-1113/HomePlug 1.0, HomePlug AV, IEEE 1901, and HomePlug GP. STMicroelectronics will manufacture the chip, and both STMicroelectronics and Arkados will market a version of the device specifically targeted at “bridging” applications such as Ethernet-to-Powerline adapters, or other applications where only a MAC/PHY implementation is needed. Arkados will continue to focus on marketing the chip for more full-featured connected media applications such as whole-house audio, IPTV, and segments of the smart-grid market.





We have also entered into go-to-market strategies with a number of ODMs and other technology companies. Since many companies in this space target the same customer base as we do, we plan to collaborate to create solutions and offer even greater turnkey value for OEMs. We have announced relationships and strategies with several companies, including GigaFast and Tatung.





Arkados’ relationship with Tatung, the $7B global ODM, constitutes a one-stop shop for the industry’s technology and manufacturing needs for distributing digital content in homes. Together, the companies deliver complete product solutions to consumer product manufacturers.





In July 2004, Arkados entered into a Silicon Product Development and Product Collaboration Agreement with GDA Technologies, Inc., under which GDA assists Arkados in translating Arkados AI-1100 chip designs into a mask that can be used by a semiconductor foundry to manufacture Arkados-designed integrated circuits in a cost effective manner. We paid GDA $175,000 under the agreement in Fiscal 2007 and will pay GDA 20% of production costs as compensation for production management services. In addition, we issued 150,000 shares of our restricted common stock to GDA for nominal consideration.





Manufacturing





We currently use Fujitsu Japan for all of our wafer fabrication and assembly, and Fujitsu and GDA Technologies for a portion of our design and testing. This “fabless” manufacturing strategy is designed to allow us to concentrate on our design strengths, minimize fixed costs and capital expenditures, access advanced manufacturing facilities, and provide flexibility on sourcing multiple leading-edge technologies through strategic alliances. We expect to qualify each product, participate in process and package development, define and control the manufacturing process at our suppliers where possible and practicable, develop or participate in the development of test programs, and perform production testing of products in accordance with our quality management system. If possible, we plan to use multiple foundries, assembly houses, and test houses. Our efforts to develop multiple sources of supply have been hindered by our lack of adequate working capital





In connection with the development of our next generation chip, we have entered into a development agreement with STMicroelectronics.  The agreement allows Arkados to complete the design and manufacturing of without making the costly investment of taping out a new chip. STMicroelectronics is contributing to the investment for the development and manufacturing for the Arkados-designed chip.  The new chips will be sold by STMicroelectronics, under its own branding, and by Arkados as the next generation ArkTIC® chip.





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Research and Development





We have focused on R&D since our inception. Our company has placed significant value on the work done by our engineering staff, and we continue to create new software solutions, technology implementations, system-on-chip semiconductors, and the creation and development of intellectual property, that focus on helping our customers to get full-featured connected products to market quickly and at a lower cost.





We concentrate our research and development efforts on the design and development of new products for each of our principal markets. As of August 13, 2010, ten of our thirteen employees are dedicated to research and development.  Research and development expenses were $2,700,413 and  $2,069,179 in the years ended May 31, 2010 and  2009, respectively, although most of these expenses remain unpaid.





Our 2007 acquisition of Aster Wireless, near Rochester, NY strengthened our intellectual property portfolio and added three R&D employees to those working in New Jersey. Since the acquisition, one member of the group has left the company.  The intellectual property that was developed by Aster has allowed us to introduce new products complementary to our existing product offerings. An example is our offering of a license to an implementation of the 802.15.3b Wireless Multimedia MAC.





Our future success is highly dependent upon our ability to develop complex new products, to transfer new products to volume production in a timely fashion, to introduce them to the marketplace ahead of the competition, to maintain competitive features, and to have them selected for design into products of leading systems manufacturers, all of which are challenged by our lack of working capital and diversion of management’s time and attention from Arkados’ business to emergency financing and debt restructuring.





Our future success may also depend on assisting our customers with integration of our components into their new products, including providing support from the concept stage through design, launch, and production ramp. In this new converged marketplace, we believe the role of the traditional semiconductor provider is changing, and we have positioned ourselves as a platform provider that becomes an integral part of our customer’s product development process. We believe that our focus on application related features and software may contribute to our success.





Patents, Licenses and Trademarks





We have been awarded 13 U.S. Patents (with an additional 2 that have recently been allowed by the USPTO), which we believe is an indicator that we have developed a good understanding regarding key industry developments. We believe our patents not only help us to safeguard our intellectual property, but will help us to position our company as a leader in this space. We believe that some of our recently awarded patents are integral to the implementation of powerline communication networks, which may create value in our company given the global market for this technology and the vast number of potential players in the marketplace.





We rely on trade secret, patent, copyright, and trademark laws to protect our intellectual property in our products and technology. We intend to continue this practice in the future. In addition to our issued U.S. patents, we have 22 pending U.S. patent applications, and various corresponding international patents and applications.





Intellectual Property Portfolio





Examples of our IP portfolio include methods for increasing resistance to noise, allowing more robust transmissions, maximizing throughput, and several product-level applications such as adaptors and connectivity devices. We believe our patent portfolio will provide a competitive edge in the areas of the technology based on such new standards such as IEEE1901 and upcoming ITU G.hn standards.





We diligently protect our inventions with US and International patents. Currently, we have been issued 13 patents by the United States Patent & Trademark Office, and have 22 pending applications. We also prosecute our valuable IP on an international basis, and currently have 7 Pending International Applications. [[U R HEER]]





We have registered trademarks for Arkados® and ArkTIC® and the Arkados logo. We have two other trademark applications pending: Direct to SpeakerTM and Whole House Audio in a BoxTM.





As a member of the HomePlug Alliance, we are obligated to license Necessary Patent Claims (intellectual property rights without the use of which products cannot conform to the HomePlug specifications) to any member of the alliance (including competitors)





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on a reasonable and non-discriminatory basis (known as RaND) as defined in the alliance’s Sponsor Agreement and Contributor Agreement. Under our license and development agreements, we retain title to our patents, patent applications and other licensed technology, and to any improvements that we develop.





To complement our own research and development efforts, we have also licensed, and expect to continue to license, from third parties a variety of intellectual property and technologies important to our business.





Although we have not received any notification from third parties that we are infringing any of their intellectual property, there may be third party patents or other intellectual property that we are infringing. If that were the case, third parties could assert infringement claims against us or seek an injunction on the sale of any of our products in the future. If such infringement were found to exist, we may attempt to acquire the requisite licenses or rights to use such technology or intellectual property. However, we cannot assure you that such licenses or rights could be obtained on favorable terms or at all.




The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. Even if we receive a patent grant we would not be able to offer any assurance that it will not be invalidated, circumvented, or challenged, that rights granted under the patent will provide competitive advantages to us, or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. As is typical in the semiconductor industry, we expect that we and our customers may have received and may receive in the future, communications from third parties asserting patents, mask work rights, or copyrights on certain of our products and technologies. In the event third parties were to make a valid intellectual property claim and a license was not available on commercially reasonable terms, our operating results could be harmed. Litigation, which could result in substantial cost to us and diversion of our resources, may also be necessary to defend us against claimed infringement of the rights of others. An unfavorable outcome in any such suit could have an adverse effect on our future operations and/or liquidity.





Competition





Arkados faces intense competition as a solution provider, a technology developer of standards-based powerline technologies, as well as from other technologies also focused on our target markets.  We believe we have had success despite our lack of capital and therefore manpower because of our ability to develop SoC/software solutions that help our customers to create full-featured products that are cost-effective and can be brought to market quickly.





Differentiation of Arkados Solutions


Some manufacturers have attempted to add HomePlug-based chips to their existing products.  This “bolt-on” approach often leads to products that are functional; however, the end product can be very expensive with decreased margins.





Arkados’ solutions offer a completely different approach.  By incorporating a processor and multiple interfaces into the same chip that houses HomePlug communication technology, and by providing application level software that runs on the chip, Arkados presents a more cost-effective and more flexible strategy to bring products to market.





Building on the architecture of the HomePlug 1.0 chip that offered a wide range of advantages over the competition, Arkados recently announced a HomePlug AV System-on-Chip to provide an even greater range of differentiation and advantages. This chip is called the AI-2100, which will be developed and marketed in conjunction with STMicroelectronics.





Business Environment


Markets for our products are highly competitive and we expect that competition will continue to increase. We compete with other semiconductor suppliers that offer standard semiconductors, application-specific integrated circuits, and fully customized integrated circuits, including embedded software, chip, and board-level products.





Our competitive strategy has been to provide cost-effective integrated products bundled with software that is designed to support a turnkey approach for a variety of applications. We believe this approach, coupled with the benefits of powerline communications technology, allows us to effectively compete due the following aspects:





·
Due to embedded HomePlug standard technology, we believe our product performance includes unique features such as whole-house connectivity, high throughput, ease of setup, and Quality-of-service mechanisms that preserve a positive end-user experience





·
Due to the integration of our system-on-chip and firmware solutions, we believe our potential customers will benefit from quicker time-to-market, a competitive bill-of-materials cost, an enhanced feature set, and lower development costs





·
Due to our reliance on international technology standards, we believe our solutions are able comply with regulatory requirements on a global basis





We face competition both from established players that are beginning to focus on powerline networking technology, as well as recent entrants in the field. Some of these competitors create solutions that are compliant with HomePlug Alliance specifications, while other competitors’ products are based on proprietary technologies. Immediate key competitors in the HomePlug powerline networking portion include Afa Technologies, Atheros Communications, Inc., (who recently acquired powerline chip manufacturer Intellon Corporation), Gigle Semiconductor, Maxim Integrated Products Inc., Sigma Designs (who recently acquired phoneline and powerline chip designer Coppergate) and SPiDCOM .  Marvell (recently acquired assets of DS2) and Panasonic build ICs that are incompatible with the HomePlug standard.





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We expect to face additional competition from new entrants in each of our markets, which may include both large domestic and international integrated circuit manufacturers and smaller, emerging companies. Many of our competitors have substantially greater financial, engineering, manufacturing, marketing, technical, distribution and other resources, broader product lines, greater intellectual property rights, and longer relationships with customers than we have.





In addition, there are organizations worldwide may attempt to create technology standards that compete with the industry specifications established by the HomePlug Powerline Alliance. These include the Institute of Electrical and Electronics Engineers (IEEE) and the International Telecommunication Union (ITU) which may adopt standards different from, and incompatible with, the technology inside our products. We also participate in these standards efforts. Other industry organizations promote powerline communications, such as the Universal Powerline Association, the Consumer Electronics Powerline Communication Alliance (CEPCA) and the High Definition Powerline Communications (HD-PLC) Alliance. They have also established technology or coexistence specifications that may conflict with the HomePlug specifications.





As a provider of powerline home connectivity integrated circuits, we face additional competition from other home connectivity technologies such as twisted pair cable, coaxial cable and wireless media. Despite the broad array of different technologies deployed to date, we believe those technologies that do not require new wires such as HomePNA, MoCA, 802.11 and other wireless alternatives, will provide competition to powerline solutions.





Sales and Marketing





We have been selling our solutions and products worldwide using the following channels:




·
Sales and marketing partnerships with established companies.




These relationships generally help to establish the presence in specific regions and access customers through already developed relationships. The benefits of using this channel are numerous, among them are added credibility, reduction of upfront sales and marketing expenses, acceleration of volume sales through incumbency of the customer base, and local customer support and account management.




·
Advanced development partnerships with strategic customers.




The benefits of using this channel include the creation of product focus, reduction of upfront sales and marketing expenses, acceleration of sales volumes through early commitments, and creation of incremental development revenues.





We planned to develop our sales force to include a network of direct sales regions. We also planned to establish international sales offices and develop relationships with appropriate organizations located worldwide. We expect to supplement our direct sales force with sales representative organizations and distributors. The scope and development of our sales and marketing organization has been severely limited and depends, among other things, on the amount of capital available to us.





Our marketing consists of various programs that help create awareness and promote the benefits of our various and the value of our technology to our target industries. Much of the marketing is handled through press releases, website, involvement in trade shows and conferences, working through industry organizations, press interview opportunities, placed articles, newsletters, white papers, and through interpersonal relationships developed through numerous methods. We have at times hired agencies to assist with specialized functions. Our marketing efforts are not only challenged by our inability to finance these activities but by the markets awareness of our precarious financial position.





Regulatory Environment





Our customers’ products, which contain our solutions for powerline communications technology must adhere to regulations about transmission power, permissible frequencies of operation and electromagnetic interference (EMI) for both U.S. and foreign governments. In some countries, certification tests must be performed to ensure a vendor’s products comply with the regulations. While it is our customers who are responsible to obtain certifications, we need to ensure international regulations are adhered to.





The Federal Communications Commission (FCC) administers regulations in the United States. Our solutions are unlicensed devices in the U.S.A. and receive no regulatory protection from interference from other devices and may not cause any harmful interference to licensed devices. Those who operate unlicensed devices must stop using a device when the FCC declares that the device is causing harmful interference. Products using our solutions over power lines both inside and outside the home are FCC-regulated and must comply with radiated emission limits and various other technical standards.





Outside of the United States, the International Electrotechnical Commission, International Special Committee on Radio





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Interference (IEC/CISPR) is the primary authority. IEC member states import IEC/CISPR standards into their own national laws either in whole or in part. Powerline communications regulations are based upon specific country requirements. In some countries, regulations may limit the use of powerline communications in certain circumstances or to certain power levels or frequency bands.





Before products can be sold, most countries require electronic products to comply with safety testing or to be certified. While it is our customers who are responsible to obtain certifications, we need to ensure international regulations are adhered to.





Regulations and their enforcement and interpretation vary between countries. Regulatory change or certification methodologies may require a redesign of products containing our solutions. At its most severe, regulatory changes could terminate the use of products already in the marketplace.





Backlog





We expect sales outside of strategic partnership agreements to be made primarily pursuant to standard short-term purchase orders for delivery of standard products. We expect the quantity actually ordered by the customer, as well as the shipment schedules, to be frequently revised, without significant penalty, to reflect changes in the customer’s needs. As a result, we believe that in the future, our backlog at any given time should not be used as a meaningful indicator of future revenues.





As of May 31, 2010, we had no backlog of orders.





Employees





As of May 31, 2010, we had 12, full-time employees, including our CEO, Oleg Logvinov. Nine of our full time employees, including our CEO, are engaged in research, development, engineering with the remainder being divided between marketing and administration.  Our future success depends, in part, on our ability to continue to attract, retain and motivate highly qualified technical, marketing, engineering, and management personnel. Due to the highly competitive nature of the marketplace that we operate in and our financial condition, we have lost employees since May 31, 2010 and may continue to lose key employees.  As of May 31, 2010, we have not paid $4,167,522 in compensation to our employees.  We are negotiating with our employees to reach an agreement to pay a portion of past due compensation at the closing of a restructuring and financing ransactions and while we have an agreement in principle with our employees in this regard, there are no binding agreements with employees concerning this arrangement.  Further, since we have no written agreements or firm commitments for financing or debt restructuring, even if we had agreements with employees, we cannot be assured that they will remain in our employ unless financing and debt restructuring occurs.  None of our employees are parties to collective bargaining agreements and, except for our inability to pay our employees in full, we believe our relations with employees are good.





From time to time, we also employ outside contractors either for a specific project, or to supplement our staff on a temporary basis.





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ITEM 1A.
RISK FACTORS.





An investment in our common stock is speculative in nature, involves a high degree of risk and should not be made by any investor who cannot afford the loss of their entire investment. Each prospective purchaser should carefully consider the following risks and speculative factors associated with our business and capital structure, as well as others described elsewhere in this report, before making any decision to buy, sell or hold our common stock.





This report contains certain statements relating to future events or the future financial performance of our company. Readers are cautioned that such statements are only predictions, involve risks and uncertainties, and that actual events or results may differ materially. In evaluating such statements, prospective investors should specifically consider the various factors identified in this memorandum, including the matters set forth below, which could cause actual results to differ materially from those indicated by such forward-looking statements.





Risks Related to Our Financial Condition





Defaults on Secured and Unsecured Debt.





As of May 31, 2010, $18,426,377 of secured debt including interest in the form of 6% secured convertible debentures originally due December 28, 2008 and due June 28, 2009 (the “Secured Debentures”), of which $5,205,617 is held by related parties, outstanding at May 31, 2010 is in default, as is $1,031,651 principal and interest on unsecured notes due June 28, 2009.  In addition, as of May 31, 2010, $4,167,522 of salary remains due to our employees and our accounts payable was approximately $ 1,959,356 , of which $1,656,244 was over 90 days.





On July 2, 2009 we received notice of default from a law firm representing approximately 45% of our outstanding Secured Debentures by reason of non-payment. This event triggers an “Event of Default” under the terms of the Debentures on July 8, 2009, absent payment in full.  The Event of Default entitles the holders of the Debentures to redemption at the rate of 130% of the principal and accrued interest outstanding, interest on unpaid interest and principal at the rate of 18% per annum commencing on July 8, 2009 and reimbursement for expenses incurred enforcing the obligations.  The holders of the Secured Debentures have all of the rights and remedies secured creditors holding a first priority security interest in all of our assets under the transaction documents and applicable law, including the right to demand assembly of our assets for sale to satisfy the obligations.  These rights are exercised through Bushido Capital Master Fund, LP, as representative of the holders of the Debentures (“Bushido”).








As of July 6, 2009 the $1,066,500 principal amount of 6% Convertible Subordinated Notes (the “Notes”) due June 30, 2009 were also in default by reason on non-payment.  Under the terms of the Notes, the interest rate increases to 12% during the period the Notes are in default and the holders are entitled to the costs of collection. We plan to discuss forbearance or extension of the due dates of the Notes with the holders and their representatives, but there can be no assurance that any such agreement can be reached.





We continue to negotiate with the holders of each class of debt to fashion a forbearance agreement, compromise or convert outstanding debt into equity, potentially sell assets and refocus our business in the power line networking space and thereby facilitate raising additional investor capital. There is no binding agreement on anyone’s part to do so and no assurance can be given that the terms will be acceptable to the holders of all of the secured debt.  We have also received indications of interest from potential private and strategic investors concerning the terms and conditions upon which they would make an investment in Arkados, including the terms upon which the secured debt and other debt would have to be compromised and converted for them to make such investments, but there is no binding commitment on anyone’s part to complete the transactions.  Finally, without commitment on anyone’s part, we have discussed converting a substantial portion of past due compensation with our employees if the financing and restructuring of our debt can be completed.    In the absence of financing and debt restructuring, our operation are severely constrained and we may have to suspend operations altogether.  In addition, unless the terms of financing and restructuring is acceptable to our general trade creditors, we remain at the risk of creditors filing an involuntary petition pursuant to the U.S. Bankruptcy Code.





Dependence on financing.





Since we are not generating significant revenue compared to our operating expenses, we are dependent on outside sources of financing. We have financed our operations by issuing secured and unsecured convertible debt and equity securities in private





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placements, in some cases with equity incentives for the investor in the form of warrants to purchase our common stock and have borrowed from affiliates of our Chairman of the Board. We have sought and will continue to seek various sources of financing but there are no commitments from anyone to provide us with financing. If we are unable to obtain financing, we may have to suspend operations, sell assets and will not be able to execute our business plan.  Since we have defaulted on our obligations to secured debt holders and unsecured debt holders, any short term or equity financing is dependent either on the restructuring of our debt or forbearance of holders of secured and unsecured debt.





Inability to obtain additional financing would result in the suspension of our business.





Our ability to continue our operations depends on our ability to obtain financing. If adequate funds are not available we will not be able to retain existing and/or attract new employees, support product development and fabrication, take advantage of market opportunities, develop or enhance new products, pursue acquisitions that would complement our existing product offerings or enhance our technical capabilities to develop new products or execute our business strategy.





Terms of our outstanding 6% Secured Convertible Debentures originally due December 28, 2008 in default impedes our ability to obtain financing.





We issued $9,283,461 principal amount of 6% Secured Convertible Debentures originally due December 28, 2008 during the period from December 2004 to December 31, 2007.  Due to the capitalization of interest payments and the issuance of additional principal as a penalty as of April 1, 2008 and June 2009, the principal and interest amount of the Debentures outstanding was $18,426,377 as of May 31, 2010 and $19,226,097 as of August 31, 2010. The documents related to these securities, although amended in January 2007 to eliminate the requirement that the holders of 60.1% of the outstanding principal amount consent to our issuance of shares, debt or fixed convertible securities to finance our operations, continue to contain a full “ratchet down” provision which has a dilutive effect which is triggered by future financing at an effective price lower than the conversion and warrant exercise price. While a substantial portion of the net proceeds of the sale of the Debentures was initially used to repay pre-existing debt, all of the proceeds during the fiscal year 2007 and 2008 were used to support Arkados’ operations. There is no assurance that the holders will continue to provide additional funds to us or that future financing will not be impeded by the anti-dilution provisions of the documents. Our ability to continue our operations depends on our ability to obtain financing. If adequate funds are not available on acceptable terms, we may not be able to retain existing and/or attract new employees, support product development and fabrication, take advantage of market opportunities, develop or enhance new products, pursue acquisitions that would complement our existing product offerings or enhance our technical capabilities to develop new products or execute our business strategy.





If we lose key employees and consultants, including our Chairman and CEO, or are unable to attract or retain qualified personnel, our business will suffer.





Our viability depends, in part, on our ability to continue to attract, retain and motivate highly qualified technical, marketing, engineering, and management personnel. Due to the highly competitive nature of the marketplace that we operate in and our financial condition, we have lost two employees during the year ended  May 31, 2010, one employee through August 31, 2010 and we may continue to lose key employees.  We are highly dependent on our management, particularly our CEO, Oleg Logvinov and our Chairman, Andreas Typaldos.  The loss of the services of either of Mr. Logvinov, Mr. Typaldos or other personnel could have a material adverse effect on our operations.  Although Mr. Logvinov is a party to an employment agreement for his services until May 24, 2008, from time to time, our inability to make payments under the agreement may give him the right to terminate his employment with us at any time on short notice.  As of May 31, 2010 we have failed to make payments totaling $946,207, due to Mr. Logvinov, comprised of an unpaid bonus and salar.  We are negotiating a longer term agreement with Mr. Logvinov, but there can be no assurance that he will remain associated with us.  Similarly, Mr. Typaldos provides services to us on a month to month basis under a consulting agreement that expired on May 31, 2007 and there is no assurance that Mr. Typaldos will continue to devote time and attention to our business.  As of May 31, 2010, we owed $3,836,522 of compensation to all officers and other employees, including Mr. Logvinov.  Our failure to satisfy these obligations creates a continuing morale problem, increases the risk of our losing personnel at every level and minimizes our chance to retain additional or replacement staff.





Our independent registered public accounting firm has expressed doubt about our ability to continue as a going concern, which may hinder our ability to obtain future financing





Our consolidated financial statements as of May 31, 2010 have been prepared under the assumption that we will continue as a going concern for the year ending May 31, 2011.  Our independent registered public accounting firm has issued a report that included an explanatory paragraph referring to our recurring losses from operations and net capital deficiency and expressing substantial doubt in our ability to continue as a going concern without additional capital becoming available. Our ability to continue as a going concern is dependent upon our ability to obtain additional equity or debt financing, attain further operating efficiencies, reduce expenditures, and, ultimately, to generate revenue.  The financial statements do not include any adjustments





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that might result from the outcome of this uncertainty





We have not generated significant revenue from our principal intended activities and we have been dependent on a small number of customers for substantially all of out revenue.





While our most recent quarters have reflected what we believe is the beginning of regular customer activity, as a development stage company, we have generated limited revenue principally from providing development services and generating data in field test scenarios. We have not sold sufficient quantities of mass produced semiconductors, which is the primary part of our expected revenue stream going forward. In addition, substantially all of our revenue has been from a small number of customers. It is difficult, in a market that is rapidly evolving, to evaluate the future sales performance of powerline technology, and our implementation of it. We may not successfully address any of these risks and may never have significant revenue.





We expect losses will continue for the foreseeable future. Our stock price may be affected by such losses.





In our short history, we have not reported an operating profit and do not expect to report a profit in the near future, if at all. We have experienced losses from operations since inception. Losses are likely to continue, and may cause volatility in our stock price.





Risks Related to Our Business Plans and Operations





Consumer demand may not develop as we anticipate, and our business will suffer.





The initial and primary customers of our semiconductors are OEMs of devices with uses for connectivity. OEM acceptance of powerline technology will be driven by consumer demand for home connectivity. If consumer demand does not develop as we anticipate, our products will sell slowly, or not at all, and our business will suffer.





There are several factors that may affect the expansion of the home connectivity market:





·
the emergence of competing standards for home connectivity




·
new content or products that attract a large consumer base




·
interoperability between different products in the same market




·
the success of marketing by OEMs




·
the cost and availability of connected products using this technology or competing technologies





We have only limited ability to influence in the resolution of the foregoing.





Powerline solutions for home connectivity may not gain acceptance.





Currently, Ethernet and Wireless technologies enjoy a large market share of the home connectivity market.  As the market broadens beyond computer networking to include audio/video applications, it is unclear which medium will be predominant. Among the competing physical media, including coaxial cable, Ethernet, phone line, and wireless, many are actively supported by various trade associations that represent the interests of a variety of companies. Some have greater market acceptance. If powerline technology does not achieve market acceptance, there may be less demand or no demand at all, and our business will suffer.





Powerline technologies, other than the technologies implemented by Arkados may proliferate.





Arkados is developing products that comply with the specifications for powerline networking developed by members of the HomePlug Powerline Alliance. However, there may be other competing, independent efforts in this market. To the extent that a competing effort establishes the predominant industry standard for powerline technologies that are not based on Arkados’ chosen technologies, or, if no standard predominates in each market, our business will suffer.





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Products that incorporate our chosen technologies may fail in operation, or fail to be certified by standards organizations.





Our ODM/OEM customers may produce products that fail to work properly, either as a consequence of the inclusion of our semiconductors and software, or an unrelated problem; in which case, our business may suffer. If products that incorporate our solutions fail to pass standards tests, our business will suffer.





We may be unable to sell large volumes of semiconductors.





While we plan to attract customers with plans for large numbers of products, there may be cases when significant effort results in few semiconductors sold. When a company agrees to develop products that use our solutions, and agrees to purchase our solutions in volume, we consider the agreement a “design win.” Achieving a design win does not create a binding commitment from that customer. A design win is merely an expression of interest by a customer to make volume purchases, but at any time a customer can discontinue using our solutions. To the extent that we are unable to convert design wins into volume sales, our business will suffer.





In addition, we our dire financial situation has limited our ability to acquire inventory in cases where there is a customer demand and we have had to seek customer financing of inventory or other non-traditional financing arrangements, further limiting our ability to sell sufficient volume to benefit from economies of scale.





We may not be able to attract and retain engineering and technical talent.





The needs of the business coupled with capital constraints will dictate our ability to hire and retain staff, but we expect to need personnel in our technical and engineering disciplines, as well as in operational roles. Since powerline technology is a narrow engineering and technical specialty and we have limited financial resources, attracting experienced and retaining talent has and is expected to continue to be difficult. If we are unable to attract and retain qualified personnel, our ability to develop and produce our products will be limited.





Our solutions have a long development and sales cycle. We will continue to incur significant expenses before revenues are realized.





Significant company resources must be dedicated to research and development, production and sales and marketing in order to properly sell solutions into our target markets.  We have and will continue incur substantial product development expenses before generating associated revenues. Customers typically spend two to nine months in testing before volume production of its own products, which incorporate our power line connectivity solution. Sales cycles are lengthy and produce delays between the time we incur expenses for research, development, sales and marketing efforts, and the time that we generate revenue, if any revenue is generated. If we do not generate revenue after we have incurred substantial expenses to develop and market any of our products, our business will suffer.





We will depend on our OEM and ODM customers to produce successful products that incorporate our solutions.





Our customers are OEMs and ODMs in our target markets. They integrate our ICs into their products. If their products are not successful, we may not sell volume quantities of our semiconductors. OEM and ODM products may be unsuccessful for many reasons which are beyond our control. Any of these reasons may harm our business.





We will rely on third parties to fabricate, assemble and test our solutions, which may increase costs or create delays.





As a “fabless” semiconductor manufacturer, we do not own or operate a semiconductor fabrication, assembly or testing facility. We have entered into an agreement with GDA Technologies, Inc. to manage this process for us. In the future, GDA or contract foundries, and assembly and test houses selected by us may also be adversely affected for reasons beyond our control. This may result in our inability to obtain products within the time frames, volumes or costs we require, or at all. Any disruption in the availability of products, or problems associated with the delivery, quality or cost of fabrication, assembly and testing of our products may cause our business to suffer.





Our specifications may result in unacceptable manufacturing yields from our suppliers, which may increase our product costs or reduce supplies.





We write specifications and create designs and our third-party suppliers manufacture chips based on those specifications and designs. We have not yet entered into volume production of our products, and our specifications may fall short of producing volumes of semiconductors effectively and efficiently. This may cause dies on our wafers to function poorly.





The term “yield” is used to express the proportion of functional die expressed as a percentage of total die on a wafer. If expected





25


yields are not reached, our product costs will increase. We may also experience problems when our products are scaled to smaller geometries. Problems with yield may not be identified until late in the product development cycle, or even once an end-product is built and sold. Yield problems are difficult to detect, time consuming and expensive to correct. These issues could affect our intention to deliver products to customers in a timely manner.





Defects in our products could hurt the business by harming our reputation, decreasing our market acceptance, losing customer accounts, and creating liabilities for our company.





Integrated circuits are highly complex products, and may contain defects or bugs which may not be detected until other products that incorporate our chips are shipped and being used by end-users. Defects may harm our reputation and make customers reluctant to buy our products. Correcting these defects is an expensive process. If defects are not discovered until after we have commenced commercial production of a new product, we might incur substantial additional development costs. If we fail to solve problems in time, we may incur product recall, repair or replacement costs. These problems may also result in claims against us by our customers or consumers. Any such problems could divert our company resources from other development efforts. Moreover, we would likely lose, or experience a delay in, the market acceptance of our products. We could also lose credibility with our current and prospective customers.





Regulation in certain regions of the world, which limits our international market.





Our powerline communication products are designed to operate on frequencies that are currently restricted by government regulations in certain areas of the world, Japan as an example. As a result, our semiconductors cannot be used in products used in such areas at this time. The international market will remain limited unless the existing regulations are changed or until we develop products that can operate within the constraints imposed by the existing regulations.





Future Federal Communications Commission, or FCC, regulation may restrict sales of our products adversely affecting our business.





Our powerline communication products are designed to operate on frequencies that are not currently restricted by FCC regulations. OEM products incorporating our ICs are regulated by the FCC. Operation of these products currently is not restricted by the FCC as long as the products do not interfere with other radio frequency, or RF, bands licensed by the FCC. We cannot assure you that this will continue to be the case. Should government regulations change in the future, making operation of our customers’ products at their current radio frequency bands subject to restrictive regulation, or subjecting the frequencies on which our products operate to restrictions, our customers’ desire to purchase our products could diminish and our business may suffer.





Our business is highly dependent on the expansion of the consumer digital entertainment electronics market.





We expect that the main growth in our product demand will be driven by the consumer digital entertainment electronics market. We are focusing on audio/video transmission and distribution products for the in-home use. We expect the consumer digital market to expand; however, our strategy may not be successful. Given current economic conditions in the United States and internationally, as well as the large installed base of consumer electronics products, consumer spending on home electronic products may not increase as expected. In addition, the potential decline in consumer confidence and consumer spending could have a material adverse effect on our business.





Our success depends on our ability to introduce new products on a timely basis.





Our success depends upon our ability to develop new products for new and existing markets, to introduce these products in a timely manner, and to have these products gain market acceptance. The development of new products is highly complex and we may experience delays in developing and introducing them. Successful product development and introduction depend on a number of factors, including:





·
proper new product definition,





·
timely completion of design and testing of new products,




·
assisting our customers with integration of our components into their new products, including providing support from the concept stage through design, launch and production ramp,





·
successfully developing and implementing the software necessary to integrate our products into our customers’ products,





·
achievement of acceptable manufacturing yields,





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·
availability of wafer, assembly, and test capacity,





·
market acceptance of our products and the products of our customers





·
obtaining and retaining industry certification requirements.





Although we seek to design products that have the potential to become industry standard products, we cannot assure you that the market leaders will adopt any products introduced by us, or that any products that may be initially accepted by our customers that are market leaders will become industry standard products. Both revenues and margins may be materially affected if new product introductions are delayed, or if our products are not designed into successive generations of our customers’ products. We cannot assure you that we will be able to meet these challenges, or adjust to changing market conditions as quickly and cost-effectively as necessary to compete successfully. Our failure to develop and introduce new products successfully could harm our business and operating results.





Successful product design and development is dependent on our ability to attract, retain, and motivate qualified design engineers, of which there is a limited number. Due to the complexity and variety of CMOS, precision linear, and mixed-signal circuits, the limited number of qualified circuit designers and software engineers, and the limited effectiveness of computer-aided design systems in the design of such circuits, we cannot assure you that we will be able to successfully develop and introduce new products on a timely basis.





Strong competition in the high-performance integrated circuit market may harm our business.





The integrated circuit industry is intensely competitive and is characterized by rapid technological change, price erosion, and design and other technological obsolescence. Because of shortened product life cycles and even shorter design-in cycles in a number of the markets that we serve, particularly consumer entertainment, our competitors have increasingly frequent opportunities to achieve design wins in next-generation systems. In the event that competitors succeed in supplanting our products, our desired market share may not be attainable and/or sustainable and net sales, gross margins, and results of operations would be adversely affected.





In powerline communications, our principal competitors include Atheros Communications, Inc., (who recently acquired powerline chip manufacturer Intellon Corporation), Maxim, DS2, Panasonic, Gigle Semiconductor, Sigma Designs (who recently acquired Coppergate), and Spidcom. In Network and Media Processors Conexant, Cirrus Logic, Micrel, Texas Instruments, Atmel, and Sharp. Many of our competitors have substantially greater financial, engineering, manufacturing, marketing, technical, distribution and other resources, broader product lines, greater intellectual property rights, and longer relationships with customers than we have. We also expect intensified competition from emerging companies and from customers who develop their own integrated circuit products. In addition, some of our current and future competitors maintain their own fabrication facilities, which could benefit them in connection with cost, capacity and technical issues.





Increased competition could adversely affect our business. We cannot assure you that we will be able to compete successfully in the future or that competitive pressures will not adversely affect our financial condition and results of operations. Competitive pressures could reduce market acceptance of our products and result in price reductions and increases in expenses that could adversely affect our business and our financial condition.





Our products may be characterized by average selling prices (ASPs) that decline over short time periods; if we are unable to introduce new products with higher selling prices or reduce our costs, our business and operating results could be harmed.





Historically in the integrated circuit industry, average selling prices of products have decreased over time, while manufacturing costs may remain fixed. If we are unable to introduce new products with higher margins or to reduce manufacturing costs to offset anticipated decreases in the prices of our products, our operating results may be adversely affected. In addition, because of high fixed costs in our industry, we are limited in our ability to reduce total costs quickly in response to any revenue shortfalls. Because of these factors, we may experience material adverse fluctuations in our future operating results on a quarterly or annual basis.





Our products are complex and could contain defects, which could reduce sales of those products or result in claims against us.





Product development in the markets we serve is becoming more focused on the integration of multiple functions on individual devices. In addition to that, powerline communication is a relatively new technology. There is a general trend towards increasingly complex products. The greater integration of functions and complexity of operations of our products increases the risk that our customers or end users could discover latent defects or subtle faults after volumes of product have been shipped. This could result in:





27


·
material recall and replacement costs for product warranty and support,





·
adverse impact to our customer relationships by the occurrence of significant defects,





·
delay in recognition or loss of revenues, loss of market share, or failure to achieve market acceptance, and





·
diversion of the attention of our engineering personnel from our product development efforts.





The occurrence of any of these problems could result in the delay or loss of market acceptance of our products and would likely harm our business, and may result into our inability to secure a reasonable share of the market, In addition, any defects or other problems with our products could result in financial or other damages to our customers who could seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend.





We rely on independent foundries to manufacture all of our wafers.





We rely on independent foundries to manufacture all of our wafers. In order to produce our silicon, we need to secure appropriate manufacturing services and capacities. Our reliance on outside foundries involves several risks and uncertainties, including the:





·
inability to secure appropriate manufacturing services and capacities





·
possibility of an interruption or loss of manufacturing capacity





·
lack of control over delivery schedules, quality assurance, manufacturing yields and costs





·
possible misappropriation of our intellectual property





·
inability to reduce our costs as quickly as competitors who manufacture their own products and are not bound by set prices.




Market conditions could result in wafers being in short supply and prevent us from having adequate supply to meet our customer requirements. In addition, any prolonged inability to utilize third-party foundries because of fire, natural disaster, or otherwise, would have a material adverse effect on our financial condition and results of operations. If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and, consequently, our sales would likely be reduced, and we may be forced to purchase wafers from higher-cost suppliers or to pay expediting charges to obtain additional supply, if we are able to acquire wafers at all.





In order to secure additional foundry capacity, we may enter into contracts that commit us to purchase specified quantities of silicon wafers over extended periods. In the future, we may not be able to secure sufficient capacity with foundries in a timely fashion or at all, and such arrangements, if any, may not be on terms favorable to us. Moreover, if we are able to secure foundry capacity, we may be obligated to utilize all of that capacity or incur penalties. These penalties may be expensive and could harm our financial results.





We will be dependent on our subcontractors to perform some of the design and key manufacturing functions for us.





We will depend on third-party subcontractors for the elements of the design, assembly, packaging, and testing of our products. International operations and sales may be subject to political and economic risks, including political instability, currency controls, exchange rate fluctuations, and changes in import/export regulations, tariff and freight rates, as well as the risks of natural disaster. Although we will seek to reduce our dependence on a limited number of subcontractors as demand for our products merits, the concentration of subcontractors and manufacturing operations in certain areas of the World could subject us to the risks of conducting business internationally, including political and economic conditions in such regions as Asia, India, etc. Disruption or termination of the assembly, packaging or testing of our products could occur, and such disruptions could harm our business and operating results. In addition, we are unable to predict whether events such as the epidemic of SARS will have a negative effect on the design, supply, testing, and packaging of our products.





We may be unable to protect our intellectual property rights from third-party claims and litigation.





Our success depends on our ability to obtain patents and licenses and to preserve our other intellectual property rights covering our technology, applications, products, and development and testing tools. We seek patent protection for those inventions and technologies for which we believe such protection is suitable and is likely to provide a competitive advantage to us. In some cases, patent applications have been deemed abandoned because we lacked adequate financial resources to promptly prosecute the applications. As a result of our financial condition, we have been unable to secure the services of patent counsel since June 30, 2009, and our inability to engage experienced counsel may slow the approval process or negatively affect the quality and scope of





28


the patent applications we file. We also rely substantially on trade secrets, proprietary technology, non-disclosure and other contractual agreements, and technical measures to protect our technology, application, design, and manufacturing know-how, and work actively to foster continuing technological innovation to maintain and protect our competitive position. We cannot assure you that steps taken by us to protect our intellectual property will be adequate, that our competitors will not independently develop or patent substantially equivalent or superior technologies or be able to design around patents that we may receive, or that our intellectual property will not be misappropriated. Also, the laws of some foreign countries may not protect our intellectual property as much as the laws of the United States.





Potential intellectual property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.





The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. Even if we receive a patent grant we would not be able to offer any assurance that it will not be invalidated, circumvented, or challenged, that rights granted under the patent will provide competitive advantages to us, or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. As is typical in the semiconductor industry, we expect that we and our customers may have received and may receive in the future, communications from third parties asserting patents, mask work rights, or copyrights on certain of our products and technologies. In the event third parties were to make a valid intellectual property claim and a license was not available on commercially reasonable terms, our operating results could be harmed. Litigation, which could result in substantial cost to us and diversion of our resources, may also be necessary to defend us against claimed infringement of the rights of others. An unfavorable outcome in any such suit could have an adverse effect on our future operations and/or liquidity.





If we are unable to make continued substantial investments in research and development, we may not be able to sell our products.





The sale of our solutions requires significant expenditures in research and development to both customize our solutions and roll out our new generation of chips. If we fail to make sufficient expenditures in research and development programs, new technologies and process improvements implemented by our competitors could render our current and planned products obsolete, and our business could be harmed. Substantially all of our operating expenses are related to research and development.





Obligation to license certain intellectual property rights.





As a member of the HomePlug Alliance, TIA TR30.1 and IEEE P1901, we are obligated to license certain intellectual property rights to our competitors, on a non-discriminatory basis, which may adversely affect our ability to compete.





Risks Related To Our Common Stock And Its Market Value





If we fail to remain current on our reporting requirements, we could be removed from the OTC Bulletin Board which would limit the ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market.





Companies trading on the OTC Bulletin Board, such as us, must be reporting issuers under Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, and must be current in their reports under Section 13, in order to maintain price quotation privileges on the OTC Bulletin Board, and to be timely in such filings.  If we fail to remain current on our reporting requirements or file late three times in 12 calendar months, our stock could be removed from the OTC Bulletin Board.  This report was filed more than 30 days after its due date.  As a result, the market liquidity for our securities could be severely adversely affected by limiting the ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market.  There can be no assurance that in the future we will always be current in our reporting requirements.





Our common stock is subject to the “penny stock” rules of the SEC and the trading market in our securities is limited, which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock.





SEC Rule 15g-9 establishes the definition of a “penny stock,” for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions.  For any transaction involving a penny stock, unless exempt, the rules require:





·
that a broker or dealer approve a person’s account for transactions in penny stocks; and





·
the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.





29


In order to approve a person’s account for transactions in penny stocks, the broker or dealer must:





·
obtain financial information and investment experience objectives of the person; and





·
make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.





The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:





·
sets forth the basis on which the broker or dealer made the suitability determination; and





·
that the broker or dealer received a signed, written agreement from the investor prior to the transaction.





Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules.  This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.





Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and about the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions.  Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.





The market price of our common stock may be adversely affected by several factors.





The market price of our common stock could fluctuate significantly in response to various factors and events, including:





·
our ability to execute our business plan;





·
operating results below expectations;





·
announcements of technological innovations or new products by us or our competitors;





·
loss of any strategic relationship;





·
industry developments;





·
economic and other external factors; and





·
period-to-period fluctuations in our financial results.





In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.





We have not paid dividends in the past and do not expect to pay dividends in the future.  Any return on investment may be limited to the value of our common stock.





We have never paid cash dividends on our capital stock and do not anticipate paying cash dividends on our capital stock in the foreseeable future.  The payment of dividends on our capital stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as the board of directors may consider relevant.  If we do not pay dividends, our common stock may be less valuable because a return on your investment will only occur if our common stock price appreciates.





A sale of a substantial number of shares of our common stock may cause the price of our common stock to decline.





If our stockholders sell substantial amounts of our common stock in the public market, including shares issued upon the exercise of outstanding options or warrants, the market price of our common stock could fall.  These sales also may make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.  Amendments to Rule 144 effective in February 2008 also substantially reduce holding periods and eliminate burdens such as filing notices sale for non-affiliated holders.  The amendments to the Rule are applicable to the purchasers of securities prior to and following the effective date of the amendments.




30


Provisions contained in outstanding secured convertible debentures provide holders a greater share in the proceeds of a cash sale or merger than the amount of the outstanding debt.





Certain provisions of the principal amount of the outstanding 6% Secured Debentures require the redemption of such debentures and the warrants issued in connection with the sale of the debentures in the event of a cash sale of our business or cash merger that would give the debenture holders a return substantially greater than the outstanding debt and interest.  Such payments would be made before cash could be distributed either to general creditors or the holders of our common stock.  The sale of these debentures has been the principal source of our working capital since December 2005 and no authorization on the part of our stockholders is require for our continuing to issue these securities.  Although we have sought and continue to seek equity financing to replace the sale of these securities as our primary source of working capital, we have not been able to do so and there is no assurance that we will be able to do so in the future.

















































31


Executive Officers of the Registrant





Our executive officers are:





Name

PositionAndreas Typaldos

Chairman of the BoardOleg Logvinov

President, CEO and a DirectorLarry Crawford CrawfoBarbara Kane-Burke1

CFO , VP and SecretaryGrant Ogata

Executive Vice President of Worldwide Operations





Andreas Typaldos is a principal stockholder and was appointed Chairman of our Board in February, 2005. Although our by-laws provide that the Chairman of the Board’s primary responsibilities relate to the conduct of board and stockholder meetings, Mr. Typaldos also serves as a consultant to us on a part-time basis and has a significant impact on our strategic planning, marketing and capital raising activities. He has thirty years of software experience as an entrepreneur and founder/investor of a number of technology companies. In 1997, Mr. Typaldos founded Enikia, LLC, whose technology and assets were subsequently acquired by an entity controlled by Mr. Typaldos and merged into our Arkados, Inc. subsidiary in May 2004. Mr. Typaldos serves as CEO of Xandros, Inc., a privately held company, engaged in the sale of Linux desktop applications. From September 1998 until June 2003, as founder and principal investor, Mr. Typaldos also built a multi-million dollar software consulting business, e-Vantage Solutions, Inc., until that company’s consulting activities ended shortly after September 11, 2001. In addition, from September 1999 until December 2001, Mr. Typaldos was active as Interim Chairman and CEO at NetGain Development, Inc., which was an internet incubator/investment firm that funded internet and enabling technology companies, including Enikia, Linux Global Partners, and other internet and technology companies. Prior to that, Mr. Typaldos founded his first consulting and software company in 1973 and in 1978, founded a successor company, AxsOne (formerly known as Computron), which he took public in 1995 and of which he as President until 1994 and Chairman/CEO until 1996. AxsOne is an international client/server and internet-based enterprise applications software company that supplies Fortune 5000 companies with records and content management and compliance software (i.e., email and Instant Messaging-IM management), as well as financial applications and workflow solutions.  Mr. Typaldos has a Bachelors of Science Degree from Columbia University in Mathematical Methods for Engineering and Operations Research. He also holds a Masters of Science Degree in Computer Science from Pratt Institute. Mr. Typaldos serves on the Board of Directors and Advisory Boards of a number of companies and non-profit organizations.





Oleg Logvinov was appointed President, CEO and a director on August 12, 2004 and has served as President of Arkados since we merged Miletos into Arkados. Prior to the merger, from February, 2000 to March, 2004, Mr. Logvinov served as Vice President of Engineering and later as President of Enikia LLC. From March, 1998 to February, 2000, he served as Senior Director of Product Development and System Engineering at OpenCon Systems Inc., a telecommunications software service provider, and later CyberPath Inc., a venture-funded VoDSL Gateway company spun off by OpenCon Systems Inc. Prior to that, he held senior management positions at NITECH, INC from1996 to 1998, and CEM, Inc from 1991 to 1996. Mr. Logvinov holds a masters degree equivalent in electrical engineering from the Technical University of Ukraine (KPI). He has also worked as a senior research scientist and later research team leader at an R&D laboratory at the Technical University of Ukraine and the Ukraine Department of Energy.  Oleg Logvinov is the Chief Technical Officer and a past President of the HomePlug Powerline Alliance. Mr. Logvinov was recently elected to serve as a member of IEEE SA Standards Board. He is a frequent industry speaker, representing both the HomePlug alliance and Arkados at conferences around the world.





Larry Crawford was appointed Chief Financial Officer and Senior Vice President of the Arkados Group, Inc. on October 1, 2008. Prior to joining Arkados, Mr. Crawford served as CFO and EVP of Entech Solar, Inc., a publically traded solar renewable energy company. Previously, Mr. Crawford served as CFO and EVP of Spectrum Group International (a publically traded service company), CFO of Arzee Holdings, Inc., and VP of Finance and CFO of Talon, Inc, a wholly owned subsidiary of Coats Viyella, plc,. Mr. Crawford is certified as a CPA in NJ, NC and PA.





Grant Ogata joined Arkados in March 2007 as Executive Vice President of Worldwide Operations. Mr. Ogata had been working with Arkados in a part-time capacity since September 2006. Mr. Ogata was formerly Vice President of Global Sourcing and Product Development of RadioShack Corporation Mr. Ogata has 28 years of experience in the consumer electronics industry.  At RadioShack, Mr. Ogata was responsible for developing hundreds of innovative products, establishing key strategic partners and managing global sourcing and product development offices in Japan, Taiwan, Hong Kong, China and Fort Worth, Texas. Throughout the years, and through a six-year expatriate assignment in Asia, Mr. Ogata gained intricate knowledge and contacts with key consumer electronic manufacturers around the world. He has been instrumental in beginning the transition of Arkados





32


from a research and development company with solutions for distributing audio and video through power lines, to a commercial enterprise that provides these solutions to top tier companies globally.




ITEM 1B.
UNRESOLVED STAFF COMMENTS.




None.





ITEM 2.
DESCRIPTION OF PROPERTY.





Our executive offices are located at 220 Old New Brunswick Road, Piscataway, NJ 08854. The facility is approximately 6,600 sq. feet, occupied pursuant to a lease which expired on July 31, 2009 and is adequate for our current activities.  On June 30, 2009 the company entered into a five year renewal lease expiring July 31, 2014 for its present facility.





As a result of the acquisition of Aster Wireless in March of 2007, we also have offices located at 150 Lucius Gordon Dr., West Henrietta, NY 14586. The facility is approximately 1,041 sq. feet, occupied pursuant to a lease which expired on February 28, 2009 and is adequate for our current activities; we are currently leasing the Henrietta, NY facilities on a month to month basis.





As a result of our poor financial position and lack of financing, we are often behind in our rent which could result in our being evicted from our facilities. While we have been successful in negotiating extensions of the time our landlord’s require us to cure such defaults in the past, there is no assurance that we can continue to obtain such waivers and extensions.





ITEM 3.
LEGAL PROCEEDINGS.





We are and may be subject to litigation from our general creditors for amounts past due for materials and services.  Individually, such claims do not exceed $2,400 (the amount deemed to require disclosure in response to this item), but since as of May 31, 2010, $4,167,522 of salary remains due to our employees and our accounts payable was approximately $1,959,356, of which $1,656,244  was over 90 days old, such suits may total more than such amount at any given time.  We evaluate each case on what we believe is its merits and respond by either offering settlement, offering to settle for the issuance of shares of our common stock, or raise counterclaims or defenses to the action, as we deem appropriate.





The outcome of any litigation is inherently uncertain and we are required under our certificate of incorporation, bylaws and employment agreements to indemnify our officers and directors for certain liabilities, including the cost of defending litigation brought against them in their capacity as such. Nevertheless, a portion of our indemnification liability is insured and shares of our common stock were escrowed at the time of the merger in which Arkados is the surviving corporation, to indemnify us against certain claims being made in the above actions.




ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.





None.


33


PART II





ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.





Our common stock is currently quoted on the Over-The-Counter Bulletin Board under the symbol “AKDS.OB.”





Market Information





Our shares of common stock were first quoted on the Over-The-Counter Bulletin Board in 1999. The following table presents the high and low bid prices per share of our common stock as quoted for each quarter in the years ended May 31, 2010 and May 31, 2009 which information was provided by NASDAQ Trading and Market Services.





Fiscal Year ended May 31, 2010High Bid

Low BidQuarter ended:May 31, 2010
$0.10

$0.10February 28, 2010
$0.12

$0.08November 30, 2009
$0.06

$0.06August 31, 2009
$0.15

$0.08Fiscal Year ended May 31, 2009High Bid

Low BidQuarter ended:May 31, 2009
$0.51

$0.11February 28, 2009
$0.35

$0.10November 30, 2008
$0.36

$0.16August 31, 2008
$0.33

$0.21





The above prices represent inter-dealer quotations, without markup, markdown or commissions, and may not represent actual transactions. The trading volume of our common stock fluctuates and may be limited or nonexistent from time to time. As a result, the above prices should not be considered to represent a liquid trading market.





Holders





As of September 13, 2010, we had 211 stockholders of record of our common stock.





Dividend Policy





We have paid no dividends on our common stock and we do not expect to pay cash dividends in the foreseeable future. The terms of the Secured Debentures , of which there was $19,226,097 principal and interest outstanding at August 31, 2010,prohibit our payment of any cash dividends or distributions without the consent of the holders of 60% of the principal amount outstanding at the time of such dividend or distribution. We currently do not have surplus from which we could pay dividends and intend to retain any future earnings to finance the growth and development of our business.





Recent Sales Of Unregistered Securities; Use Of Proceeds From Registered Securities





Information concerning our sales of unregistered securities during the period covered by this report has been reported by us on previously filed reports on Form 10-Q and Form 8-K.





Equity Compensation Plan Information





The following table sets forth certain information about our equity compensation plans and agreements as of May 31, 2010:





34


Plan Category
Number of securities

to be issued upon

exercise of

outstanding options,

warrants and rights



(a)
Weighted-average

exercise price of

outstanding options,

warrants and rights



(b)
Number of securities

remaining available

for future issuance

under equity

compensation plans

(excluding securities

reflected in column

(a)



(c)Equity compensation plans

approved by security holders
—
—
—Equity compensation plans not

approved by security holders
17,150,236
$0.30
3,121,400Total
17,150,236
$0.30
3,121,400





Our board adopted a stock option plan in 1998 which was approved by stockholders. The plan reserved 3,000,000 shares of old common stock for issuance upon the granting of incentive and non-qualified stock option until June 30, 2008 with terms up to 10 years from the dated of grant.  As a result of a reverse stock split the number of shares available for grant was reduced to 60,000.





In 2004, our board approved our 2004 Stock Option and Restricted Stock Plan (the “2004 Plan”) and set aside 6,000,000 shares for grant pursuant to incentive and non-qualified stock options, and restricted stock awards.  The 2004 Plan was amended by the board in June 2006, to increase the number of shares subject to options that can be granted to our officers, directors, employees and consultants to 10,000,000. The Plan was later amended in March 2007 and November 2008 to increase this amount to 15,000,000 and 22,500,000, respectively. The 2004 Plan has not been approved by our stockholders and accordingly, no “incentive stock options” as defined in the Internal Revenue Code can be granted until such approval is obtained. The 2004 Plan is currently administered by the Compensation Committee of our board of directors.  As of May 31, 2010, there were options to purchase 17,150,236 shares outstanding under the 2004 Plan, as amended, of which 14,002,239 were vested.











35


ITEM 6.
SELECTED FINANCIAL DATA





The following selected financial data should be read in conjunction with, and are qualified in their entirety by, the consolidated financial statements and related notes thereto contained in “Item 8. Financial Statements and Supplementary Data” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.


Year Ended May 31.2010



2009


2008


2007


2006Revenues


295,870




763,040



856,676



131,735



112,094Operating expenses


4,658,474




5,592,375



5,133,059
2


5,325,180
2


3,591,658Other income (expense), net


(6,821,032
)



(1,725,457
)


(2,307,219
) 3


(744,084
)


(465,472
)Loss before income taxes


(11,478,230
)



(7,203,631
)


(6,879,148
)


(6,033,075
)


(4,025,016
)Net loss applicable to common shareholders







(6,762,218
)


(6,478,999
) 4


(6,033,075
)


(4,025,016
)Total assets


510,141




955,646



1,390,689



1,424,905



594,987Long term obligations


—




—



—
5


8,237,061



4,255,789Cash dividends declared


—




—



—



—



—Net loss per share basic and diluted

$
(0.35
)


$
(0.22
)

$
(0.25
)

$
(0.24
)

$
(0.17
)Weighted average of common sharesOutstanding - basic and diluted


33,109,791




30,193,463



26,134,528
6


25,152,463
6


23,777,360




1.
Includes revenues related for a long term arrangement for product development and supply with one client that ended during fiscal year 20062.
Increases related to the effect of the acquisition of Aster Wireless in the amounts of $520,879 and $146,746 in the year ended May 31, 2008 and May 31, 2007, respectively3.
Includes interest penalty of 1,004,701 resulting from of waiver all potential defaults by the debtholders caused by our not making a scheduled interest payment of approximately $255,0004.
Includes benefit of sales of Arkados NJ Net Operating Loss in 2008 of $400,149,5.
As of May 31, 2008, all long term debt is due within the fiscal year 2009 and is therefore classified as short term debt.6.
Includes the issuance of 1,078,554 shares related to the acquisition of Aster Wireless




36


ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS





Readers are urged to carefully review and consider the various disclosures made by us in this Form 10-K for the period ended May 31, 2010, and our other filings with the U.S. Securities and Exchange Commission. These reports and filings attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this Form 10-K speak only as of the date hereof and we disclaim any obligation to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.





Plan of Operation





We are a technology solutions company engaged in research and development activities focused on the portion of the industry that provides the semiconductors and software to enable broadband communications over standard electricity lines. Arkados is member of an alliance of nearly 70 companies referred to as the HomePlug Powerline Alliance. The alliance’s mission is to enable and promote rapid availability, adoption and implementation of cost effective, interoperable and standards-based home powerline networks and products. Arkados is also a member of the IEEE P1901 working group that is focused on the standardization of powerline communication technology.





During the year ended May 31, 2010:




·
Several product companies have started shipping products that incorporate our chip and software solutions.




-
Russound is now shipping the Collage Powerline Media and Intercom system, a flexible and expandable system that provides access to two-way transmission of audio, video, data, and internet media with metadata feedback without the need of running new zone-to-zone wiring. Reviews from CePro, E-Gear, Home Theater Magazine, and Home Entertainment Magazine have been exceedingly positive.




-
NuVo Technologies is now shipping Renovia, offering whole-home audio in up to 8 different rooms, quick and simple installation, and built-in AM/FM/SIRIUS-Ready Dual Tuners.




-
Currently in the market, our solutions form the engine for products marketed by Germany’s devolo AG (the world-leader in powerline communications products).  Devolo’s audio adapters, which transmit audio over household power lines, are currently in retail stores throughout Europe.




-
We provide the underlying technology for an iPod-based whole-house audio system from IOGEAR, which is sold online market in the near future in the U.S. and other parts of the world.  The Arkados solution, as embodied in this product, has already won a major award for Arkados, having been one of only 15 products (out of over 20,000) to receive G4 Television’s CES 2008 “Best of the Best” product award.




·
With Tatung Company, a worldwide leader in the design and manufacturing of digital consumer, industrial and energy products, Arkados demonstrated products that combined HomePlug® powerline communications and WiMAX technologies at Computex 2009. The demonstration included fully connected solutions that bridge Smart Energy, Internet connectivity, and connected consumer electronics.




·
At the 2010 International Consumer Electronics Show, we participated together with ST Microelectronics to promote our upcoming jointly-developed system-on-chip solution that incorporates four global powerline communications technologies: HomePlug AV, IEEE 1901, HomePlug 1.0, and HomePlug GP. It is planned to be most compatible chip on the market. The exhibition at CES 2010 was hosted by an industry body focused on growing the market for powerline communications called the HomePlug Powerline Alliance, which the Arkados team co-founded in 2000.




·
We continued to increase our focus on sales and marketing and customer acquisition, after developing and demonstrating reference designs and prototypes of end-user products that incorporated our AI-1100 chip, the first in our family of ArkTIC® solutions, and demonstrated its capabilities and competitive advantages.




·
Arkados solutions have been shown in a number of public venues, including the 2008/2009/2010 International Consumer Electronics Show, Computex 2009, CeBIT 2009, CEDIA Expo 2009, Electronic House Expo 2009, and other conferences. The Company’s prototypes or products have been publicly announced and/or demonstrated by Analog Devices, Channel Vision, Checkolite, Corporate Systems Engineering, devolo AG, Freescale, GigaFast, GoodWay, IOGEAR, NuVo, Meiloon, PAC Electronics, Russound, Tatung, Zinwell, and Zylux. Many of these companies are suppliers to top tier brands in the market place. Tatung’s service provider business has used the Arkados chip in WiMAX-to-Powerline demonstrations. Several of these relationships, among others, have progressed into sales of chips, software development services, and related revenue.




·
Over the past several years, we have participated in a broad variety of public events and conferences including the CES,


37
 ·
Over the past several years, we have participated in a broad variety of public events and conferences including the CES,


We continue to market our chip and reference design products to individual potential customers, including both OEMs and ODMs. Such potential customers, if they ultimately agree to design our chips into their end-user products (as is the case with OEMs) or in the products of their own OEM customers (as is the case with ODMs), could be responsible for the introduction of multiple end-user products into the market, based on the timetables required for such product introductions. Such an event could produce multiple revenue streams, including revenues from each potential OEM customer that uses our chips in their end-user products. In the case of each potential ODM customer that uses our chips in the designs of the multiple OEM customers served by each ODM, there could be multiple revenue streams attributable to each ODM that chooses to work with our chips. In both cases, however, such revenue streams will affect future quarters, based on the timetable associated with the deployment of end-user products by such OEM and ODM customers. Thus far, two such ODMs and seven OEMs have publicly announced their offering of a product incorporating our AI-1100 SoC. We need additional funding to capitalize on these opportunities.





We have positioned ourselves to service significant demand from any major electronics or networking manufacturer. We have held discussions at various levels with household names in those industries, and we believe that many of these talks may lead to firm orders in growing quantities.





We require additional funding for the expansion of our research and development efforts and the expansion of our sales and marketing organization, and to fund consulting and manufacturing work needed in order for our chip to be ready and available for mass production. We also plan to develop various end-user product prototypes and reference designs to support our marketing efforts.





We will contract with third parties for all of our wafer fabrication and assembly, as well as for a portion of our design and testing. This “fabless” manufacturing strategy is designed to allow us to concentrate on our design strengths, minimize fixed costs and capital expenditures, access advanced manufacturing facilities, and provide flexibility on sourcing multiple leading-edge technologies through strategic alliances.





We expect to qualify each product, participate in process and package development, define and control the manufacturing process at our suppliers where possible and practicable, develop or participate in the development of test programs, and perform production testing of products in accordance with our quality management system. If possible, we plan to use multiple foundries, assembly houses, and test houses.





We have not had significant revenue from operations since inception and, as of  May 31, 2010, we are still a development stage company. Furthermore, we have financed operating losses since September 2004 with the proceeds primarily from related party lending from our major stockholder and affiliated lenders, as well as other stockholders and lenders, and from a capital raise to qualified investors through a retail brokerage firm. From December 2005 to May 31, 2008, we sold an aggregate $8,428,461 of 6% secured convertible debentures due December 28, 2008 of which $6,145,884 was purchased by institutional investors and the balance of $2,282,576 by a limited liability company owned equally by our Chairman’s wife and another director, Kathryn Typaldos and $45,000 principal amount to the partners of Sommer & Schneider LLP, our principal securities counsel to settle an equivalent amount of past due legal fees. During the fiscal year 2006, we paid down a substantial portion of outstanding short term debt and other liability and have issued approximately 600,000 shares of our common stock in satisfaction of approximately $406,000 of short term liabilities. From June 1, 2008 to August 31, 2008, we received approximately $649,000 of financing which was converted into equity in August 2008.  In addition, we received an additional $20,000 which represents borrowings from related parties.





As of August 31, 2010, $19,226,097 of secured debt in the form of 18% secured convertible debentures originally due December 28, 2008 and due June 28, 2009 (the “Secured Debentures”), of which $5,431,544 is held by related parties, is in default, as is $1,043,748 principal and interest on unsecured notes due June 28, 2009.  In addition, as of August 31,2 010, $4,284,967 of salary remains due to our employees and our accounts payable was approximately $2.000.000, of which $1,920,000 was over 90 days.





On July 2, 2009 we received notice of default from a law firm representing approximately 45% of our outstanding Secured Debentures by reason of non-payment. This event triggers an “Event of Default” under the terms of the Debentures on July 8, 2009, absent payment in full.  The Event of Default entitles the holders of the Debentures to redemption at the rate of 130% of the principal and accrued interest outstanding, interest on unpaid interest and principal at the rate of 18% per annum commencing on July 8, 2009 and reimbursement for expenses incurred enforcing the obligations.  The holders of the Secured Debentures have all of the rights and remedies secured creditors holding a first priority security interest in all of our assets under the transaction documents and applicable law, including the right to demand assembly of our assets for sale to satisfy the obligations.  These rights are exercised through Bushido Capital Master Fund, LP, as representative of the holders of the Debentures (“Bushido”).




38


We continue to negotiate with the holders of each class of debt to fashion a forbearance agreement, compromise or convert outstanding debt into equity and thereby facilitate raising additional investor capital.  There is no binding agreement on anyone’s part to do so and no assurance can be given that the terms will be acceptable to the holders of all of the secured debt.  We have also received indications of interest from potential private and strategic investors concerning the terms and conditions upon which they would make an investment in Arkados, including the terms upon which the secured debt and other debt would have to be compromised and converted for them to make such investments, but there is no binding commitment on anyone’s part to complete the transactions.  Finally, without commitment on anyone’s part, we have discussed converting a substantial portion of past due compensation with our employees if the financing and restructuring of our debt can be completed.    In the absence of financing and debt restructuring, our operation are severely constrained and we may have to suspend operations altogether.  In addition, unless the terms of financing and restructuring is acceptable to our general trade creditors, we remain at the risk of creditors filing an involuntary petition pursuant to the U.S. Bankruptcy Code.





Every aspect of our business remains constrained by our limited capital resources and the threat of having to cease operations as a result of our lack of capital. If we are unable to raise funds to finance our working capital needs, we will not have the capital necessary for ongoing operations and for making our chip ready for mass production and we could lose professional staff necessary to develop our products and the value of our technology could be impaired. In addition, the lack of adequate funding will jeopardize our development and delivery schedule of our planned products. Such delays could in turn jeopardize relationships with our current customers, strategic partners and prospective suppliers.





Critical Accounting Policies





Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our accounting policies are described in Note 2 of the notes to our consolidated financial statements included in this report. Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following is a brief discussion of the more significant accounting policies and methods used by us. In addition, Financial Reporting Release No. 67 was recently released by the SEC to require all companies to include a discussion to address, among other things, liquidity, off-balance sheet arrangements, contractual obligations and commercial commitments.





Basis of Presentation





Our consolidated financial statements have been prepared assuming we will continue as a going concern despite substantial doubt as to our ability to do so. Management anticipates losses in the foreseeable future and plans to finance losses by raising additional capital. If we are unable to continue as a going concern, adjustments would have to be made to the carrying value of assets.





Revenue Recognition





We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended (“SAB 101”). SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Under the provisions of SAB 101, we recognize revenue when products are shipped, and the collection of the resulting receivable is probable. If revenues are from a long term arrangement, revenue is recognized when pre-determined milestones, which generally are related to substantial scientific or technical achievement, are accomplished.





Accounting for Stock Based Compensation





The computation of the expense associated with stock-based compensation requires the use of a valuation model. SFAS 123(R) is a new and very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility, expected option lives, and expected option forfeiture rates, to value equity-based compensation. We currently use a Black-Scholes option pricing model to calculate the fair value of its stock options. We primarily use historical data to determine the assumptions to be used in the Black-Scholes model and have no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions to reflect future stock price volatility and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards. SFAS 123(R) requires the recognition of the fair value of stock compensation in net income. Although every effort is made to ensure the accuracy of our estimates and assumptions, significant unanticipated changes in those estimates,





39


interpretations and assumptions may result in recording stock option expense that may materially impact our financial statements for each respective reporting period.





Accounting for Registration Payment Arrangements





The Company has reviewed the accounting for registration rights terms relating to the shares of common stock issuable upon the conversion and exercise, respectively, of the 6% Secured Convertible Debentures and related warrants under the recently adopted FSP EITF 00-19-2. The Company granted demand registration rights to the purchasers of the 6% Secured Debentures which requires the Company to file an initial registration 45 days following demand. Under the registration rights agreement, the Company incurs a penalty if it fails to file within the 45 day period or if the SEC had not declared the registration effective 90 days after filing. The holders of the 6% Secured Debentures have not demanded registration. The Company believes it can comply with a demand for registration in a timely manner and therefore no accrual for the registration rights penalties has been made.





The Year ended May 31, 2010





During the year ended May 31, 2010, we had revenues of $295,870 of revenues compared to $763,000 for the same period in 2009. Revenues were a combination of revenues from chip sales in the amount of $80,000 and revenues from service contracts in the amount of $215,870  related to the achievement of certain milestones remaining under a number of long term development contracts. We estimated gross margin from the receivable based upon cost estimates we prepared for the provision of all of the services and products in the arrangement. Total operating expenses for the year ended May 31, 2010 were $4,658,474 compared to $5,592,375 in the same period of fiscal year 2009. In both periods, the most significant expenses were personnel, professional fees and related expenses. Research and development expenses during the year were $2,700,413 million.





Of the total $4,758,474 in operating expenses in fiscal year 2010, approximately $1,176,759   was related to the issuance of stock and stock options for services rendered by both our employees and outside consultants. In the prior year period, this amount was $2,289,684. Given our reliance on outside sources of capital, we expect significant additional charges relating to stock


compensation.





Interest expenses increased $5,095,575 for the year ended May 31, 2010 compared to the prior year primarily as a result of the recognition of penalties in the form of a 30% increase in principal and a tripling of the interest rate to 18% upon our default in the Secured Debentures.





The Year ended May 31, 2009





During the year ended May 31, 2009, we had revenues of $763,000 of revenues compared to $857,000 for the same period in 2008. Revenues were a combination of revenues from chip sales in the amount of $158,000 and revenues from service contracts in the amount of $605,000 related to the achievement of certain milestones remaining under a number of long term development contracts. We estimated gross margin from the receivable based upon cost estimates we prepared for the provision of all of the services and products in the arrangement. Total operating expenses for the year ended May 31, 2009 were $5.6 million compared to $5.1 million in the same period of fiscal year 2008. In both periods, the most significant expenses were personnel, professional fees and related expenses. Research and development expenses during the year were $2.1 million. Of the total $5.6 million in operating expenses in fiscal year 2009, approximately $2,289,684 was related to the issuance of stock and stock options for services rendered by both our employees and outside consultants. In the prior year period, this amount was $856,000. Given our reliance on outside sources of capital, we expect significant additional charges relating to stock compensation.





Liquidity and Capital Resources





Our principal source of operating capital has been provided in the form of equity investments and, the private placement of debt securities coupled with warrants and related party loans. We do not have any significant sources of revenue from our operations. No assurance can be given that we can engage in any public or private sales of our equity or debt securities to raise working capital. We have depended, in part, upon loans from our present stockholders or management and there can be no assurances that our present stockholders or management will make any additional loans to us.





During the year ended May 31, 2010, we were able to borrow additional working capital in the form of 8% unsecured loans totaling approximately $1,000,000. Of these amounts, $70,000 were from Related Parties. The cash from these financing ctivities were used by operations during the period.





40


During the year ended May 31, 2009, we were able to raise $810,000 through a private placement of our stock and warrants to accredited investors. As of the year ended May 31, 2008, we had cash of approximately $24,000 and negative working capital of $8,433,334 compared to cash of $24,000 and negative working capital of $15,988,337 at May 31, 2008. The decrease in working capital is related primarily to the increase in payables and accrued payroll balances. Subsequent to May 31, 2008, we received approximately $649,000 which was converted into equity in August 2008.  In addition, we received an additional $20,000 which represents borrowings from related parties. All of these funds were used to support normal operating activities.





Our present material commitments are the compensation of our employees, including our executive officers, and professional and administrative fees and expenses associated with the preparation of our filings with the Securities and Exchange Commission and other regulatory requirements.





As described under “Plan of Operations,” we are in default on secured debt, unsecured notes, obligations to employees and substantially all of our accounts payable are over 90 days past due.  These conditions make raising capital in any form extremely difficult.  We have negotiated with each class of creditors and believe that our outstanding debt can be settled on terms that will be acceptable to possible individual investors and strategic investors, but there are no  binding agreements or commitments in this regard.  While we have been able to finance a small portion of our critical cash requirements by selling bridge notes, there is no assurance that such sales will continue or that sufficient funds are raised in this manner to permit us to operate and timely execute our plans for restructuring debt and raising capital.





As of May 31, 2010, we had cash of $16,345 and negative working capital of  $28,358,048 compared to cash of $10,371 and negative working capital of  $ 18,488,419 at May 31, 2009.





Commitments





We do not have any commitments which are required to be disclosed in tabular form as of May 31, 2010.





Off Balance Sheet Arrangements





We do not have any off balance sheet arrangements.




ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Not applicable.





ITEM 8.
FINANCIAL STATEMENTS.





Our financial statements are filed under this Item 8, beginning on page F-1 of this report.





41


Arkados Group, Inc. and Subsidiaries


Development Stage Enterprise








CONTENTS

















PageREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMF – 1CONSOLIDATED FINANCIAL STATEMENTSConsolidated Balance Sheets
F – 2Consolidated Statement of Operations
F – 3Consolidated Statement of Changes in Stockholders’ Deficiency
F – 4 to 5Consolidated Statement of Cash Flows
F – 6NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
F – 7 to

F – 74








42


Report of Independent Registered Public Accounting Firm
 
 Board of Directors and Stockholders
 Arkados Group, Inc. and Subsidiaries
  We have audited the accompanying consolidated balance sheets of Arkados Group, Inc. and subsidiaries (A Development Stage Enterprise) as of May 31, 2010 and May 31, 2009, and the related consolidated statements of operations, stockholders’ deficiency, and cash flows for each of the years ended May 31, 2010 and 2009  and for the period June 1, 2004 to May 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements for the period March 24, 2004 (inception) to May 31, 2004 which reflects total revenues and a net loss of $0 and $693,833, respectively, of the cumulative totals.
 
 We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
 
 In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of May 31, 2010 and May 31, 2009, and the results of its operations and cash flows for each of the years ended May 31, 2010 and 2009 and for the period June 1, 2004 to May 31, 2010 in conformity with generally accepted accounting principles in the United States.
 
 The accompanying financial statements have been prepared assuming that Arkados Group, Inc. will continue as a going concern. As more fully described in Note 2, the Company has incurred recurring operating losses and will have to obtain additional capital to sustain operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments to reflect the possible effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
 
 By:
/s/Sherb & Co., LLPSHERB & CO, LLPCertified Public Accountants
 New York, New York
 
 September 13, 2010
    
 F-1
 ARKADOS GROUP, INC. and Subsidiaries
 Consolidated Balance Sheet
 (A Development Stage Enterprise)
 
 May 31,2009

2010Current Assets:Cash

$
10,371

$
16,345Accounts receivable, net


72,815


7,709Inventory


29,819Total Current Assets


113,005


24,054Deferred financing costs


533,330


284,126Equipment, net


36,181


28,272Intangible assets, net


216,902


139,921Prepaid and other assets


56,228


33,768$
955,646

$
510,141Liabilities and Stockholders’ DeficiencyCurrent Liabilities:Accrued expense and other liabilities

$
4,821,646

$
9,927,810Related party debt


187,700


247,700Notes  payable


206,802


1,142,301Payroll taxes and related penalties and interest payable


936,906


936,906Convertible Debntures


12,448,967


16,127,388Total Current Liabilities


18,602,021


28,382,105Convertible Debentures, including related party debt


—Commitments and Contingencies


—Stockholders’ DeficiencyConvertible Preferred Stock - $.0001 par value;5,000,000 shares authorized, zero shares outstanding


—Common stock, $.0001 par value, 100,000,000 sharesauthorized, 32,738,397 and 34,926,261,issued and outstanding in 2009 and 2010, respectively


3,274


3,493Additional Paid in capital


21,638,124


22,890,547Treasury Stock


(16,000)


(16,000)Accumulated Deficit during development stage


(39,271,774)


(50,750,004)Total Stockholders’deficiency


(17,646,375)


(27,871,964)$
955,646

$
510,141
 
 See notes to consolidated financial statements.
  F-2
 ARKADOS GROUP, INC. and Subsidiaries
 Consolidated Statement of Operations
 (A Development Stage Enterprise)
  Cumulative

During the

Development

Stage (March

24, 2004 toYear Ended May 31,


May 31, 2010)2009


2010


(Unaudited)Net Sales

$
763,040


$
295,869


$
2,992,998Cost of Goods Sold


648,839



294,593



2,014,797Gross Profit


114,201



1,277



978,201Research and Development Expenses


2,069,179



2,700,413



11,321,906General and Administrative Expenses


3,523,196



1,958,061



20,551,061Net Loss From Operations


(5,478,174
)


(4,657,197
)


(30,894,766
)Interest Income (Expense)


(1,725,457
)


(6,821,032
)


(12,419,532
)Net Loss Before Income Taxes


(7,203,631
)


(11,478,230
)


(43,314,298
)Provision for Income Taxes (Benefit)


(441,413
)






(841,562
)Net Loss

$
(6,762,218
)

$
(11,478,230
)

$
(42,472,736
)Net loss per share - basic and diluted

$
(0.22
)

$
(0.35
)Weighted Average of Common SharesOutstanding - basic and diluted


30,193,463



33,109,791
 
 
 See notes to consolidated financial statements
 
 
 F-3
 ARKADOS GROUP, INC. and Subsidiaries
 Consolidated Statement of Stockholders’ Deficiency
 (A Development Stage Enterprise)
 Inception March 24, 2004 to May 31, 2004 and the Years Ended May 31, 2005-May 31, 2010
   AccumulatedDeficitAdditional


During





TotalPreferred Stock


Common Stock

Paid in


Development


Treasury


Stockholders’Shares

Amount


Shares

Amount

Capital


Stage


Stock


DeficiencyBalance as of March 24, 2004 (Unaudited)Post foreclosure sale
—

$
—


5,569

$
5,569

$
1,988,185

$
(8,277,267)

$
—

$
(6,283,513)Effect of Reorganization and Merger–May 24, 2004
—


—


21,473,364


(3,422)


4,105,180


—


(16,000)


4,085,758Sale of shares pursuant to PPM
—


—


841,666


84


950,116


—


—


950,200Issuance of shares for settlement of debts
—


—


181,068


18


168,185


—


—


168,203Amortization of stock compensation
—


—


—


—


359,537


—


—


359,537Net loss (March 24,2004 to May 31, 2004)(Unaudited)
—


—


—


—


—


(693,833)


—


(693,833)Balance as of May 31, 2004
—


—


22,501,667


2,250


7,571,202


(8,971,100)


(16,000)


(1,413,648)Shares issued for services
—


—


575,000


58


724,753


—


—


724,811Debt converted to equity
—


—


125,000


13


75,483


—


—


75,496Issuance of options for services
—


—


—


—


198,169


—


—


198,169Valuation of equity rights and beneficial conversion features of debt raise
—


—


—


—


234,353


—


—


234,353Amortization of stock compensation
—


—


—


—


3,617,681


—


—


3,617,681
 
 F-4
 ARKADOS GROUP, INC. and Subsidiaries
 Consolidated Statement of Stockholders’ Deficiency
 (A Development Stage Enterprise)
 Inception March 24, 2004 to May 31, 2004 and the Years Ended May 31, 2005-May 31, 2010
 
 
 Net Loss
—


—


—


—


—


(7,001,365)


—


(7,001,365)Balance as of May 31, 2005
—


—


23,201,667


2,321


12,421,641


(15,972,465)


(16,000)


(3,564,503)Shares issued for services
—


—


75,000


8


22,492


—


—


22,500Debt converted to equity
—


—


609,786


61


405,683


—


—


405,744Shares issued for debt accommodations and penalties
—


—


466,600


47


267,253


—


—


267,300Options issued for services
—


—


—


—


69,170


—


—


69,170Valuation of equity rights and beneficial conversion features of debt raise
—


—


—


—


404,555


—


—


404,555Amortization of stock compensation
—


—


—


—


497,347


—


—


497,347Net Loss
—


—


—


—


—


(4,025,016)


—


(4,025,016Balance as of May 31, 2006
—

$
—


24,353,053
$

2,437
$

14,088,141
$

(19,997,481
$

(16,000)
$

(5,922,903)Shares issued for services
—


—


475,000


47


341,953


—


—


342,000Options issued for services
—


—


—


—


197,923


—


—


197,923Valuation of equity rights
—


—


—


—


424,247


—


—


424,247Amortization of stock compensation
—


—


—


—


418,997


—


—


418,997Exercise of options
—


—


175,604


17


1,739


—


—


1,756Issuance of common stock for Aster Acquisition
—


—


1,078,564


107


461,712


—


—


461,819Net loss
—


—


—


—


—


(6,033,075)


—


(6,033,075)Balance as of May 31, 2007
—


—


26,082,221


2,608


15,934,712


(26,030,556)


(16,000)


(10,109,236)Shares issued for services
—


—


196,667


20


63,480


—


—


63,500Options issued for services
—


—


—


—


105,448


—


—


105,448Valuation of equity rights
—


—


—


—


1,064,495


—


—


1,064,495Amortization of stock compensation
—


—


—


—


697,687


—


—


697,688
 
 
 
 F-5
 ARKADOS GROUP, INC. and Subsidiaries
 Consolidated Statement of Stockholders’ Deficiency
 (A Development Stage Enterprise)
 Inception March 24, 2004 to May 31, 2004 and the Years Ended May 31, 2005-May 31, 2010
 
 Net Loss
—


—


—


—


—


(6,478,999)


—


(6,478,999)Balance as of May 31, 2008
—


—


26,278,888

$
2,628

$
17,865,822

$
(32,509,556)

$
(16,000)

$
(14,657,104)Shares issued for services
—


—


2,134,469


213


422,542


—


—


422,755Private Placement






3,380,159


338


809,700








810,038Conversion of Debt






944,881


95


409,018








409,113Options issued for services
—


—


—


—


90,246


—


—


90,246Valuation of equity rights
—


—


—


—


264,111


—


—


264,111Amortization of stock compensation
—


—


—


—


1,776,683


—


—


1,776,683Exercise of optionsNet Loss
—


—


—


—


—


(6,762,218)


—


(6,762,224))Balance as of May 31, 2009
—


—


32,738,397

$
3,274

$
21,638,124

$
(39,271,774)

$
(16,000)

$
(17,646,375)Shares issued for servicesPrivate PlacementConversion of DebtOptions issued for servicesValuation of equity rights












54,000








54,000Amortization of stock compensation












1,176,762








1,176,762Exercise of options






2,187,864


219


21,660








21,879Net Loss















(11,478,230)





(11,478,228)Balance as of May 31, 2010
—


—


34,926,621

$
3,493

$
22,890,547

$
(50,750,004)

$
(16,000 )

$
(27,871,964)
 
 
 See notes to consolidated financial statements.
 
 F-6
 ARKADOS GROUP, INC. and Subsidiaries
 Consolidated Statement of Cash Flow
 (A Development Stage Enterprise)
  Cumulative Duringthe DevelopmentStage(March 24, 2004 toYear Ended May 31,


May 31, 2010)Cash Flows From Operating Activities

2009


2010


(Unaudited)Net Loss

$
(6,762,136
)


(11,478,230
)

$
(42,472,736
)Adjustments to reconcile net loss to net cash providedby (used) in operating activities:Depreciation and Amortization


448,259



84,890



1,577,722Common stock and warrants issued for services


2,289,684



1,230,763



11,102,518Warrants and Beneficial Conversion Rights with Debt


142,130



—



627,716Debt and Interest penalty


—



3,678,4215



4,683,122Changes to Assets and Liabilities:

Accounts Recievable


(37,839
)


65,106



(7,709
)Inventory


(29,189
)


29,819



630Deferred Expenses


365,783



249,204



674,276Prepaid and Other assets


—



22,460



(80,981
)Payroll taxes and related penalties and interest payable


—


—



(22,916
)Related party payable


23,717


—



—Accounts Payable and accrued expenses


2,696,400



5,106,162



9,913,094Net Cash Provided by (Used) in Operating Activities


(910,737
)


(1,011,405
)


14,005,294Cash Flows from Investing ActivitiesPurchases of capital expenditures and Patents


(5,242
)

—



(140,671
)Net Cash Used in Investing Activities


(5,242
)

—



(140,671
)Cash Provided by Financing ActivitiesRelated party payables


10,000


—



1,586,726Note Payable


206,802



995,500



1,327,302Contribution of capital


—







1,232,646Exercise of Stock Options


810,038



21,879



23,635Repayment of debt


(125,000
)

—



(469,256
)Proceeds from convertible Debt

—


—



1,066,550Issuance of Debentures


—


—



9,533,411Repayment of related party payables


—


—



(949,027
)Net Cash Provided by Financing Activities


901,840



1,017,379



14,162,025Net (Decrease) Increase in Cash


(14,139
)


5,974



16,060Cash, beginning of the period


24,480



10,371



285Cash, end of the period

$
10,371



16,345


$
16,345Supplemental disclosures of cash flow information:Conversion of debt for equity

$
409,113



——Conversion of accrued interest to debt

$
673,049



—
 
 
 See notes to consolidated financial statements.
  F-7
 Arkados Group, Inc. & Subsidiaries (A Development Stage Enterprise)
 NOTES TO FINANCIAL STATEMENTS
 YEARS ENDED MAY 31, 2010 and 2009
  1.
DESCRIPTION OF BUSINESS
 
 Arkados Group, Inc. (the “Company”), pursuant to an “Agreement and Plan of Merger”, (“the Merger Agreement”) dated May 7, 2004 and consummated on May 24, 2004, merged a wholly owned subsidiary, CDK Merger Corp., with Miletos, Inc. (the “Merger”). CDK Merger Corp. was renamed “Arkados, Inc.” On August 30, 2006 the Company changed its name from CDKNET.COM, Inc. to Arkados Group, Inc. All references to CDKNET.COM, Inc. have been changed accordingly. Since Arkados Group, Inc. and subsidiaries prior to May 7, 2004 had no meaningful operations, this merger has been recorded as a reorganization of Arkados, Inc. via a reverse merger with Arkados Group, Inc.
 
 The Company, a development stage enterprise, is a fabless semiconductor company providing integrated system-on-chip solutions that directly support networking, smart grid and multimedia applications.  Arkados, “the HomePlug Applications Company,” delivers a universal platform that enables the effortless networking of home entertainment and computer devices using standard electricity lines. We also license some ingredient technologies for wireless multimedia solutions. The Company’s system-on-chip solutions are uniquely designed to drive a wide variety of powerline-communication solutions such as utility company “smart grid” applications, and powerline-enabled consumer electronics and home computing products, such as stereo components, radios, speakers, MP3 players, computers, televisions, gaming consoles, security cameras and cable and DSL modems. With Arkados’ solutions, customers can bring numerous sophisticated, full-featured products to market faster at a lower overall development cost using a single platform: the company’s versatile and programmable ArkTIC® platform. Arkados solutions leverage the benefits of standard powerline communications technologies that are used worldwide for in-building and to-the-home Broadband Powerline (“BPL”) applications.  The Company is a member of an industry alliance of several companies referred to as the HomePlug Powerline Alliance, “HomePlug”, for developing the standard of such technologies and is a member of the IEEE P1901 working group.
 
 Miletos, Inc. was a newly established entity, which acquired the assets and business of Enikia, LLC in a public foreclosure sale on March 23, 2004 in exchange for the forgiveness of $4,000,000 of secured debt and the assumption of certain outstanding liabilities. The assets and certain liabilities acquired at the foreclosure sale have been recorded at historical cost basis. The new entity, Miletos, Inc. was predominately owned by a controlled group, which was the same controlled group of Enikia, LLC and the same group became majority holders.
 
 The accompanying financials have been presented on a development stage basis using March 24, 2004 as the date of inception.
 
 Pursuant to the Merger Agreement, the consideration for the merger consisted of 16,340,577 shares of the Company’s restricted common stock (250,000 of such common shares were contingent shares and were returned for cancellation as they were not called upon as a result of a breach of a warranty or representation) and 3,634,642 stock options at prices ranging from $.01 to $1.20 per share. In addition $950,200 was raised through the sale of equity for working capital of the Company.
 
 
 2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  a.
Basis of Presentation - The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred net losses of approximately $42 million since inception including a net loss of over $11 million for the recent year ended May 31, 2010. Additionally, the Company had a net working capital deficiency and shareholders’ deficiencies at May 31, 2010 and 2009, and negative cash flow from operations since inception. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management expects to incur additional losses in the foreseeable future and recognizes the need to raise capital to remain viable. The accompanying consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.
 
 F-8
 
 b.
Principles of consolidation - The consolidated financial statements include the accounts of Arkados Group, Inc. (the “Parent”), and it’s wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
  c.
Business combinations - We account for acquired businesses using the purchase method of accounting which requires that the assets and liabilities assumed be recorded at the date of acquisition at their respective fair values. Because of the expertise required to value intangible assets and intellectual property research and development “IPR&D”, we typically engage a third party valuation firm to assist management in determining those values. Valuation of intangible assets and IPR&D entails significant estimates and assumptions including, but not limited to: determining the timing and expected costs to complete projects, estimating future cash flows from product sales, and developing appropriate discount rates and probability rates by project. We believe that the fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions. To the extent actual results differ from those estimates, our future results of operations may be affected by incurring charges to our statements of operations. Additionally, estimates for purchase price allocations may change as subsequent information becomes available.
  d.
Cash and cash equivalents - The Company considers investments in highly liquid instruments with a maturity of three months or less to be cash equivalents.
  e.
Allowance for doubtful accounts - The Company records a bad debt expense / allowance based on management’s estimate of uncollectible accounts. The Company has not recorded any bad debt expense in each of the years ended May 31, 2009 and 2010
  f.
Equipment - Equipment is recorded at cost. Depreciation is provided on the straight-line method based upon the estimated useful lives of the respective assets. Equipment is being depreciated over a period of seven years. Maintenance, repairs and minor renewals are charged to operations as incurred, whereas the cost of significant betterments is capitalized. Upon the sale or retirement of property and equipment, the related costs and accumulated depreciation are eliminated from the accounts and gains or losses are reflected in operations.
  g.
Impairment of Long-Lived Assets - The Company reviews long-lived assets, certain identifiable assets and goodwill related to those assets on a quarterly basis for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recovered. To the extent there has been any impairment such impairment has been record in the statement of operations.
  h.
Fair Value of Financial Instruments - The carrying value of cash, accounts receivable, other receivables, accounts payable and accrued expenses approximate their fair values based on the short-term maturity of these instruments. The carrying amounts of debt were also estimated to approximate fair value. The Company can not estimate the fair value of the remaining outstanding payroll taxes, penalties and interest recorded in connection with the merger.
  i.
Revenue Recognition - The Company derives revenues from two sources – sales of products and revenues related to service and custom development activities.  For product sales, revenue is recognized when our products are shipped to our customers. Shipping documents and the completion of any customer acceptance requirements, when applicable, are used to verify product delivery or that services have been rendered.  Shipping costs are charged to cost of sales as incurred.  For sales related to development, the Company recorded revenues pursuant to a number of term development contracts. The revenues are earned and recorded are based on pre-determined milestones. When revenues within a pre-determined milestone have been partially earned, the Company records such progress billings as “Revenues earned not yet billed.” Such revenues are billable under the terms of the arrangement once the milestone has been fully completed. The Company also monitors estimated costs to complete such long term contract to the revenues to be earned to ensure that if there is an estimated loss to record to complete their obligation to fulfill the terms of such development contract, such loss existed. As of May 31, 2010, there were no long term contracts for which revenues were yet to be earned outstanding.
 
 F-9
 j.
Shipping and Handling Costs - Shipping and handling costs are normally FOB the Company’s factory. These costs are included in cost of goods sold.
  k.
Inventory and Reserves – Inventories are stated on a first-in first-out basis at the lower of cost or market value. Cost includes fabricated wafers, purchased integrated circuits, subcontractor costs (such as assembly and test). Any write-down of inventory to reduce carrying value to lower of cost or market value is charged to cost of sales.
  l.
Advertising Costs - All advertising costs, are expensed as incurred. The Company has not had any advertising costs in each of the last two years.
  m.
Loss Per Share - Basic net loss per common share is computed by dividing net loss by the weighted average number of shares of common stock outstanding. For the years ended May 31, 2010 and 2009 diluted loss per share is the same as basic loss per share since the inclusion of approximately 23 and 23  million stock options and warrants, respectively, and as well as 23 and 24 million shares of common stock issuable upon conversion of convertible indebtedness, respectively, would be anti-dilutive.
  n.
Stock Options – The Company adopted the FASB Guidance for, “Share Based Payments.” which  requires companies to expense the value of employee stock options and similar awards and applies to all outstanding and vested stock-based awards.
 
 In computing the impact, the fair value of each option is estimated on the date of grant based on the Black-Scholes options-pricing model utilizing certain assumptions for a risk free interest rate; volatility; and expected remaining lives of the awards. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. In estimating the Company’s forfeiture rate, the Company analyzed its historical forfeiture rate, the remaining lives of unvested options, and the amount of vested options as a percentage of total options outstanding. If the Company’s actual forfeiture rate is materially different from its estimate, or if the Company reevaluates the forfeiture rate in the future, the stock-based compensation expense could be significantly different from what we have recorded in the current period.
 
 In accordance with  the FASB Guidance for the fair value of each option grant has been estimated as of the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:
 
 The Company has recorded compensation expense for the years ended May 31, 2010 and, 2009, in the amounts of $1,176,759 and $1,860,929, respectively attributed to the issuance and vesting of common shares,  stock options and warrants for services. Such amount is included general and administrative expenses on the statement of operations.
  For Years Ended May 312010

2009Risk free interest rate
1.32-1.65%

2.13%-3.49%Expected life
3 years

1-4 yearsDividend rate
0.0%

0.00%Expected volatility
206%-251%

64%-239%
 
 
 o.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.
  F-10
 p.
Comprehensive Income – FASB Guidance for, “Reporting Comprehensive Income”, establishes standards for reporting and displaying comprehensive income, comprising net income and other non-owner changes in equity, in the financial statements. For all periods presented, comprehensive income was the same as net income.
 
 q.
Research and Development – Research and Development expenses principally consist of costs surrounding the development of our ArkTIC® chip-and-software platform. This includes labor and equipment related to intellectual property development, manufacturing and development of test platforms, software development systems, certification testing systems, customer application support, licensing of appropriate technologies. Some development expenses are paid to outside consultants who perform work that is delivered to us. All research and development costs are expensed as incurred.
 
 r.
Recent Accounting Pronouncements – In June 2009, the FASB issued guidance which will amend the Consolidation Topic of the Codification. The guidance addresses the effects of eliminating the qualifying special-purpose entity (QSPE) concept and responds to concerns over the transparency of enterprises’ involvement with variable interest entities (VIE’s). The guidance is effective beginning on January 1, 2010. We do not expect the adoption of this guidance to have an impact on our financial statements.





All other new accounting pronouncements issued but not yet effective have been deemed not to be relevant.
 
  
 
 
 
 
 
 
 
 .
 
 F-11
 
 3.
ACQUISITION OF ASTER WIRELESS TECHNOLOGIES, INC.
 
 On March 3, 2007 we completed the merger (“Aster Merger) of Arkados Wireless Technologies, Inc., a wholly owned subsidiary of the Company (“Merger Sub”) with Aster Wireless, Inc. a Delaware corporation (“Aster”) pursuant to that Agreement and Plan of Merger dated February 13, 2007 by and among the Company, Merger Sub and Aster (the “Merger Agreement”).  The assets and liabilities of Aster are recorded as of the acquisition date at their estimated fair values. The reported consolidated financial condition and results of operations of Arkados after completion of the Aster Merger reflects these values, but will not be restated retroactively to reflect the historical consolidated financial position or results of operations at Aster. Arkados issued 1,000,000 shares of Arkados common stock upon the cancellation of all shares of Aster capital stock outstanding.  Under the terms of the Aster Merger, the Aster employees received 50% of their deferred payroll which was paid 50% in cash and the balance by the issuance of 78,564 shares of 50% in Arkados stock.
 
  The purchase price is as follows (table in thousands):
 
 Fair value of Arkados shares issued at closing

$
462Transaction costs incurred by Arkados


22Purchase price

$
484
 
 The fair value of the Arkados shares used in determining the purchase price was $0.43 per share, which was the price of Arkados common stock on the day that the closing took place, March 2, 2007
 
 
 The purchase price has been allocated based on a valuation of Aster’s tangible and intangible assets and liabilities an their following fair values (in thousands)
 
 Total current assets

$
20Property and equipment and other assets


17Intangible assets


493Total current liabilities


(74
)Total

$
456
 
 
 
 
 
 
 
 
 
 
 
 
 
 F-12
 The Company’s 2007 consolidated statement of operations includes the results of operations from Aster from March 3, 2007 forward.  The following table presents unaudited pro forma consolidated results of operations for Arkados for the years ended May 31, 2006 and 2007 as though the Aster acquisition was completed as of the beginning of each period.
 
 Year Ended

May 31, 2006


Year Ended

May 31, 2007Net loss attributable to common shareholders

$
(4,562,406
)

$
(6,576,100
)Net loss per share attributable to common shareholdersBasic and diluted

$
(.18
)

$
(.25
)Weighted average shares outstanding


24,855,924



25,982,128
 
 
 4.
CONCENTRATION OF CREDIT RISK
 
 The Company’s accounts receivable were concentrated with two customers.  Accounts Receivable balances for the years ending May 31, 2010 and 2009 were $7,709 and $72,815, respectively on revenues of $295,870 and $763,040 for the same respective periods.
 
 The Company may periodically have cash in excess of $250,000, the Federal Deposit Insurance Corp. “FDIC” insurable limit. As of May 31, 2010 the cash balance was $16,345, which was $233,655 below the insurable limit.
 
 
 5.
EQUIPMENT
 
 At May 31, 2009 and May 31, 2010 equipment consists of the following:
 
 May 31, 2009


May 31, 2010Furniture

$
14,878


$
14,878Computers


10,840



10,840Equipment


39,033



39,033Total


64,751



64,751Less: Accumulated depreciation


(28,569
)


(32,799
)Net

$
36,181


$
28,272
 
 Depreciation expense for the years ended  May 31, 2010 and 2009 was $7,909 and $8,921, respectively.
 
 
 F-13
 
 6.
INTANGIBLE ASSETS
 
 At May 31, 2010 and May 31, 2009, the Company owned 40 patents and patents pending and 36 patents and patents pending, respectively, which are currently, being used in the development of the Company’s products. Excluding the value assigned to patents as part of the Aster acquisition, the Company had recorded $472,509 of gross patents costs and $465,984 of accumulated amortization as of May 31, 2010.
 
 The Company has allocated the intangible assets associated with the Aster acquisition to Personnel, Patents and Technology.  The total value, the number of years to be amortized, and the annual expense associated with such amortization are contained in the table below.
  May 312010


2009Total Intangible Assets

$
965,961


$
965,961Accum Amortization


(826,040
)


(749,059
)Net intangible assets

$
139,921


$
216,902
 
 
 Amortization for the next five years will be as follows: Fiscal year 2011 will be $76,982, fiscal year 2012 will be $57,996 and fiscal years 2013-2014 will each be $1,041 per year.
 
 F-14
 7.
PAYROLL TAX LIABILITIES
 
 Enikia was in arrears for several years in its payment of federal and state payroll taxes. Pursuant to the Merger Agreement, the Parent assumed up to $1.2 million of the delinquent payroll taxes due and outstanding with the remaining difference an assumed liability of the major shareholder of the Company. During the year ended May 31, 2006, the Company made payments to both Federal and State of NJ taxing authorities in the amount of $874,000. The payments represented payroll taxes withheld by Miletos from its employees but not remitted to the taxing authorities.  During the year ended May 31, 2008, an additional $64,106 payment was made to the State of NJ for payment of payroll taxes. Currently, there is $937,000 still recorded on the Company’s books as due and outstanding to both the federal and state tax authorities for penalties and interest incurred by Enikia related to its payroll liabilities. The Company does not believe that it has a legal obligation to pay anything more to any taxing authority, but until such clearance is received from the appropriate agencies, the Company has elected to keep the liability on its books.
 
 
 8.
ACCRUED EXPENSES AND OTHER LIABILITIES
 
 As of May 31, 2010 and May 31, 2009, accrued expenses and other liabilities consist of the following approximate amounts:
 
 Year Ended May 31,2010


2009Accounts payable

$
1,959,359


$
1,743,289Accrued compensation


4,167,522



2,389,805Accrued interest and penalties payable


3,671,137



489,212Liabilities assumed per merger agreement


34,673



34,673Accrued other


95,119



164,667$
9,297,810


$
4,821,646
 
 
 9.
CONVERTIBLE DEBENTURES AND RELATED PARTY PAYABLES
  10% Convertible Notes - During the period from March 18, 2005 to May 12, 2005, the Company issued $750,000 of 10% convertible extendable notes initially due June 8, 2005 (the “10% Notes”). The due date of the 10% Notes was extended at the Company’s option to September 8, 2005 by the Company’s payment of an extension fee aggregating $20,000 for the entire issue and paying interest due on the 10% Notes to June 8, 2005. The Company paid $37,500 of principal with related interest on September 18, 2005 in full payment of two of the outstanding notes and obtained the extension of the $712,500 then remaining notes by paying an additional sum of $20,000 and issuing 85,000 shares of common stock to the remaining holders of the 10% Notes. An expense of $76,500 was recorded related to the issuance of the 85,000 shares of common stock, using a share price of $.90. The Company paid $22,167 of principal pursuant to a mandatory prepayment provision in September, 2005. Principal and accrued interest on the 10% Notes are convertible at the holders’ option into shares of the Company’s common stock only after an event of
 
 
 
 
 
 F-15
 default, as defined in the Notes at the lower of $0.67 or the average closing bid price of the Company’s common stock on the ten trading days preceding conversion. The conversion right is limited in that it may not be exercised by a holder to the extent it would result in such holder becoming the beneficial owner of more than 4.99% of the Company’s common stock. The 10% Notes were issued with 825,000 of three year common stock warrant exercisable for $0.67 per share in the basis of one warrant for each $1 of principal.
 
 2005 6% Convertible Notes - During the quarters ended August 31, 2005 and November 30, 2005, the Company raised $912,500 and $154,000, respectively, of gross proceeds from the private placement of an aggregate of 10.665 units (the “Units”) each consisting of $100,000 principal amount 6% convertible subordinated promissory notes (the “6% Notes”) and 14,286 detached warrants (the “Warrants”) to purchase a like number of shares of the Company’s common stock, for $0.35 per share. The Company issued an aggregate of 152,359 Warrants to the purchasers of the Units, which have been valued at $74,802 and have been amortized as interest expense over the term of the 6% Notes. In addition, the Company issued 238,213 common stock warrants exercisable at $0.65 as part compensation to the placement agent, which have been valued at $111,668 and will be amortized as interest expense along with other expenses of the offering. Both the $0.35 and $0.65 Warrants have a “net exercise” provision that permits the holder to convert the Warrants into shares of the Company’s common stock. The 6% Notes (1) are due July 7, 2007 with interest at the annual rate of 6% from the date of original issuance (increasing to 12% per annum from an event of default as defined in the 6% Notes); (2) are unsecured obligations of the Company and subordinated to senior secured loans to the Company (if any) from banks, finance companies and similar institutions that extend credit in the regular cause of such institution’s business; (3) are convertible, subject to certain conditions and at two different price levels ($1.125 and $1.575 for a period of twenty trading days following the bid price of common stock closing above $1.50 and $2.50, respectively, for a period of five consecutive trading days), into shares of common stock; and (4) may be redeemed by the Company in certain limited circumstances described below prior to maturity. Since the beneficial conversion feature of the 6% Notes is (at the lowest price) at a price greater than the market price of the stock upon issuance of the 6% Notes, no value has been estimated or recorded for the beneficial conversion feature.
 
 On July 6, 2007, the Company reached an agreement with more that the requisite holders of 2/3 of the outstanding $1,066,500 principal amount of 6% Convertible Subordinated Notes due July 7, 2007 to extend the due date of the Notes to June 30, 2008. In exchange for the amendment, the Company agreed to issue approximately 188,200 three year warrants to purchase shares of the Company’s common stock for $0.85 per share and lowered conversion prices in the Notes to $0.85.
 
 On July 9, 2008,  Arkados Group Inc. (the “Company”) reached an agreement with more than the requisite holders of 2/3 of the outstanding $1,066,500 principal amount of 6% Convertible Subordinated Notes (the “Notes”) due June 30, 2008 to extend the due date of the Notes to June 30, 2009.  In exchange for the amendment, the Company agreed to exchange approximately 876,100 shares of common stock, pro rata, for notes in the original principal amount of $306,618.
 
 During fiscal year 2010, the company defaulted on the repayment of $12,073,611 accrued interest and principal due the Company’s secured debt holders and $983,516 of unsecured loans.
 
 Conversion of Debt and Waiver
 
 On, July 9, 2008, the Company reached an agreement and waiver with the holders of the Trident Notes to the conversion  of $306,618 of principal and interest (representing 25% of such principal and interest due as of June 30, 2008) in exchange for the issuance of approximately 876,100 shares of the Company’s Common Stock to the holders of the Company’s outstanding 6% Convertible Subordinated Notes due June 30, 2008, and the simultaneous amendment of the Trident Notes to extend the due date one year, from June 30, 2008 to June 30, 2009.
 
 On August 7, 2008, Arkados Group, Inc. and the holders of the requisite principal amount of outstanding 6% Secured Convertible Debentures due December 28, 2008 executed an agreement to amend the debentures and make certain waivers, concurrently with the closing of $750,000 of the private placement as follows:
 
 1.
In exchange for debentures aggregating 25% of the principal outstanding or $2,845,815.25, the Company will issue identical debentures, except the conversion price will be $0.25 rather than 0.85.
 
 F-16
 2.
In exchange for 25% of the outstanding warrants held by debenture holders, the Company will issue 2,332,131 warrants identical to the warrants surrendered, except that the warrant exercise price is reduced from $0.85 to $0.25 and the warrants are only exercisable for cash until December 1, 2008.
 
 3.
The due date of the debentures is extended six months to June 28, 2009, and will be extended another six months to December 28, 2009 if the Company raised equity financing, in the aggregated of more than $2,000,000 by the maturity date of the debentures, as amended.
 
 4.
Interest due on the debentures will be added to principal until maturity.
 
 5.
The holders of the Debentures and Warrants waive the right of first refusal and any anti-dilution adjustments with respect to Company financing of up to $3,000,000 at no less than $0.25 per share and 50% warrant coverage completed on or before October 31, 2008.
 
 Related Party Borrowings - Through December 19, 2005, the Company borrowed $253,075 from three directors and one stockholder. These advances were due on demand with interest at the annual rate of 6% and $225,000 was paid on January 10, 2006. See subsequent event for conversion of the remaining balance into shares of the Company’s common stock with the holders.
 
 From March 1, 2008 through May 31, 2008, the Company borrowed $177,700 from two directors.  These advances were due on demand with interest at the annual rate of 6%.
 
 6% Secured Debentures - On December 19, 2005, the Company borrowed $267,900 from one of the accredited investors that ultimately purchased 6% secured convertible debentures (the “6% Secured Debentures”) in the December 28, 2005 financing. The loan was made on an unsecured basis, was due on demand and was forgiven in exchange for $267,900 of the $2.0 million principal amount of the 6% Secured Debentures and related warrants. On December 28, 2005, the Company issued $2.0 million aggregate principal amount and authorized $3.5 million 6% Secured Debentures to three institutional investors. The 6% Secured Debentures have a term of three years and mature on December 28, 2008, pay interest at the rate of 6% per annum, initially payable semi-annually on January 1 and July 1 of each year beginning July 1, 2006, and are secured by a grant of a security interest into substantially all of the Company’s assets. The Company may elect to pay interest on the 6% Secured Debentures in cash or in shares of common stock, subject to certain conditions related to the market for such shares stock and the registration of the shares issuable upon conversion of the 6% Secured Debentures under the Securities Act of 1933, as amended (the “Securities Act”).
 
 The 6% Secured Debentures are convertible at any time at the option of the holder into shares of the Company’s common stock at a price of $0.85 per share, subject to adjustment as set forth therein. If, after the effective date of the registration statement we agreed to file under the Securities Act (the “Registration”), the closing price for the Company’s common stock exceeds $1.70 for any 20 consecutive trading days, The Company may, within one trading day after the end of such period, require the holders of the 6% Secured Debentures to immediately convert all or part of the then outstanding principal amount of their 6% Secured Debentures. The terms of the conversion rights also contain certain dilution provisions.
 
 The Company has reviewed the accounting for registration rights terms relating to the shares of common stock issuable upon the conversion and exercise, respectively, of the 6% Secured Convertible Debentures and related warrants under the recently adopted FSP EITF 00-19-2. The Company granted demand registration rights to the purchasers of the 6% Secured Debentures which requires the Company to file an initial registration 45 days following demand. Under the registration rights agreement, the Company incurs a penalty if it fails to file within the 45 day period or if the SEC had not declared the registration effective 90 days after filing. The holders of the 6% Secured Debentures have not demanded registration. The Company believes it can comply with a demand for registration in a timely manner and therefore no accrual for the registration rights penalties has been made.”
 
 On December 28, 2005, pursuant to the purchase agreements with the purchasers of the 6% Secured Debentures, the Company issued warrants to purchase an aggregate of 941,176 shares of common stock for $1.00 per share, on or prior to December 28, 2010 and short term warrants to purchase up to an aggregate of 941,176 additional shares of common stock for $0.85 per share, each subject to anti-dilution adjustments, including a “full ratchet down” to the purchasers of the 6% Secured Debentures. The short term warrants are exercisable at any time prior to the earlier of December 28, 2007 (subsequently changed to December 28, 2010) or twelve months after the effective date of the Registration Statement. If no effective registration statement is obtained after one year then such warrants have a cashless exercise option feature.
 
 F-17
 Upon the occurrence of certain events of default defined in the 6% Secured Debentures, including events of default under the transaction documents related to the financing, the full principal amount of the 6% Secured Debentures, together with interest and other amounts owing, become immediately due and payable, the principal obligation increases to 130% of the principal balance and the interest rate increases to 18%.
 
 The transaction documents relating to the 6% Secured Debentures issued in December 2005 contained a covenant that the Company would obtain the conversion of an aggregate of $746,600 principal and related interest into shares of the Company’s Common Stock at or above $0.67 per share on or before January 15, 2006. On February 1, 2006, as part of the sale of an additional $375,884 of the 6% Secured Debentures described above, the Company and the holders of all outstanding 6% Debentures agreed to modify the covenant to permit the Company to issue 604,956 shares of common stock and pay $405,744 in full satisfaction of such outstanding principal and interest concurrently with the additional investment and waived prior defaults. Two of the parties that agreed to accept shares of common stock in lieu of repayment were directors of the Company, of which one received 75,078 shares in satisfaction of $50,303 of principal and interest and the other received 76,969 shares in lieu of $51,989 of principal and interest.
 
 On February 1, 2006, and February 24, 2006 the Company issued $375,884 and $500,000, respectively, of additional principal of 6% Secured Debentures on substantially the same terms as those debentures issued on December 28, 2005. As a result, an aggregate of $2,875,884 of these debentures were outstanding as of February 28, 2006. On February 1, 2006 and February 24, 2006 the Company issued 176,887 and 235,294 additional short and long term warrants, respectively, to the purchasers of the additional 6% Secured Debentures. As a result, there were 1,353,357 short and 1,353,357 long term warrants outstanding as of May 31, 2007.
 
 On March 31, 2006, the Company issued $500,000 additional principal of the 6% Secured Debentures to a limited liability company owned equally by the wife of our chairman and another director on substantially the same terms as the 6% Secured Debentures issued on December 28, 2005. After giving effect to this additional issuance, there was $3,375,884 principal amount of the 6% Secured Debentures outstanding, as well as 1,588,651 of the five year and 1,588,651 of the short term warrants outstanding.
 
 The Company received an advance of $500,000 from one of the holders of 6% Secured Debentures on June 1, 2006.  The advance was due on demand and forgiven in exchange for $500,000 principal amount of 6% Secured Debentures and related warrants on June 30, 2006.
 
 The Company issued $1,773,471 aggregate principal amount of 6% Secured Debentures on June 30, 2006.  The consideration received by the Company for the Secured Debentures consisted of $500,000 cash, forgiveness of repayment of the $500,000 advance received June 1, 2006, forgiveness of $773,470 related party debt due to Andreas Typaldos, the Company’s Chairman and principal shareholder and a limited partnership controlled by his wife. The debentures have a term of three years and mature on December 28, 2008. The 6% Secured Debentures pay interest at the rate of 6% per annum, payable semi-annually on January 1 and July 1 of each year beginning January 1, 2007.  These debentures are on substantially the same terms as, and rank pari passu to, an aggregate of $3,875,884 of 6% Secured Debentures outstanding as of May 31, 2006.  The Company issued 834,575 short term and 834,574 long term warrants to the purchasers of the 6% Secured Debentures and entered into a security agreement granting the purchasers a security interest in its assets to secure the Company’s obligations under the debentures. Obligations under the debentures are guaranteed by the Company’s wholly-owned operating subsidiary.  At the same time, the outstanding short term warrants were amended to expire at the earlier of December 28, 2010 or the twelve months after the effective date of the Registration Statement.
 
 On June 30, 2006, the Company signed a letter amendment to the consulting agreement with Andreas Typaldos dated May 21, 2004. The amendment removes the condition that the Company raise $1,000,000 of equity financing before paying consulting fees that accrued at the rate of $15,000 per month commencing June 1, 2006 as an inducement for Mr. Typaldos forgiving the $360,000 of accrued and unpaid fees in exchange for the $360,000 principal amount of 6% Secured Debentures and related warrants.
 
 On August 18, 2006, the Company entered into an amendment agreement with the holders of the $3,875,884 principal amount of 6% Secured Debentures outstanding as of May 31, 2006, including a limited liability company owned by the wife of our Chairman, and one of our directors. The Amendment agreement makes material changes to the securities purchase agreements, warrants, registration rights agreements, security agreements and other ancillary documents we executed in connection with an aggregate of $3,875,884 of 6% debentures the Company sold during the period from December 28, 2005 to March 31, 2006.  The material changes give the holders the same rights of redemption in the event of a cash purchase of our assets as those held by the of $1,773,470.83 aggregate principal amount of 6% Secured Debentures issued on June 30, 2006. As a result of the Amendment, all of the 6% Secured Debentures and warrants
 
 
 F-18
 must be redeemed by the Company at a premium if it agrees to sell all of the Company’s assets to a third party for cash and cash equivalents. In addition, as a result of the amendment, all holders of the 6% Secured Debentures have the right to have shares of Common Stock issuable upon conversion of the debentures and exercise of the related warrants registered for resale under the Securities Act of 1933 within 60 days after receiving written demand of the holders of 60.1% of such securities and have it declared effective 90 days thereafter.
 
 On September 26, 2006, October 19, 2006 and November 30, 2006, the Company issued $500,000, $500,000 and $400,000, respectively, of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 658,824 short term and 658,824 long term warrants to the purchasers of the 6% Secured Debentures.
 
 On January 8, 2007, the Company entered into an amendment agreement with the holders of the 6% Secured Debentures.  The Amendment agreement makes material changes to the securities purchase agreements, warrants, registration rights agreements, security agreements and other ancillary documents we executed in connection with the 6% debentures the Company sold during the period from December 28, 2005 to January 8, 2007, including removing the negative covenant prohibiting the Company from issuing stock, warrants or convertible securities at a fixed price to finance its operations, permitting the issuance of additional secured debentures and warrants on the same terms as the outstanding such securities, and providing that interest due on the debentures on January 1, 2007 and July 1, 2007 be added to principal on those dates.
 
 On January 8, 2007 and February 28, 2007, the Company issued $288,000 and $327,000, respectively, of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 289,410 short and 289,410 long term warrants issued with these 6% Secured Debentures.
 
 On September 26, 2006, October 19, 2006 and November 30, 2006, the Company issued $500,000, $500,000 and $400,000, respectively, of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 658,824 short term and 658,824 long term warrants to the purchasers of the 6% Secured Debentures.
 
 During the fourth quarter of 2007, the Company issued an aggregate of $1,264,106 of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 594,874 short term and 594,874 long term warrants to the purchasers of the 6% Secured Debentures.  The individual issuances are identified below:
 
 March 12, 2007

$
20,000March 28, 2007


150,000April 15, 2007


115,000April 30, 2007


70,000May 10,2007


380,000May 31, 2007


529,106Total during the 4th quarter of 2007

$
1,264,106
 
 During the first half of 2008, the Company borrowed $855,000 at the times set forth below, on an unsecured basis from affiliates of the Company’s Chairman and two non-employee directors, with the understanding that these advances would be exchanged for additional 6% Secured Debentures and related warrants.  Such an exchange is subject to the consent of the holders of outstanding 6% Secured Debentures or the satisfaction of the holders’ pre-emptive rights.
 
 July 10, 2007

$
215,000August 3, 2007


150,000August 22, 2007


50,000August 27, 2007


20,000August 31, 2007


50,000September 28, 2007


100,000October 16, 2007


60,000October 30, 2007


90,000November 7, 2007


70,000November 19, 2007


50,000Total during the 1st half of 2008

$
855,000
 
 F-19
 On December 15, 2007, this related party debt was converted to additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 402,353 short-term and 402,353 long-term warrants to the purchasers of the 6% Secured Debentures.  Based on the issuance date of the debentures, debt discounts were recorded in the third quarter of 2008 in the amount of $118,723, respectively for 402,353 short and 402,353 long term warrants issued with these 6% Secured Debentures.
 
 The amortization recorded attributed to all the debt discounts amounted to $303,803 and has been recorded as interest expense for the year ended May 31, 2008.
 
 On December 6, 2007, the Company entered into an Amendment Agreement with the holders of the outstanding 6% Secured Debentures which made material changes to the 6% Secured Debentures and other ancillary documents we executed in connection to an aggregate of $8,428,461 of 6% Secured Debentures sold to investors during the period from December 28, 2005 to May 31, 2007.  The material changes were made, at the Company’s request, to facilitate the possible private placement of equity securities included:
 
 ·
waiver of defaults which could have occurred as a result of the Company failing to make an interest payment of approximately $230,000 on January 1, 2008 until the earlier of an equity financing or March 3, 2008;
 
 ·
deferral of any request on the part of the holders of the 6% Secured Debentures, to require the filing of a registration statement under the Securities Act within 45 days of the request until April 15, 2008;
 
 ·
waiver of pre-emptive rights with respect to the equity financing; and
 
 ·
extending the maturity date of the 6% Secured Debentures twelve months to December 28, 2009 and converting all interest payments into additional principal (as of the date such payment is due) if the Company completes equity financing of $2.0 million on or before March 3, 2008.
 
 The Company also agreed to amend the 10,065,210 warrants outstanding and issued with the then outstanding 6% Secured Debentures to be consistent with the 804,706 new warrants issued December 15, 2007 by extending the expiration date from an outside date of December 28, 2010 to December 28, 2012 and removing any restriction on exercising the warrants on a cashless basis or any provision which accelerates the expiration date if the shares issuable on exercise of the warrants are registered for resale under the Securities Act.
 
 Additional Financing
 
 From June 1, 2008 to August 31, 2008, we completed an additional $50,000 of financing which was converted into equity in August 2008.
 
 On August 7, 2008, we issued 1,690,080 units each consisting of two shares of our common stock and one warrant to 18 accredited investors for aggregate consideration of $845,038.47.  Of this consideration, $762,593.66 was cash or cash advances incurred after April 15, 2008 and the balance was in exchange for prior obligations for borrowed money and other accounts payable.  The warrants are exercisable until June 30. 2013 and entitle the holder to acquire one additional share of our common stock for $0.25 per share. We issued the shares of common stock and warrants in reliance on Rule 506 of Regulation D, Section 4(2) and 4(11) of the Act for privately placed securities issued to accredited investors.  No broker dealer was engaged for the offering and we did not pay any commissions in connection with the sale of these securities.
 
 During the 3rd quarter of 2008, a deferred expense was recorded in the amount of $774,789 for the extension of the expiration date of the warrants to December 28, 2012.  The amortization recorded for the year 2008 was $103,306 and has been recorded as interest expense for the year ended May 31, 2008.
 
 On April 2, 2008, the Company entered into a Waiver and Amendment Agreement with the holders of $9,283,461 issued principal amount of 6% secured convertible debentures due December 28, 2008.  Pursuant to the Waiver and Amendment, the Holders agreed to waive all potential defaults caused by our not making a scheduled interest payment of approximately $255,000 which became due under the terms of the Debentures, as previously amended on March 3, 2008.  The Holders agreed to add the interest due to principal and make such a waiver in exchange for the Company issuing additional Debentures equal to 10% of the principal amount of the Debentures held by the Holders (after adding the past due interest to principal).
 
 F-20
 As of May 31, 2010, there was a total of $18,037,441 in principal amount, including interest converted to debt, of the 6% Secured Debentures and 9,328,494 warrants outstanding.
 
 During fiscal year 2009, a debt discount was recorded of $134,574 for warrants issued with these 6% Secured Debentures. The amortization recorded attributed to the debt discounts amounted to $480,530 and has been recorded as interest expense for the year ended May 31, 2009.
 
 During fiscal year 2008, a debt discount was recorded of $118,723 for warrants issued with these 6% Secured Debentures. The amortization recorded attributed to the debt discounts amounted to $302,803 and has been recorded as interest expense for the year ended May 31, 2008.
 
 As of May 31, 2010, $19,069,092  of our senior debt and notes payable are in default. As as the respective lenders and Company work toward crafting a forbearance agreement and raising additional capital for the Company.
 
 Other Obligations - As a consequence of the Company raising a aggregate of $3 million of financing since June 2004, pursuant to the Company’s May 2004 employment agreement with its chief executive officer, $91,875 of deferred salary payments for the period from May 2004 to January 2006 representing 24.5% of his agreed salary for such period and a bonus of $65,333 was due December 29, 2005. While the deferred salary of $91,875 has been paid, the bonus of $65,333 remains outstanding. The Company’s chief executive officer temporarily waived the right to receive immediate payment of the $65,333 until May 31, 2007.  The Company’s failure to pay this bonus and other amounts due under the employment agreement gives the chief executive the right to terminate the agreement and continue to receive salary at the annual rate of $300,000 for twelve months following the date of such termination.
 
 The Company has authorized the issue and sale of 6% Subordinated Notes due August 15, 2008 in the aggregate principal amount of not more than U.S. $500,000.  Through year-end May 31, 2008, $125,000 was received as part of this Subordinated Note.
 
 During the year ended May 31, 2010, the Company borrowed $995,500 in unsecured bridge financing at 8% interest to fund critical working capital needs. The due date of these notes is December 1, 2010.
 
 Included in accrued expenses and other liabilities as of May, 31, 2010 is unpaid accrued payroll, bonus, vacation, payroll taxes and expenses due executive officers totaling $2,170,781. Of this amount, $ 974,657 was due to Oleg Logvinov, CEO and President and $1,199,124 was due to three other officers of the Company.
 
 Included in accrued expenses and other liabilities as of May, 31, 2010 is unpaid accrued payroll of $ 3,836,522 (which includes 20 months of unpaid payroll for non-executive employees in the amount of $1,662,741and approximately10 quarters of unpaid executive payroll in the amount of $2,173,781), an unpaid bonus of $65,333 due to the Company’s CEO since December 2005 and unpaid expense reimbursement of approximately $79,000 due to executive officers.
 
 Related Party Activities - As of May 31, 2010 and May 31, 2009, the Company has reported a related party payable in the amount of $247,700 and $187,700, respectively which represents funds that were advance to the Company by Officers of the Company.
 
 In aggregate, $5,102,900 or 38.1% of the $18,037,441 of 6% Secured Debentures, related party debt and notes payable is held by related parties.
 
 DERIVATIVE LIABILITIES
  Effective June 1, 2009, the Company adopted the provisions of EITF 07-05 “Determining Whether an Instrument (or Embedded Feature) is Indexed to a Company's Own Stock,” which was codified into ASC Topic 815 – Derivatives and Hedging. ASC 815 applies to any freestanding financial instruments or embedded features that have characteristics of a derivative and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. The Company has 11,735,004 of warrants with exercise reset provisions, which are considered freestanding derivative instruments. ASC 815 requires these warrants to be recorded as liabilities as they are no longer afforded equity treatment assumptions: risk free rates from 1.32% to 1.39%, expected life terms ranging from 0.5 years to 2.0 years, an expected volatility range of 206% to 251% depending on the term of such equity contracts and a dividend rate of 0.0%. The fair value of the warrants issued and outstanding at May 31, 2010, attributed to this derivative liability has been determined to be immaterial due to the low stock price in comparison to the exercise price, hence there was no adjustment to make upon adoption of this accounting standard..
 
 F-21
 
 10.
INCOME TAXES
 
 At May 31, 2010, the Company has available unused net operating loss carryovers approximately $35,400,000that may be applied against future taxable income and expire at various dates through 2030. The Company has a deferred tax asset arising from such net operating loss deductions and has recorded an increase to the full valuation allowance in the amount of $4,287,000 for the year ended May 31, 2010 since the likelihood of realization of the tax benefits cannot be determined.
 
 2010


2009Deferred tax asset:Net operating loss carryforward

$
12,277,000


$
8,720,000Accrued Compensation


1,570,000



840,000Valuation allowance


(13,847,000
)


(9,560,000
)Net deferred tax asset

$
—


$
—
 
 A reconciliation of the statutory federal income tax benefit to actual tax benefit is as follows:
 
 Year Ended May 31,2010

2009Statutory federal income tax benefit
35%

35%Permanent timing differences -

equity rights
(4%)

(12%)Income tax benefit not utilized
(37%)

(29%)State tax benefit
6%

6%
 
 The Company has had greater than 50% change in ownership of certain stock holdings by shareholders of the Company pursuant to Section 382 of the Internal Revenue Code, the net operating losses may be limited as to its utilization on an annual basis. Currently no such evaluation has been performed.
 
 In 2008, the Company sold $4,127,010 of its State Net Operating Loss carryforwards under the State of New Jersey’s Technology Business Tax Certificate Transfer Program (the Program”). The Program allows qualified technology and biotechnology businesses in New Jersey to sell unused amounts of net operating loss carryforwards and defined research and development tax credits for cash. The proceeds from the sale in 2007, net of commissions, were $447,094 and were recorded as a tax benefit in the accompanying statements of operations.  The State renews the Program annually and currently limits the aggregate proceeds to $60,000,000. We cannot be certain if we will be able to sell any of our remaining or future New Jersey loss carryforwards or tax credits under the Program.
 
 The Company was not able to participate in the State of New Jersey Technology Business Tax Certificate transfer Program in fiscal year 2010 due to a loss of two full time employees in New Jersey. The program mandates that 75% of the Company’s full time employees be working in new Jersey at the time of application and at the time of receipt of the tax transfer funds.
 
 
 F-22
 11.
SHAREHOLDERS’ DEFICIENCY
 
 2004 transactions-(Unaudited)
 
 a.
On May 7, 2004, CDKNET.com, Inc and Miletos entered into an “Agreement and Plan of Merger” (“the Merger Agreement”). On May 24, 2004, the merger was consummated between a wholly owned subsidiary of CDKNET.com, Inc (CDK Merger Corp) and Miletos, Inc. The successor subsidiary was renamed Arkados, Inc. Because CDKNET.com, Inc and its subsidiaries had no meaningful operations prior to May 7, 2004 and equity ownership in CDKNET.com, Inc. in an amount greater than 50% was issued to the shareholders of Miletos, Inc., this transaction has been recorded as a reorganization of Arkados, Inc. via a reverse merger with CDKNET.com, Inc.
 
 
 b.
In May 2004, prior to the consummation of the aforementioned reverse merger, the Company; (a) issued 200,000 common shares for services rendered by several individuals valued at $1.50 a share and were expensed prior to the consummation of the aforementioned reverse merger, (b) converted $150,834 of indebtedness owed to a law firm affiliated with the former CEO for 150,000 shares of common stock, (c) converted $165,000 of convertible debentures and related accrued of $51,539 for 549,866 shares of common stock.
 
 
 c.
Pursuant to the Merger Agreement, as amended, the consideration for the merger consisted of 16,340,577 shares of the Company’s restricted common stock (250,000 of such common shares are contingent shares and will be returned for cancellation unless called upon as a result of a breach of warranty), 39,401 shares of common stock to the former employees of Enikia, 100,000 shares were issued to the major shareholder to assume the satisfaction of certain outstanding 401K liabilities due to the employees of the predecessor entity, 2,484,644 stock options exercisable at $.01 per share, 1,149,998 stock options exercisable at $1.20 per share. In addition $950,200 was raised through the sale of 791,833 shares of common stock of the Company, 41,667 shares of common stock were issued to satisfy $50,000 of indebtedness, and 49,833 shares of common stock for $59,800 of services rendered related to the equity raise. The $59,800 of services rendered was recorded as a cost of raising such equity.
 
 
 d.
The 883,334 shares issued, pursuant to the terms of the Purchase Agreement relating to the aforementioned equity raise, have certain registration rights. In addition, such shareholders are entitled to liquidated damages, if a registration statement, registering such shares, is not filed within 90 days of June 1, 2004 or if the registration statement is not declared effective until 120 days after June 1, 2004, or 180 days if such registration statement is subject to review by the Securities and Exchange Commission. Such liquidated damages are calculated monthly based on the delayed days of such registration not being effective. Such calculation is 2% per month of the purchase price paid by such shareholders for the 883,333 shares purchased limited to an aggregate of 18% of the aggregate purchase price paid for the 883,333 shares purchased. The Company accrued $190,800 in penalties for the failure to register such shares issued.
 
 
 e.
The major shareholder of the Company allocated 2,345,410 shares of his shares in the Company to satisfy assumed obligations of Enikia for services previously rendered to the predecessor entities. Pursuant to Topic 5T of the Staff Accounting Bulletins, such contribution of the common shares of the Company have been recorded as a contribution by the shareholder to the Company in satisfaction of such liabilities recorded of $1,288,185.
 
 
 F-23
 2005 transactions
 
 f.
During fiscal 2005, the Company issued 575,000 shares of common stock net of another 1,050,000, which was returned for non performance. These shares were valued at the fair market value of such stock upon issuance at prices ranging from $.50 to $2.15 per share. The aggregate compensation expense recorded in this fiscal year for these shares issued was $724,811
 
 
 g.
During fiscal 2005, the Company issued 610,000 options at an exercise price of $1.20 per share which was above fair market value to its employees and directors and 1,725,000 options to third parties for services rendered at exercise prices ranging from $.01 to $1.20 per share. No compensation has been recorded for the options issued to employees and directors. The options to third parties have been valued at $900,461, which $582,292 has yet to be expensed due to the term of such services being performed.
 
 
 h.
The Company recorded $234,143 of interest expense related to the valuation of the detachable warrants and the beneficial conversion feature of $750,000 in debt raised from March to May 2005. This debt matured on June 8, 2005, hence predominately all of such interest expense was recorded in fiscal 2005.
 
 
 i.
In August 2004, a vendor converted $75,496 of payables for 125,000 shares of common stock.
 
 
 2006 transactions
 
 j.
During the year ended May 31, 2006, the Company issued 750,000 stock options with an exercise price of $.45 per share to management and its employees, which vest over four years. Another 100,000 fully vested stock options with an exercise price of $.45 were issued to a consultant, an expense of $52,420 was recorded for these stock options.k.
On March 20, 3006, the Company issued warrants to purchase up to 180,000 shares of our common stock for $0.85 per share to Emerging Capital Markets LLC as part compensation for investor relations consulting services for a three month period. The warrants vest in equal thirds on the first day of April, May and June 2006, provided there is no material breach of the related consulting agreement. Such investor relations consulting services agreement also provides for cash compensation in the amount of $20,000 per month for three months. This investor relations consulting agreement also provides for the requirement to obtain approval form this individual for any potential reverse stock splits greater than 1 for 5 and has the option to renew such agreement for another three months on the same terms.
 
 
 2007 transactions
 
 l.
In June 2006, the Company approved the issuance of 475,000 shares of Arkados stock, or $342,000, to Mr. Andreas Typaldos in recognition of his efforts to obtain financing for Arkados.
 
 m.
During the first quarter of 2007, the Company issued to management and its employees: 1,785,000 stock options with exercise prices ranging from $.43 to $.85; all of which vest over four years.
 
 n.
During the third quarter of 2007, the Company issued 100,000 shares with an exercise price of $.40 per share to the incoming CFO as a component of her employment contract.  Another 240,000 stock options with an exercise price of $.50, vesting over 6 months, were issued to a consultant; an expense of $80,917 was recorded for these stock options.
 
 F-24
 o.
On March 3, 2007, Arkados Wireless Technologies, Inc., our wholly owned subsidiary, filed a merger certificate completing the acquisition of Aster Wireless, Inc., a previously unaffiliated Delaware corporation.  The consideration for the Merger was 1,000,000 restricted shares of our common stock. In addition, the Company issued an aggregate of 259,000 seven-year options to four employees through the acquisition exercisable at $0.405 per share which vest over 4 years aggregate of 78,564 shares of restricted stock to such employees.  We also issued 300,000 seven-year options to a consultant which vested on March 1, 2008 and are exercisable at $0.405 per share; an expense of $100,146 was recognized.
 
 p.
During the fourth quarter of 2007, the Company issued 3,010,000 stock options with exercise prices ranging from $.33 to $.40 per share to management and its employees, which vest over four years. Another 50,000 fully vested stock options with an exercise price of $.50 were issued to a consultant; an expense of $16,858 was recorded for these stock options.
  q.
The Company issued 175,604 shares of its common stock with gross proceeds of $1,756 from the exercise of options by employees.
 
 r.
For the year ended May 31, 2007, the Company incurred a non-cash charge of $418,997 for the amortization of stock options.
 
 
 2008 transactions
 
 s.
During the first quarter of 2008, the Company issued 30,000 shares to a vendor at a cost of $13,500 for the settlement of an outstanding balance.  During the fourth quarter of 2008, the Company issued 166,667 shares to a consultant at a cost of $50,000.
 
 t.
During the first quarter of 2008, the Company issued 190,000 options to three service providers; an expense in the amount of $50,274 was recognized for these options.  During the fourth quarter, the Company extended the expiration period of 263,333 options for an employee whose contract was not renewed; an expense in the amount of $30,244 was recognized for this extension.  In addition, in the same period, the Company issued 150,000 fully vested options with an exercise price of $.32 to a consultant; an expense in the amount of $24,930 was recognized for these options.
 
 u.
During the third quarter of 2008, the Company issued 2,494,000 stock options with exercise prices of $.30 per share to management and its employees, which vest over four years.
 
 v.
During the fourth quarter of 2008, the Company extended the expiration for two years of 2,227,864 $.01 options due to expire on May 24, 2008 issued to employees at the time of the reorganization. The value determined by Black Scholes of $714,076 will be amortized over the next two years for this extension.
 
 w.
For the year ended May 31, 2008, the Company incurred a non-cash charge of $697,688 for the amortization of stock options.
 
 2009 transactions
 
 x.
500,000 options were awarded to two service providers; an expense in the amount of $90,246 was recognized in the year ended May 31, 2009 for these options.  These stock options and warrants are exercisable for three to ten years from the grant date.
 
 y.
2,134,469 shares of stock were granted to service providers and a former employee during the year ended May 31, 2009; $422,755 of consulting, compensation expense or reduction of accrued compensation.
 
 z.
A refinancing and the closing on new monies received occurred in July 2008, whereby certain debts were extended in conjunction with conversion of some indebtedness in the amount of $409,113 for 944,881 shares of common stock, 2,332,131 warrants were issued to certain debt holders exercisable at $.25 per share expiring on December 1, 2008 were valued at $264,111 and expensed, accordingly, and $810,038 of monies received net of $35,000 in legal fess from May 2008 to July 2008 resulting in 3,380,159 shares of common stock being issued.
 
 aa.
In February 2009 the Company’s Compensation Committee and Board of Director’s elected to cancel certain underwater options that had been granted to employees. A total of 8,438,184 options with exercise prices ranging from $0.25 to $1.20 were cancelled and new options totaling 75% of the total of the cancelled options (6,328,638 options) were issued to employees with an exercise price of $0.15 , the closing price on February 6, 2009, the date of grant. As a result of this measurement, no additional stock compensation expense was required to be recorded on the new options. The unamortized value of the cancelled options of the cancelled options, $888,384, will be amortized over the two year vesting period of the newly issued options. As 50 % of the options were vested on the date of grant, a compensation expense was recorded in the amount of $444,192 on the grant date.
 
 To determine the stock compensation expense of this transaction, the Company, in accordance with FASB Guidance, measured the Black Scholes value of the cancelled option as at the date of grant against the Black Scholes value of the newly issued options on the date of grant. For the year ended May 31, 2010, the Company incurred a non-cash charge of $1,176,794 for the amortization of stock options during the year.
 
 F-25
 11.
STOCK-BASED COMPENSATION
 
 The Company accounted for its stock option plans under APB No. 25, “Accounting for Stock Issued to Employees,” under which no compensation cost is recognized through May 31, 2005 and provided pro-forma disclosure only as provided for under the FASB Guidance.
 
 Effective June 1, 2005, the Company adopted the FASB Guidance “Accounting for Stock-Based Compensation”.
 
 Compensation based stock option and warrant activity for warrants and qualified and unqualified stock options are summarized as follows:
  Shares


Weighted

Average

Exercise PriceOutstanding at May 31, 2006


6,886,652


$
0.64Granted


5,824,000



0.49Exercised


(175,604
)


0.01Expired or cancelled


0



—Outstanding at May 31, 2007


12,535,048


$
0.58Granted


5,365,197



0.21Exercised


0Expired or cancelled


(2,927,864
)


0.22Outstanding at May 31, 2008


14,972,381


$
0.51Granted


14,427,600



0.15-0.25Exercised


0Expired or cancelled


(9,438,184)



0.25-1.20Outstanding at May 31, 2009


19,961,797


$
0.27Granted


0Exercised


2,228,364



0.01Expired or cancelled


583,197



0.25Outstanding at May 31, 2010


17,150,236


$
0.30
 
 
 
 
 
 
 
 F-26
 Information, at date of issuance, regarding stock option grants during the year ended May 31, 2010. There were no stock option grants made during the year ended May 31, 2010.
 
 Year ended May 31, 2010

Shares


Weighted-

Average

Exercise

Price


Weighted-

Average

Fair

ValueExercise price exceeds market price


—


$
—


$
—Exercise price equals market price


—


$
—


$
—Exercise price is less than market price


—


$
—


$
—
 
 
 The following table summarizes information about options outstanding and exercisable at May 31, 2010:
 
 Options Outstanding and exercisableNumber

Outstanding

Weighted-

Average

Remaining Life

In Years

Weighted-

Average

Exercise

Price

Number

ExercisableRange of exercise prices:$.01 to $0.25


13,107,236


4.5

$
0.20


9,959,239$0.26 - $1.00


2,957,000


4.5

$
0.30


2,957,000$1.01 - $1.20


1,086,000


1.5

$
1.20


1,086,00017,150,236,797




$
0.30


14,002,239
 
 The compensation expense attributed to the issuance of the options and warrants will be recognized as they vest / earned. These stock options and warrants are exercisable for three to ten years from the grant date.
 
 The employee stock option plan stock options are exercisable for ten years from the grant date and vest over various terms from the grant date to three years.
 
 
 
 
 
 
 
 F-27
 The issuance of warrants attributed to debt issuances are summarized as follows:
 Shares


Weighted

Average

Exercise PriceOutstanding at May 31, 2006


4,392,874


$
.84Granted


4,655,366



.93Exercised


0



—Expired or cancelled


0



—Outstanding at May 31, 2007


9,048,240



.88Granted


1,821,676



.85Exercised


0



—Expired or cancelled


(825,000
)


.67Outstanding at May 31, 2008


10,044,916



.84Granted


4,022,225



0.25Exercised


0Expired or cancelled


(2,332,137)



0.85Outstanding at May 31, 2009


11,735,004



0.63Granted


0



—Exercised


0



—Expired or cancelled


0



—Outstanding at May 31, 2010


11,735,004



0.63
 
 
 Information, at date of issuance, regarding warrant grants during the year ended May 31, 2010. There were no warrant grants made during the year ended May 31, 2010.
 
 Year ended May 31, 2010

Shares


Weighted-

Average

Exercise

Price


Weighted-

Average

Fair

ValueExercise price exceeds market price


—


$
—


$
—Exercise price equals market price


—



—



—Exercise price is less than market price


—



—



—
 
 
 The following table summarizes information about warrants and exercisable at May 31, 2010:
 
 Outstanding and exercisableNumber

Outstanding

Weighted-

average

remaining life

in years

Weighted-

Average

Exercise

Price

Number

ExercisableRange of exercise prices:$.01 to $.25


4,022,225


2.6

$
.25


4,022,225$.26 - $.99


7,712,779


2.6

$
.85


7,712,77911,735,004








11,735,004
 
 Interest expense attributed to the aforementioned warrants is being amortized over the ratable term of each respective debt arrangement.
  
 F-28
  12.
COMMITMENTS AND CONTINGENCIES
 
 
 a.
The Company leases office space in Piscataway, New Jersey pursuant to a lease that began on May 8, 2006 and which expired on July 31, 2009. On July 1, 2009, the company entered into a five year renewal lease with its landlord and will remain in its present facility through July 31, 2014. The annual base rent is approximately $103,670.  The Company also leases office space in New York pursuant to a lease that began on March 1, 2007 and which expired on February 23, 2009. The annual base rent is approximately $10,400. The company is presently leasing the New York premises on a month to month basis. There are no other material rental or lease commitment arrangements as of May 31, 2010.Total rental expenses for the years ended May 31, 2010 and 2009 were approximately $133,705 and $132,098, respectively.
 
 
 b.
The Company and its’ subsidiary, Arkados, have entered into employment agreements with all of the employees of Arkados, including the CEO, CFO and VP of Worldwide Operations of the Company. The general terms of the combined employment agreements are; (a) each employment agreement provides for a base salary up to $300,000 depending on the employment position of such employee, (b) each employee will receive standard employment benefits comparable to those previously provided.
 
       
 F-29
 ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
 
 None.
 
 
 ITEM 9A.
CONTROLS AND PROCEDURES
 
 Not applicable.
 
 
 ITEM 9A(T) 9A(T).
CONTROLS AND PROCEDURES
 
 (a) Evaluation of Disclosure Controls and Procedures
 
 Our senior management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-15 and 15d-15 under the Exchange Act) designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive officer or officers and principal financial officers, to allow timely decisions regarding required disclosure.
 
 In performing its audit of our Consolidated Financial Statements for Fiscal 2006, our independent auditors, Sherb & Co., LLP “Sherb”, notified our Board of Directors of a material weakness in internal controls under standards established by the American Institute of Certified Public Accountants. Reportable conditions and material weaknesses involve matters coming to the attention of our auditors relating to significant deficiencies in the design or operation of internal controls that, in their judgment, could adversely affect our ability to record, process, summarize, and report financial data consistent with the assertions of management in the consolidated financial statements.
 
 A material weakness is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. As of May 31, 2006, we did not maintain effective controls related to transactional accounting and financial reporting and reported these findings in our Form 10-KSB Annual Report for the year ended May 31, 2006. These deficiencies included a lack of timely and sufficient financial statement account reconciliation and analysis and lack of sufficient support resources within the accounting and finance department. Management believes that such control deficiencies represented a material weakness in internal control over financial reporting that resulted in a reasonable likelihood that a material misstatement in our financial statements will not be prevented or detected by our employees in the normal course of performing their assigned functions.
 
 During the fiscal quarter ended February 28, 2007 we hired a full time financial executive who became Chief Financial Officer in April 2007 and undertook to remedy the deficiencies and prepare our accounting systems to comply with the management reporting and audit requirements with respect to internal controls in accordance with Section 404 of Sarbanes-Oxley applicable to us for the fiscal years ending May 31, 2009 and May 31, 2010, respectively.  As noted below, our evaluation of our disclosure controls and procedures permitted management to conclude that such controls were not effective as of May 31, 2010.  Due to its small size and limited financial resources, the Company’s CFO, is the only employee involved in accounting and financial reporting.  As a result, there is no segregation of duties within the accounting function, leaving all aspects of financial control and physical control of cash in the hands of the same employee.  The CFO is currently working to put it in place compensating levels of controls to provide for greater segregation of duties.  This assessment should not be considered a report on efficacy of such controls as would be required under Section 404 of SOX in connection with the audit of our financial statements for the year ending May 31, 2010.
 
 We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Accounting Officer, of our disclosure controls and procedures as defined in Exchange Act Rule 13(a)-15(e). In designing and evaluating our disclosure controls and procedures, we recognize that any disclosure controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objective. As of May 31, 2010, management concluded that our disclosure controls and procedures are not effective.
 
 43
 (b) Management’s Report on Internal Control over Financial Reporting
 
 This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this annual report.  Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal controls over financial reporting beginning with our financial statements for the year ending May 31, 2010.
 
 (c) Changes in Internal Controls Over Financial Reporting
 
 As a result of the identification of a material weakness described above, we have implemented the following changes:
 
 ·
We have hired a full time financial executive in January 2007, who was appointed Chief Financial Officer in April 2007
 
 ·
Organized an Audit Committee consisting of our two outside directors
 
 ·
Began the implementation of formalized policies, procedures and process documentation
 
 Although we have implemented the measures described above and believe they are effective, we have not evaluated such controls against any standard, such as the framework provided by Committee of Sponsoring Organizations of the Treadway Commission (COSO) and expect that such documentation and testing will take significant time and effort. We expect to make additional changes to our controls as we continue to prepare to comply with the management reporting requirements of Section 404 of Sarbanes-Oxley. We recognize that “tone at the top” is a key element to an organization’s control environment and are focused and committed to providing the correct tone and structure within the company. We cannot assure you that we will not in the future identify further deficiencies in our controls. However, we plan to continue to review and make any necessary changes to the overall design of our control environment in order to enhance our corporate governance and reporting practices.
 
 Other than those described above, there have been no significant changes in our internal control over financial reporting that occurred during the last fiscal quarter of the fiscal year ended May 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
 ITEM 9B.
OTHER INFORMATION
 
 None.
 
 
 
 
 
 
 
 44
 PART III
 
 ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
 
 The directors, officers and key employees of the Company are as follows:
 
 Name
Age
PositionAndreas Typaldos**
65
ChairmanWilliam Carson**
63
DirectorGennaro Vendome*
63
DirectorHarris Cohen**
44
DirectorOleg Logvinov
47
Director, President and Chief Executive OfficerLarry Crawford
62
Chief Financial Officer, Secretary and TreasurerGrant Ogata
56
Executive Vice President, Worldwide Operations
 *    Members of the Audit Committees.
 ** Members of the Compensation Committees
 
 Board of Directors
 
 Andreas Typaldos is a principal stockholder and was appointed Chairman of the Board of Arkados in February 2005.  He has thirty years of software experience, as an entrepreneur, and as a founder and investor in a number of technology companies.  In 1997, Mr. Typaldos founded Enikia LLC, whose technology and assets were subsequently acquired by an entity controlled by Mr. Typaldos and merged into Arkados, Inc. subsidiary in May 2004.  Mr. Typaldos serves as CEO of Xandros, Inc., a privately held company engaged in the sale of Linux desktop applications.  Earlier, Mr. Typaldos built a multi-million dollar software consulting business, e-Vantage Solutions, Inc. He was active as Interim Chairman and CEO at NetGain Development, Inc., which was an internet incubator/investment firm that funded internet and enabling technology companies, including Enikia, Linux Global Partners, and other internet and technology companies. Mr. Typaldos founded his first consulting and software company in 1973 and founded a successor company, AxsOne (formerly known as Computron) in 1978. He took AxsOne public in 1995 and served as President until 1994 and Chairman/CEO until 1996. Mr. Typaldos holds a Bachelors of Science Degree from Columbia University in Mathematical Methods for Engineering and Operations Research, and a Masters of Science Degree in Computer Science from Pratt Institute. Mr. Typaldos serves on the Board of Directors and Advisory Boards of a number of companies and non-profit organizations.
 
 Gennaro Vendome was appointed a director on June 1, 2004.  He is a founder of AXS-One, Inc. and has been a Vice President and director since AXS-One’s formation in 1978.  In April 2002, Mr. Vendome was named Executive Vice President of Sales, Marketing and Consulting for North America. Mr. Vendome was Treasurer of AXS-One from 1981 until 1991 and Secretary of the Company from 1982 until 1991.  AXS-One designs, markets and supports n-tier, Internet-enabled client/server, e-business, financial, workflow, desktop data access and storage solutions and email compliance software for global 2000 businesses, and scheduling and time and expense solutions for professional services organizations. AXS-One also offers consulting, implementation, training and maintenance services in support of its customers’ use of its software products.
 
 William Carson was appointed a director on June 1, 2004.  Mr. Carson is currently serving as SVP, Medical & Regulatory Affairs of Galderma Laboratories, a pharmaceutical joint venture of Nestle and L’Oreal. Mr. Carson is also president of Biotherm Polymers, and from 1996 through 1999, he held the position of VP Scientific Affairs of Bayer Consumer Care.
 
 Harris Cohen was appointed to the Board of Directors in August 2008 and subsequently to Compensation Committee of the Board of Directors. Mr. Cohen is President of Cooper Barrons, Inc., a private investment firm and hedge fund manager, since 2002.  In 2008, he served as interim General Manager, CFO and consultant to Netanya, Inc, owner of Return to Eden, an organic healthfood store in Atlanta, Georgia.  From 1997 through 2001, he was Portfolio Manager for the Bear Stearns Small Cap Mutual Fund and Institutional Funds.  His fund was acknowledged as one of the top five small cap funds over five years based on consistency of outperformance by USA Today.  Before that, he was a Senior Equity Analyst at Furman Selz LLC from 1994-1996.  Mr. Cohen received his MBA from NYU Stern School of Business in 1993.  He graduated from Phillip Crosby’s Quality Management College.  Prior to Graduate School, Mr. Cohen worked for Coca-Cola and Barron’s Department Stores.  He received a BBA from the University of Georgia in 1984.
  45
 Oleg Logvinov was appointed President, CEO and a director on August 12, 2004 and has served as President of Arkados since the merger. Prior to the merger, from February 2000 to March 2004, Mr. Logvinov served as Vice President of Engineering and later as President of Enikia LLC. From March 1998 to February 2000, he served as Senior Director of Product Development and System Engineering at OpenCon Systems Inc., a telecommunications software service provider, and later at CyberPath Inc., a venture-funded VoDSL Gateway company spun off by OpenCon Systems Inc. Prior to that, he held senior management positions at NITECH, INC from 1996 to 1998, and CEM, Inc from 1991 to 1996.  Mr. Logvinov holds a masters degree equivalent in electrical engineering from the Technical University of Ukraine (KPI).  He has also worked as a senior research scientist and later research team leader at an R&D laboratory at the Technical University of Ukraine and the Ukraine Department of Energy. Mr. Logvinov is the immediate past president of the HomePlug Powerline Alliance and is currently serving as the Chief Technical Officer of the alliance. Mr. Logvinov is a frequent industry speaker and holds several US patents.
 
 Larry CrawfordEffective October 1, 2008, Mr. Larry Crawford, was appointed Chief Financial Officer, SVP and Secretary of the Arkados Group, Inc.  Immediately prior to this position, Mr. Crawford served as Chief Financial Officer and Executive Vice President of Entech Solar, Inc., a publicly traded solar renewable energy company. Prior to this and beginning in 2001, Mr. Crawford served as CFO and Executive Vice President of Spectrum Group International, Inc., a publicly traded collectibles service company.
 
 Mr. Crawford served as Chief Financial Officer of Arzee Holdings, Inc. from 1996 to 2001 and as Vice President of Finance and Chief Financial Officer of Talon, Inc., a subsidiary of Coats Viyella plc, a publically traded UK textile group from 1987 to 1996. Mr. Crawford earned an MBA in Finance from the Lubin School of Business at Pace University in New York. Mr. Crawford is a CPA certified in New Jersey, Pennsylvania and North Carolina.
 
 Grant Ogata joined Arkados in March 2007 as Executive Vice President of Worldwide Operations. Mr. Ogata had been working with Arkados in a part-time capacity since September 2006. Mr. Ogata was formerly Vice President of Global Sourcing and Product Development of RadioShack Corporation.  Mr. Ogata has 28 years of experience in the consumer electronics industry.
 
 At RadioShack, Mr. Ogata was responsible for developing hundreds of innovative products, establishing key strategic partners and managing global sourcing and product development offices in Japan, Taiwan, Hong Kong, China and Fort Worth, Texas. Throughout the years, and through a six-year expatriate assignment in Asia, Mr. Ogata gained intricate knowledge and contacts with key consumer electronic manufacturers around the world. He has been instrumental in beginning the transition of Arkados from a research and development company, with solutions for distributing audio and video through power lines, to a commercial enterprise that provides these solutions to top tier companies globally.
 
 
 Board Meetings
 
 During the fiscal year ended May 31, 2010, our Board of directors held 16 meetings.  Each director attended at least 13 of the meetings (in person or by conference phone) of the Board.  In addition, our Board takes action from time to time by unanimous consent.
 
 Board Committees
 
 Our Board has a standing Audit and Compensation Committee, each of which was formed in June 2007.
 
 The Audit Committee is primarily responsible for overseeing the services performed by our independent registered public accounting firm and evaluating the Company’s accounting policies and its system of internal controls. The Audit Committee is comprised of two people: Messrs. Vendome and Carson, each of whom is an independent director.  The Board of Directors has determined that none of the current directors qualifies as an Audit Committee Financial Expert as defined under applicable law, and plans to recruit one at such time as listing standards applicable to the company requires it and our financial condition permits.
 
 The Compensation Committee is primarily responsible for reviewing the compensation arrangements for the Company’s executive officers, including the Chief Executive Officer, and for administering the Company’s stock option plans. Members of the Compensation Committee are Messrs. Vendome and Carson.
 
 The charters of the Audit and Compensation Committees are filed as exhibits to this report.
  46
 Board Nominations and Appointments
 
 In considering whether to nominate any particular candidate for election to the Board, the Board will use various criteria to evaluate each candidate, including an evaluation of each candidate’s integrity, business acumen, knowledge of our business and industry, experience, diligence, conflicts of interest and the ability to act in the interests of our Stockholders. The Board plans to evaluate biographical information and interview selected candidates. The Board also plans to consider whether a potential nominee would satisfy the Nasdaq listing standards for “independence” and the SEC’s definition of “audit committee financial expert.” The Board does not plan to assign specific weights to particular criteria and no particular criterion will be a prerequisite for each prospective nominee.
 
 We do not have a formal policy with regard to the consideration of director candidates recommended by our Stockholders; however Stockholder recommendations relating to director nominees may be submitted in accordance with the procedures set forth below under the heading “Communicating with the Board of Directors”.
 
 Communicating with the Board of Directors
 
 Stockholders who wish to send communications to the Board may do so by writing to Mr. Larry Crawford, CFO and Secretary, Arkados Group, Inc., 220 Old New Brunswick Road, Piscataway, New Jersey 08854.  The mailing envelope must contain a clear notation indicating that the enclosed letter is a “Stockholder-Board Communication.” All such letters must identify the author as a Stockholder and must include the Stockholder’s full name, address and a valid telephone number. The name of any specific intended Board recipient should be noted in the communication. We will forward any such correspondence to the intended recipients; however, prior to forwarding any such correspondence, we will review such correspondence, and in our discretion, may not forward communications that relate to ordinary business affairs, communications that are primarily commercial in nature, personal grievances or communications that relate to an improper or irrelevant topic or are otherwise inappropriate for the Board’s consideration.
 
 Compensation of Directors
 
 Our executive officers do not receive compensation for their service as directors.  Each of Messrs. Vendome and Carson received ten-year options to purchase 120,000 shares of our common stock for $1.20 per share when they were appointed in May 2004, which vested 1/3 on grant, 1/3 on the first anniversary of the grant and the remaining 1/3 vested on the third anniversary of the grant.  They are also reimbursed for expenses incurred in attending meetings.
 
 Code of Ethics
 
 As part of our system of corporate governance, our Board of Directors has adopted a Code of Business Conduct and Ethics for directors and executive officers of the Company. This Code is intended to focus the Board and each director and executive officer on areas of ethical risk, provide guidance to directors and executive officer to help them recognize and deal with ethical issues, provide mechanisms to report unethical conduct, and help foster a culture of honesty and accountability. Each director and executive officer must comply with the letter and spirit of this Code.  We intend to disclose any changes in or waivers from our Code of Business Conduct and Ethics by filing a Form 8-K or by posting such information on our website.
 
 Section 16(a) Beneficial Ownership Reporting Compliance
 
 We have determined that one or more persons who, during the fiscal year ended May 31, 2010, was a “Reporting Person” defined as a director, officer or beneficial owner of more than ten percent of our common stock which is the only class of securities registered under Section 12 of the Securities Exchange Act of 1934 (the “Act”), failed to file on a timely basis, reports required by Section 16 of the Act during the most recent fiscal year.   We plan to assist the persons in filing all such forms timely in the future and to file any omitted filing.  The foregoing is based solely upon a review of Forms 3 and 4 during the most recent fiscal year as furnished to us under Rule 16a-3(d) under the Act, and Forms 5 and amendments thereto furnished to us with respect to its most recent fiscal year, and any representation received by the Company from any reporting person that no Form 5 is required.
  47
 ITEM 11.  EXECUTIVE COMPENSATION
 
 
 SUMMARY COMPENSATION TABLE
 
 The following table summarizes the total compensation of our Chief Executive Officer in 2010 and the two previous years, as well as all our other executive officers who received or would have received compensation in excess of $100,000 for the year ending May 31, 2010.
 
 Name/ Principal Position

Year

Salary


Deferred

Salary Paid


Option Award


All Other

Compensation


Total

CompensationOleg Logvinov (1)

President, Chief Executive Officer and Director

2010

$
300,000


$
0



0


$
11,734


$
311,7342009

$
300,000


$
37,500


$
0


$
0


$
337,5002008

$
300,000


$
0


$
407,912


$
65,333


$
773,245Larry Crawford(4)

2010

$
200,000


$
0


$
0


$
0


$
200,000Chief Financial Officer(current)

2009

$
133,333


$
0


$
0


$
0


$
502,080Barbara Kane-Burke(2)

Chief Financial Officer (former)2009

$
45,000


$
136,750


$



$
15,000


$
45,0002008

$
135,000


$
0


$
45,000


$
0


$
180,000Grant Ogata(3)

Executive Vice President,

Worldwide Operations

2010

$
200,000


$
0


$
0


$
0


$
200,0002009

$
200,000


$
62,497


$
147,500


$
0


$
409,9972008

$
200,000


$
0


$
101,250


$
0


$
301,250
 
 (1)
Mr. Logvinov earned a $65.333 bonus in fiscal 2008. $349, 958 of Mr. Logvinov’s 2008 earned salary and bonus was deferred at May 31, 2008.
 
 $91,875 of deferred salary payments from 2004 through 2006 were paid in fiscal 2007. This payment was a consequence of our raising an aggregate of $3 million of financing since June 2004, pursuant to our May 2004 employment agreement with our Chief Executive Officer, $91,875 of deferred salary payments for the period from May 2004 to January 2006 representing 24.5% of his agreed salary for such period. At May 31, 2010, Mr. Logvinov was owed $887,458 of salary and $15,752 of business related expenses.
 
 Mr. Logvinov was granted 920,000 two year options on 5/24/08 with an exercise price of $0.01; these options were granted to replace expiring options in the same amount and same exercise price.
 
 Mr. Logvinov was also granted 500,000 seven year options on 2/28/08 with an exercise price of $0.225; these options vest over three years with one-third vesting on each of 2/27/09, 2/27/10 and 2/27/11.
 
 In February 2009 the Company’s Compensation Committee and Board of Director’s elected to cancel certain underwater
 
 48
 options that had been granted to employees. A total of 8,438,184 options with exercise prices ranging from $0.25 to $1.20 were cancelled and new options totaling 75% of the total of the cancelled options (6,328,638 options) were issued to employees with an exercise price of $0.15, the closing price on February 6, 2009. To determine the stock compensation expense of this transaction, the Company, in accordance with FASB 123R, measured the Black Scholes value of the cancelled option as at the date of grant against the Black Scholes value of the newly issued options on the date of grant.
 
 As a result of this measurement, no additional stock compensation expense was required to be recorded on the new options. The amortized value of the cancelled options of the cancelled options, $888,384, will be amortized over the two year vesting period of the newly issued options. As 50 % of the options were vested on the date of grant, $444,192 of stock compensation expense was recorded in the quarter ended February 28, 2009.
 
 Mr. Logvinov elected to cancel 2,560,000 of his options under the above plan and to receive 1,920,000 options priced at $0.15, the closing price on the date of grant. As a result of the measurement completed on the overall employee stock option cancellation and reissuance, no additional compensation expense was recorded or attributed to this grant.
 
 (2)
Ms. Kane-Burke joined Arkados in January 2007. $99,250 of Ms. Kane-Burke’s 2008 earned salary and bonus was deferred at May 31, 2008
 
 Ms. Kane-Burke was granted 200,000 seven year options on 2/28/08 with an exercise price of $0.225; these options vest over three years with one-third vesting on each of 2/27/09, 2/27/10 and 2/27/11. Ms. Kane- Burke entered into an agreement with the Company wherein $136,750 of deferred salary was converted into a note in the amount $86,750 bearing interest at 3% and 200,000 shares of the company’s stock.
 
 (3)
Mr. Ogata joined Arkados as an employee in April 2007 and worked for Arkados as a consultant from September 2006 through March 2007. At May 31, 2010, total salary owed to Mr. Ogata was $499,169; in addition, Mr. Ogata was owed $14,679  by the Company for business related expenses.
 
 Mr. Ogata was granted 450,000 seven year options on 2/28/08 with an exercise price of $0.225; these options vest over three years with one-third vesting on each of 2/27/09, 2/27/10 and 2/27/11.
 
 On February 6, 2009, Mr. Ogata elected to cancel 1,550.000 of his options under the above cancellation and options plan and to receive 1,162,500 options priced at $0.15, the closing price on the date of grant. As a result of the measurement completed on the overall employee stock option cancellation and reissuance, no additional compensation expense was recorded or attributed to this grant.
 
 Mr. Ogata was granted 515,464 options at $0.25, our stock’s closing price on the date, December 15, 2008. Mr. Ogata was also granted 250,000 options at $0.15, our stock’s closing price on the date of grant, February 6, 2009.
 
 (4)
Options granted to Mr. Crawford are in accordance with the terms of his three year employment. The grant of 600,000    options will vest monthly over the term of Mr. Crawford’s employment agreement. The grant of 1,200,000 options will also vest monthly over the term of Mr. Crawford’s employment agreement as long as at least $16,667 of earned salary remains owing to Mr. Crawford.
 .
 49
  GRANTS OF PLAN-BASED AWARDS  Name

Grant

Date

All other Option Awards: Number of Securities  Underlying  Options (#)

Exercise or Base Price of  Option Awards ($/Sh)

Grant Date Fair

Value of Stock

and Option

Awards ($)
 
 There were no grants of Plan Based Awards in the Fiscal Year ended May 31, 2010.
  Oleg Logvinov
2/6/2009

1,920,000

(1)

$
0.15



$
0Larry Crawford
10/1/2008

600,000

(2)

$
0.22



$
112,68010/1/2008

1,200,000

(2)

$
0.25



$
256,080Grant Ogata
2/6/2009

1,162,500

(3)

$
0.15



$
02/6/2009

250,000

(3)

$
0.225



$
37,50012/15/2008

515,464

(3)

$
0.15



$
110,000
 
 There were no plan based awards during the fiscal year ending May 31, 2010.
 
 (1)               In February 2009 the Company’s Compensation Committee and Board of Director’s elected to cancel certain underwater options that had been granted to employees. A total of 8,438,184 options with exercise prices ranging from $0.25 to $1.20 were cancelled and new options totaling 75% of the total of the cancelled options (6,328,638 options) were issued to employees with an exercise price of $0.15, the closing rice on February 6, 2009, the date of. To determine the stock compensation expense of this transaction, the Company, in accordance with FASB 123R, measured the Black Scholes value of the cancelled option as at the date of grant against the Black Scholes value of the newly issued options on the date of grant.
 
 As a result of this measurement, no additional stock compensation expense was required to be recorded on the new options. The amortized value of the cancelled options of the cancelled options, $888,384, will be amortized over the two year vesting period of the newly issued options. As 50 % of the options were vested on the date of grant, $444,192 of stock compensation expense was recorded in the quarter ended February 28, 2009.
 
 Mr. Logvinov elected to cancel 2,560,000 of his options under the above plan and to receive 1,920,000 options priced at $0.15, the closing price on the date of grant. As a result of the measurement completed on the overall employee stock option cancellation and reissuance, no additional compensation expense was recorded or attributed to this grant.
 
 (2)              Options granted to Mr. Crawford are in accordance with the terms of his three year employment. The grant of 600,000 options will vest monthly over the term of Mr. Crawford’s employment agreement. The grant of 1,200,000 options will also vest monthly over the term of Mr. Crawford’s employment agreement as long as at least $16,667 of earned salary remains owing to Mr. Crawford.
 
 50
 
 OPTION EXERCISES AND STOCK VESTED IN 2010Option Awards

Stock AwardsName

Number of

Shares

Acquired on

Exercise (#)

Value Realized

on Exercise ($)

Number of

Shares Acquired

on Vesting (#)

Value

Realized on

Vesting($)Oleg Logvinov

920,000

$      18,400.00

0

$    0
    OUTSTANDING EQUITY AWARDS AT 2010 FISCAL YEAR-END
 OPTION AWARDS
 
 Number of

securities

underlying

unexercised

options (#)

Exercisable

Number of securities Underlying unexercised

options (#)

Unexercisable

Equity Incentive

Plan awards:

Number of

securities

Underlying

unexercised

Unearned

Options (#)

Option Exercise Price ($)

Option

Expiration

DateOleg Logvinov
1,920,000
(1)



1,920,000

$
0.15

2/5/2016Larry Crawford
333,333
(3)
266,667


600,000

$
0.22

9/30/2015666,667
(3)
533,333


1,200,000

$
0.25

9/30/2015Barbara Kane-Burke
200,000
(4)



200,000

$
0.41

4/172010100,000
(4)



100,000

$
0.40

1/14/2010200,000
(4)



200,000

$
0.30

2/27/2015Grant Ogata
1,162,500
(5)



1,162,500

$
0.15

2/5/2016111,111
(6)
138,889


250,000

$
0.52

2/5/2016243,414
(7)
272,050


515,464

$
0.225

2/27/2015
 
 (1)
Options to Mr. Logvinov vest 50% on date of grant and the remaining 50% vest in the year following date of grant.
 (2)
Options granted to Mr. Logvinov were fully vested on the date of grant May 24, 2008
 (3)
Options granted to Mr. Crawford in accordance with the terms of his three year employment. The grant of 600,000 options will vest monthly over the term of Mr. Crawford’s employment agreement. The grant of 1,200,000 options will also vest monthly over the term of Mr. Crawford’s employment agreement as long as at least $16,667 of earned salary remains deferred and owing to Mr. Crawford.
 (4)
Options to Ms. Kane-Burke became 100% vested in accordance with the terms of her severance agreement with the Company.
 (5)
Options to Mr. Ogata vest 50% on date of grant and the remaining 50% vest in the year following date of grant.
 (6)
Options to Mr. Ogata which are scheduled to vest in three equal annual amounts beginning on February 6, 2010.
 (7)
Options to Mr. Ogata which are scheduled to vest in three equal installments beginning on December 15, 2009.
  51
  Stock Option Plans
 
 Our current policy is that all full time key employees are considered annually for the possible grant of stock options, depending upon employee performance. The criteria for the awards are experience, uniqueness of contribution to our business and the level of performance shown during the year. Stock options are intended to generate greater loyalty and help make each employee aware of the importance of their business success of the Company.
 
 In February 2009 the Company’s Compensation Committee and Board of Director’s elected to cancel certain underwater options that had been granted to employees. A total of 8,438,184 options with exercise prices ranging from $0.25 to $1.20 were cancelled and new options totaling 75% of the total of the cancelled options (6,328,638 options) were issued to employees with an exercise price of $0.15, the closing rice on February 6, 2009, the date of. To determine the stock compensation expense of this transaction, the Company, in accordance with FASB 123R, measured the Black Scholes value of the cancelled option as at the date of grant against the Black Scholes value of the newly issued options on the date of grant.
 
 As a result of this measurement, no additional stock compensation expense was required to be recorded on the new options. The amortized value of the cancelled options of the cancelled options, $888,384, will be amortized over the two year vesting period of the newly issued options. As 50 % of the options were vested on the date of grant, $444,192 of stock compensation expense was recorded in the quarter ended February 28, 2009.
 
 As of May 31, 2009, 19,961,797 options to purchase shares of our Common Stock were outstanding under various option plans. During 2009, including the February 2009 option grants to replace underwater options, we granted 14,642,600 options to purchase shares of our Common Stock to employees, directors and consultants.
 
 A summary of the various established stock option plans is as follows:
 
 2004 Plan. Our 2004 Stock Option and Restricted Stock Plan, (“The 2004 Plan”) is administered by a committee appointed by the Board of Directors (the “Compensation Committee”). The Compensation Committee will designate the persons to receive options, the number of shares subject to the options and the terms of the options, including the option price and the duration of each option, subject to certain limitations. All stock options grants during 2007 were made from the 2004 Plan.  The 2004 Plan also permits the issuance of restricted stock which is subject to vesting and forfeiture at such times, amounts and conditions as is determined by the Compensation Committee.
 
 The maximum number of shares of Common Stock available for issuance under the 2004 Plan, as amended, is 22,500,000 shares. Each plan is subject to adjustment in the event of stock splits, stock dividends, mergers, consolidations and the like. Common Stock subject to options granted under the 2004 Plan that expire or terminate will again be available for options to be issued under each Plan.
 
 The option price is payable in cash or by check or under cashless exercise provision determined by the Compensation Committee.
 
 In the absence of a contrary provision in option agreements adopted by the Compensation Committee, under the 2004 Plan, upon termination of an optionee’s employment or consultancy, all options held by such optionee will terminate, except that any option that was exercisable on the date employment or consultancy terminated may, to the extent then exercisable, be exercised within three months thereafter (or six months thereafter if the termination is the result of permanent and total disability of the holder), and except such three month period may be extended by the Compensation Committee in its discretion. If an optionee dies while he is an employee or a consultant or during such three-month period, the option may be exercised within six months after death by the decedent’s estate or his legatees or distributees, but only to the extent exercisable at the time of death.
 
 The 2004 Plan provides that outstanding options shall vest and become immediately exercisable in the event consolidation, merger or acquisition of stock, the result of which our stockholders will own less than 50% of the voting power of the reorganized, merged or consolidated company or the sale of substantially all of our assets and the options are not assumed by the surviving company.  In such event, the holder will have 15 days to exercise the option and options will terminate on the expiration of such fifteen day period.
 
 Employment Contracts and Consulting Agreements
 
 Oleg Logvinov- On May 24, 2004, we entered into a three-year employment agreement with Oleg Logvinov, retaining him as President and CEO at an annual salary of $225,000. 24.5% of the salary was deferred until we completed a financing of at
 
 52
 least $3 million. The agreement provided for a grant of 1,380,000 options and an initial bonus of $65,473. The employment term is subject to automatic one year renewals unless either party notifies the other of their intention not to renew at lest six months prior to the expiration of the term. The agreement provides for continued salary payments for 12 months in the event of termination for reasons other than cause or expiration.  The Board increased Mr. Logvinov base salary to $300,000 as of June 1, 2007.  As of May 31, 2010, we have failed to make payments of $887,457 due to Mr. Logvinov for unpaid salary and bonus giving him the right to terminate on short notice.  We are currently negotiating a longer term agreement with Mr. Logvinov, but there can be no assurance that he will remain associated with us. The employment agreement also contains customary confidentiality and non-competition undertakings by Mr. Logvinov.
 
 Barbara Kane-Burke-On January 15, 2007,we entered into a one-year employment agreement with Barbara Kane-Burke to serve as CFO from January 15, 2007 to January 15, 2008 at an annual salary of $135,000, 100,000 options, exercisable at the fair market value of the Company’s Common Stock as of the date of grant, with 33% vesting on the first anniversary of the date of grant and the remainder vesting on the on the second and third anniversary date of the grant.  Mrs. Kane-Burke’s employment agreement also provides that if her employment is terminated within one year following a “change of control,” she will receive severance pay of 6 months of base salary for the then-current year, accelerated vesting of all unvested stock options and extended exercisability of all stock options until their respective expiration dates.
  Ms. Kane-Burke resigned from the company effective September 15, 2009. Effective with her termination, the Company entered into a severance agreement that provided for accelerated vesting of all her options and extended exercisability of all stock options until their respective expiration dates. Prior to May 31, 2009, Ms. Kane-Burke entered into another agreement with the Company wherein she accepted 200,000 shares of the Company’s common stock and a note for $86,750 bearing interest at 3% in exchange for all monies owed to her.
  Larry Crawford- On October 16, 2008, we entered into a three-year employment agreement with Larry Crawford to serve as CFO from October 1, 2008 to September 30, 2011 at an annual salary of $200,000.  1,800,000 options, exercisable at the fair market value of the Company’s Common Stock as of the date of grant vesting monthly over the three year contract and vesting period. Mr. Crawford’s employment agreement also provides that if his employment is terminated following a “change of control,” he will receive severance pay of two years months of base salary, accelerated vesting of all unvested stock options and extended exercisability of all stock options until their respective expiration dates.  As of May 31, 2010, we have failed to make payments of $308,334 due to Mr. Crawford for unpaid salary..
 
 Grant Ogata-. On March 28, 2007, we entered into a two-year employment agreement with Grant Ogata, retaining him as Executive Vice President of Worldwide Operations at an annual salary of $200,000. The agreement provided for a grant of 800,000 options. The employment term is subject to automatic one year renewals unless either party notifies the other of their intention not to renew at lest 30 days prior to the expiration of the term. The agreement provides for continued salary payments for 12 months in the event of termination for reasons other than cause or expiration.  In addition, the Company would be responsible for Mr. Ogata’s COBRA payments for one year unless he is otherwise covered by health insurance The employment agreement also contains customary confidentiality and non-competition undertakings by Mr. Ogata .As ofMay 31, 2010, we have failed to make payments of $513,848 due to Mr. Ogata for unpaid salary, bonus and expenses, giving him the right to terminate on short notice.
 
 Andreas Typaldos –On May 21, 2004, we entered into a three year consulting agreement with Andreas Typaldos, our Chairman.  The agreement permits Mr. Typaldos to serve on a part-time basis and provides for monthly compensation of $15,000.  The agreement also provided for a bonus of 10% of the aggregate consideration received by us or our Stockholder in connection with a merger, asset sale or similar transaction that occurs before May 21, 2007, provided such consideration is at least $200 million.  In September 2007, we agreed to extend the agreement and the bonus opportunity on a month-to-month basis. As ofMay 31, 2010, the company owed Mr. Typaldos $525,000 under this agreement.
  Harris Cohen- On March 3, 2010, we entered into a consulting agreement with Mr. Harris Cohen, one of our Directors. This agreement provided a stipend for the activities of Mr. Cohen in his capacity as an independent director having the sole responsibility to review, report upon and recommend that  the  Corporation take certain actions with respect to the compromise and conversion of outstanding secured debentures.
  Under this agreement, Mr. Cohen will receive a stipend of $7,000 for his services in such capacity for the period December 1, 2009 to January 31, 2010 and thereafter a monthly stipend of $3,000 per month for each month thereafter until either the outstanding debentures are fully discharged or converted, provided that the Corporation may terminate such stipend at any time upon thirty days notice after May 1, 2010.
  The agreement also provided as  additional compensation for his services during the period from December 1, 2009 until the completion of the Corporation’s plan of financing and debt restructuring a five year warrant to purchase 125,000 shares of the Corporation’s common equity as it is reconstituted following such debt financing and debt restructuring at the price of $0.05 per share after giving effect to such restructuring and financing.
 53
 
 ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
 The following table sets forth certain information known to us about the beneficial ownership of our Common Stock, as of May 31, 2010, by each beneficial owner of more than five percent of the Common Stock.  Except as otherwise indicated, each person has sole voting and investment power with respect to all shares shown as beneficially owned,  subject to community property laws where applicable.
 Name and Address of Beneficial Owner
Amount and Nature of Beneficial Ownership
Percent of Class (1)Andreas Typaldos

44 West 77th Street

New York, NY
10,092,438 (2)
28.86%
  (1)
Based upon 34,966,271 shares of Common Stock outstanding as of May 31, 2010 and with respect to each stockholder, the number of shares which would be outstanding upon the exercise by such stockholder of outstanding rights to acquire stock, either upon exercise of outstanding options, warrants or conversion of other securities exercisable within 60 days.
  (2)
Includes (i) 1,327,270 shares owned by Renee Typaldos, Mr. Typaldos’ wife, of which 577,270 may be acquired upon the conversion of notes and exercise of warrants held by a limited liability company in which Mrs. Typaldos has a 1⁄2 interest; (ii) 4,940,168 shares owned by the Andreas Typaldos Family Limited Partnership, of which Mrs. Typaldos is the sole general partner; (iii) 2,000,000 shares owned by Patras Holdings LLC, a limited liability company of which Mr. Typaldos is the managing member; and (iv) 750,000 shares held by Mr. Typaldos’ minor child and (v) 1,075,000 shares held by Mr. Typaldos.  Does not include 15,485,163 shares which may be obtained upon the conversion of outstanding notes and the exercise of outstanding warrants held by Mr. Typaldos and the Andreas Typaldos Family Limited Partnership which are subject to a contractual limiting conversion or exercise which can be waived on 60 days notice.
 
 We believe that all persons have full voting and investment power with respect to the shares. Under the rules of the Commission, a person (or group of persons) is deemed to be a “beneficial owner” of a security if he or she, directly or indirectly, has or shares a power to vote or to direct the voting of such security.  Accordingly, more than one person may be deemed to be a beneficial owner of the same security.  A person is also deemed to be a beneficial owner of any security, which the person has the right to acquire within 60 days, such as convertible notes, warrants or options to purchase shares of Common Stock.
 
 The following table sets forth certain information known to us regarding the beneficial ownership our Common Stock, as of May 31, 2010 by (a) our directors, (b) executive officers, and (c) all of our directors and executive officers as a group.  Except as otherwise indicated,  each person has sole voting and investment power with respect to all shares shown as  beneficially  owned,  subject to community  property laws where applicable.
 
   54
  Name of Beneficial Owner or

Number of Persons in Group
Amount and Nature of Beneficial Ownership
Percent of

Class (1)Andreas Typaldos
10,092,438 (2)
28.86%Oleg Logvinov
3,090,000 (3)
8.84%William H. Carson
475,904 (4)
1.36%Gennaro Vendome
1,345,188 (5)
3.85%Harris Cohen
300,000 (6)
0.86%Grant Ogata
1,565,650 (7)
4.48%Larry Crawford
1,110,000 (8)
3.17%All executive officers and directors as a group (7 persons)
17,979,180 (9)
51.42%
  (1)
Andreas Typaldos- Based upon 34,966,761 shares of Common Stock outstanding as of May 31, 2010 and with respect to each stockholder, the number of shares which would be outstanding upon the exercise by such stockholder of outstanding rights to acquire stock, either upon exercise of outstanding options, warrants or conversion of other securities exercisable within 60 days.
  (2)
Andreas Typaldos-Includes (i) 1,327,270 shares owned by Renee Typaldos, Mr. Typaldos’ wife, of which 577,270 may be acquired upon the conversion of notes and exercise of warrants held by a limited liability company in which Mrs. Typaldos has a 1⁄2 interest; (ii) 5,390,167 shares owned by the Andreas Typaldos Family Limited Partnership, of which Mrs. Typaldos is the sole general partner; (iii) 2,000,000 shares owned by Patras Holdings LLC, a limited liability company of which Mr. Typaldos is the managing member; and (iv) 750,000 shares held by Mr. Typaldos’ minor child.  Does not include 14,485,163 shares which may be obtained upon the conversion of outstanding notes and the exercise of outstanding warrants held by Mr. Typaldos and the Andreas Typaldos Family Limited Partnership which are subject to a contractual limiting conversion or exercise which can be waived on 60 days notice.
  (3)
Oleg Logvinov-Includes 1,170,000 shares of stock, and 1,920,000 vested options exercisable within 60 days of May 31, 2010.
  (4)
Bill Carson-Includes 185,904 shares, 160,000 shares held jointly with his wife, 10,000 shares owned by his son and 120,000 shares which may be acquired within 60 days of May 31, 2010 upon the exercise of outstanding options.
  (5)
Gennaro Vendome-Includes 675,015 shares, including 100,000 shares held by his wife, Laura and 120,000 shares which may be acquired upon the exercise of outstanding options and 550,173 which may be acquired upon the conversion of notes and exercise of warrants held by a limited liability company in which Mr. Vendome has a 1⁄2 interest.
  (6)
Harris Cohen- Includes 100,000 shares and 200,000 shares that be acquired upon the exercise of certain warrants held by Mr. Cohen.
  (7)
Grant Ogata-Includes 6,100 shares and vested options vesting within 60 days of May 31, 2010 to purchase 1,559,550 common shares.
  (8)
Larry Crawford- Includes 10,000 shares owned by Mr. Crawford and 1,100,000 shares that may be acquired within 60 days of May 31, 2010. ,
  (9)
Includes a total of 5,449,720 shares which may be obtained by the named executive officers and directors or person whose ownership is attributed to them upon the exercise of outstanding options and warrants and conversion of outstanding convertible securities.  See Notes (2) through (9)
 
 Beneficial ownership is determined in accordance with the rules of the Commission generally includes voting or investment power with respect to securities.  In accordance with Commission rules, shares of Common Stock that may be acquired upon exercise of stock options or warrants which are currently exercisable or which become exercisable within 60 days of the date of the table are deemed beneficially owned by the optionees.  Subject to community property laws, where  applicable, the persons or entities named in the table above have sole voting and investment  power with respect to all shares of the Common Stock indicated as beneficially owned by them.
  55
 ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
 During the period from December 28, 2005 to August 31, 2007 we issued $8,248,461 principal of 6% Secured Debentures due December 28, 2008 (the 6% “Secured Debentures”) and related long and short term warrants to several accredited investors, including certain of our affiliates.  The following table sets forth information concerning issuances of $2,622,576.71 of these securities to persons who were affiliates at the time the securities were issued:
 
 Name & Relationship

Date

Issued

Principal

Amount


Interest Added

to Principal


Long Term

Warrants1


Short Term

WarrantsCargo Holdings LLC, a limited liability company, owned equally by the wife of Andreas Typaldos and Genarro Verdone, another director

3/31/2006


$500,000.00



$38,260.83



276,816



235,294Andreas Typaldos, our chairman

6/30/2006

5/30/2007


$360,000.00

$70,000.00
2


$21,985.80

$711.67



199,308

38,754



169,412Andreas Typaldos Family Limited Partnership, a limited partnership in which our chairman’s wife is sole general partner

6/30/2006

1/8/2007

2/28/2007

5/30/2007

5/31/2007


$413,470.00

$288,000.00

$127,000.00

$380,000.00

$484,106.00



$25,251.36

$7,612.34

$3,356.83

$3,293.33

$2,504.21



170,088

159,447

70,312

210,381

268,018



144,575

135,530

59,765

178,824

227,815
  1
As adjusted July, 2007 as a result of anti-dilution provision in the warrants.
  2
Issued in satisfaction of unpaid consulting fees.
 
 The 6% Secured Debentures are convertible at any time at the option of the holder into shares of our common stock at a price of $0.85 per share, subject to adjustment as set forth therein. If, after the effective date of the registration statement we agreed to file under the Securities Act (the “Registration”), the closing price for our common stock exceeds $3.40 for any 20 consecutive trading days, we may, within one trading day after the end of such period, require the holders of the 6% Secured Debentures to immediately convert all or part of the then outstanding principal amount of their 6% Secured Debentures.  The terms of the conversion rights also contain certain dilution provisions.
 
 Upon the occurrence of certain events of default defined in the 6% Secured Debentures, including events of default under the transaction documents related to the financing, the full principal amount of the 6% Secured Debentures, together with interest and other amounts owing, become immediately due and payable, the principal obligation increases to 130% of the principal balance and the interest rate increases to 18%.  In the event of the sale or merger of the company or its assets for cash, the holders of the 6% Secured Debentures have the right to require us to redeem the 6% General Debenture for a substantial premium.
 
 During the period from June 1, 2007 to November 26, 2007 the Company borrowed $855,000 at the times set forth below, on an unsecured basis from affiliates of the Company’s Chairman and two non-employee directors, with the understanding that these advances would be exchanged for additional 6% Secured Debentures and related warrants.  Such an exchange is subject to the consent of the holders of outstanding 6% Secured Debentures or the satisfaction of the holders’ pre-emptive rights.
 
 56
 
 Lender Date

AmountJuly 10, 2007
$
215,000August 3, 2007

150,000August 22, 2007

50,000August 27, 2007

20,000August 31, 2007

50,000September 28, 2007

100,000October 16, 2007

60,000October 30, 2007

90,000November 7, 2007

70,000November 19, 2007

50,000Total
$
855,000
 
 
 
 
 
 
 
 
 
 
 
 
 
 57
 ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
 Audit Fees
 
 The aggregate fees billed and unbilled for the fiscal years ended May 31, 2009 and 2010 for professional services rendered by our principal accountants for the audits of our annual financial statements, and the review of our financial statements included in our quarterly reports on Form 10-Q were approximately $35,000 and $ 35,000, respectively.
 
 Audit-Related Fees
 
 The aggregate fees billed for the fiscal years ended May 31, 2009 and 2010 for assurance and related services rendered by our principal accountants related to the performance of the audit or review of our financial statements, specifically accounting research, were $0 and $0 respectively.
 
 Tax and Other Fees
 
 There aggregate fees billed for the fiscal years ended May 31, 2009 and 2010 for tax related or other services rendered by our principal accountants in connection with the preparation of our federal and state tax returns was $4,000 and $ 4,000, respectively.
 
 Approval of Non-audit Services and Fees
 
 We created an Audit committee during fiscal year 2007, consisting solely of independent directors and, consistent with SEC policies and guidelines regarding audit independence, the Audit Committee will responsible for the pre-approval of all audit and permissible non-audit services provided by our principal accountants on a case-by-case basis.
 
 
     
 
 
 58
 PART IV
 
 ITEM 15.
EXHIBITS
 
 EXHIBIT INDEX
 
 Incorporated by ReferenceExhibit

Number
Exhibit Description

Form
File

Number
Exhibit
Filing

Date
Filed

Herewith2.1
Agreement and Plan of Merger dated as of May 7, 2004 between CDKnet.com, Inc., CDK Merger Corp., Miletos, Inc. and Andreas Typaldos, as Representative of Certain Stockholders of Miletos, Inc.

10-K
0-27587
2.1
9/17/042.2
Amendment dated May 21, 2004 to the Agreement and Plan of Merger dated as of May 7, 2004 between CDKnet.com, Inc., CDK merger Corp., Miletos, Inc. and Andreas Typaldos, as Representative of Certain Stockholders of Miletos, Inc.

10-K
0-27587
2.2
9/17/042.3
Amendment Number 2, dated January 19, 2005, amending the Agreement and Plan of Merger, dated as of May 7, 2004, by and among CDKNet.Com, Inc., CDK Merger Corp., and Miletos, Inc., and Andreas Typaldos, in his individual capacity and as representative of the following stockholders of the Company: Renee Typaldos, Patra Holdings LLC, Andreas Typaldos Family Limited Partnership and Renee Typaldos Family Partnership, Ltd.

10-QSB
0-27587
2.1
1/23/062.4
AGREEMENT AND PLAN OF MERGER dated as of February 13, 2007, among Arkados Group, Inc., a Delaware corporation, Arkados Wireless Technologies, Inc., a Delaware corporation and a newly formed wholly owned subsidiary Arkados Group, Inc. and Aster Wireless Inc., a Delaware corporation.

8-K
0-27587
2.1
2/21/073i.1
Articles of Incorporation of the Registrant.

10-SB
0-27587
3.1
10/7/993i.2
Amendment to the Articles of Incorporation.

10-SB
0-27587
3.2
10/7/993i.3
Certificate of Merger of the Registrant.

10-SB
0-27587
3.4
10/7/993i.4
Amendment to the Articles of Incorporation.

10-SB
0-27587
3.5
10/7/993i.5
Amended and Restated Series A Designation

10-QSB
0-27587
3.1
2/14/033i.6
Amendment to Certificate of Incorporation (Reverse Split) filed November 31, 2003.

10-QSB
0-27587
3.1
2/17/043i.7
Certificate of Amendment to Certificate of Incorporation

10-QSB
0-27587
3.2
2/17/043i.8
Certificate of Ownership and Merger dated August 30, 2006.

8-K
0-27587
3.1
9/1/063ii.1
By-Laws of the Registrant.

10-SB
0-27587
3.3
10/7/99
 
 59
  4.1
Specimen of Common Stock Certificate.

10-K
0-27587
4.1
10/10/064.2*
Form of Stock Option Grant Agreement under the CDKnet.com, Inc. 2004 Stock Option and Restricted Stock Plan.

10-K
0-27587
4.7
9/17/044.3
Form of 6% Secured Convertible Debenture due December 28, 2008

8-K/A
0-27587
4.1
7/11/064.4
Form of Common Stock Purchase Warrant (long term and short term warrants differ as to price and expiration date as set forth in footnotes to the form filed)

8-K/A
0-27587
4.2
7/11/064.5
Registration Rights Agreement, dated as of December 28, 2005, by and among the Registrant, Bushido Capital Master Fund, L.P., Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K/A
0-27587
4.3
7/11/064.6
Form of Request for Extension of 6% Convertible Subordinated Note due July 7, 2007

8-K
0-27587
4.2
7/17/074.7
Form of three year warrant exercisable at $0.85

8-K
0-27587
4.3
7/17/074.8
Form of 6% Secured Convertible Debenture due December 28, 2008, as amended December 15, 2007

8-K
0-27587
4.1
12/12/074.9
Form of Common Stock Purchase Warrant, as amended December 15, 2007

8-K
0-27587
4.2
12/12/074.10
Form of 6% Secured Convertible Debenture due December 28, 2008, as amended April 2, 2008

8-K
0-27587
4.2
04/08/084.11
Form of Request for Extension

8-K
0-27587
4.2
07/22/084.12
Form of Extension, Waiver and Conversion Agreement

8-K
0-27587
4.3
07/22/084.13
Form of 6% Secured Convertible Debenture due June 28, 2009, as amended August 7, 2008 (convertible at $0.25).

8-K
0-27587
4.1
08/11/084.14
Form of New Warrant exercisable at $0.25 per share.

8-K
0-27587
4.2
08/11/084.15
Form of warrant exercisable at $0.25 per share until June 30, 2013

8-K
0-27587
4.3
08/11/0810.1*
Technology Horizons Corp. 1998 Equity Incentive Plan.

10-SB
0-27587
10.1
10/7/9910.2
Registration Rights Agreements dated as of May 21, 2004 between CDKnet.Com, Inc. and several stockholders.

10-K
0-27587
10.17.1

10.17.2
9/17/0410.3*
Consulting Agreement dated as of May 21, 2004 between CDKnet.Com, Inc. and Andreas Typaldos.

10-K
0-27587
10.18
9/17/04
 
 
 60
 
 
 10.4*
Employment Agreement dated as of May 23, 2004 between CDKnet.Com, Inc. and Oleg Logvinov.

10-K
0-27587
10.19
9/17/0410.5
Silicon Product Development Production Collaboration Agreement dated July 28, 2004 between GDA Technologies, Inc. and Arkados, Inc.

10-K
0-27587
10.23
9/17/0410.6
Form of 10% convertible extendible note due June 8, 2005 in the aggregate authorized principal amount of $750,000

10-QSB
0-27587
10.1
4/19/0510.7
Form of three year warrant exercisable at $0.67

10-QSB
0-27587
10.2
4/19/0510.8
Form of registration rights agreement relating to the 10% convertible extendible notes and three year warrants

10-QSB
0-27587
10.3
4/19/0510.9*
Stock Option Grant Agreement dated June 21, 2005

8-K
0-27587
10.1
6/24/0510.10
Form of Securities Purchase Agreement

8-K
0-27587
10.1
7/14/0510.11
Form of 6% Convertible Subordinated Note due July 7, 2007 in the aggregate authorized principal amount of $2.4 million

8-K
0-27587
10.2
7/14/0510.12
Form of three year warrant exercisable at $0.35

8-K
0-27587
10.3
7/14/0510.13
Securities Purchase Agreement, dated as of December 28, 2005, by and among the Registrant, Bushido Capital Master Fund, L.P., Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K
0-27587
99.1
1/4/0610.14
Security Agreement, dated as of December 28, 2005, by and among the Registrant, Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K
0-27587
99.2
1/4/0610.15
Subsidiary Guarantee dated as of December 28, 2005 executed by Arkados, Inc.

8-K
0-27587
99.3
1/4/0610.16
Waiver dated as of January 17, 2006 to the Securities Purchase Agreement, dated as of December 28, 2005, by and among the Registrant, Bushido Capital Master Fund, L.P., Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

10-QSB
0-27587
10.1
1/23/0610.17
Additional Issuance Agreement dated February 1, 2006 between the Registrant and Bushido Capital Master Fund, L.P.

8-K
0-27587
99.4
2/6/0610.18
Amended and Restated Extension Waiver and Debt Conversion Agreement dated as of February 1, 2006 by and among the Registrant and each of the holders of the Registrant’s outstanding 10% Convertible Extendable Notes originally due June 8, 2005, 6% Convertible Notes original due October 15, 2005 and that Grid Note dated October 15, 2004

8-K
0-27587
99.5
2/6/06
 
 
 61
 
 10.19
Debt Conversion Agreement (Note) dated as of January 11, 2006 between the Registrant and William Carson

8-K
0-27587
99.6
2/6/0610.20
Debt Conversion Agreement (Advances) dated as of January 11, 2006 between the Registrant and William Carson

8-K
0-27587
99.7
2/6/0610.21
Debt Conversion Agreement (Advances) dated as of January 11, 2006 between the Registrant and Gennaro Vendome

8-K
0-27587
99.8
2/6/0610.22
Second Additional Issuance Agreement dated February 24, 2006 between the Registrant and Bushido Capital Master Fund, L.P., Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K
0-27587
99.5
3/2/0610.23
Third Additional Issuance Agreement dated March 31, 2006 between the Registrant and Cargo Holdings LLC

8-K
0-27587
99.6
4/6/0610.24
Letter Agreement dated march 31, 2006 between the Registrant and Bushido Capital Master Fund, L.P., Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K
0-27587
99.7
4/6/0610.25
Warrant agreement dated March 20, 2006 issued to Emerging Capital Markets LLC

8-K
0-27587
99.8
4/6/0610.26
Lease Agreement effective May 8, 2006 between Arkados, Inc. and Bridgeview Plaza Associates.

8-K
0-27587
99.1
5/9/0610.27
Securities Purchase Agreement, dated as of December 28, 2005, by and among the Registrant, Bushido Capital Master Fund, L.P., Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K/A
0-27587
99.1
7/11/0610.28
Security Agreement, dated as of December 28, 2005, by and among the Registrant, Gamma Opportunity Capital Partners, L.P. Class A, and Gamma Opportunity Capital Partners, L.P. Class C

8-K/A
0-27587
99.2
7/11/0610.29
Subsidiary Guarantee dated as of December 28, 2005 executed by Arkados, Inc.

8-K/A
0-27587
99.3
7/11/0610.30*
Letter Amendment dated June 30, 2006 to the Consulting Agreement with Andreas Typaldos dated May 21, 2004

8-K/A
0-27587
99.4
7/11/0610.31
Amendment Agreement dated August 18, 2006 between CDKnet.com, Inc., Bushido Capital Master Fund, LP, Gamma Opportunity Capital Partners, LP (Classes A and C), and Cargo Holdings LLC

8-K
0-27587
99.1
8/24/06
 
 
 62
 
 
 
 10.32
Additional Issuance Agreement dated September 26, 2006 between Arkados Group, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC - Series BUS, Andreas Typaldos and Andreas Typaldos Family Limited Partnership

8-K
0-27587
99.5
10/2/0610.33
Waiver and Amendment Agreement dated September 26, 2006 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.6
10/2/06
 10.34
Waiver and Amendment Agreement dated October 24, 2006 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.6
10/30/0610.35
Third Additional Issuance Agreement dated November 30, 2006 between Arkados Group, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos and Andreas Typaldos Family Limited Partnership

8-K
0-27587
99.6
12/5/0610.36
Waiver and Amendment Agreement dated November 30, 2006 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.7
12/5/0610.37
Fourth Additional Issuance Agreement dated January 8, 2007 between Arkados Group, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos and Andreas Typaldos Family Limited Partnership

8-K
0-27587
99.8
5/11/0710.38
Fifth Additional Issuance Agreement dated February 28, 2007 between Arkados Group, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos and Andreas Typaldos Family Limited Partnership

8-K
0-27587
99.9
5/11/0710.39
Sixth Additional Issuance Agreement dated March 6, 2007 between Arkados Group, Inc., Crucian Transition, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos and Andreas Typaldos Family Limited Partnership

8-K
0-27587
99.10
5/11/0710.40
Waiver and Amendment Agreement dated January 8, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.11
5/11/07
 
 
 63
 
 10.41
Waiver and Amendment Agreement dated February 28, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.12
5/11/0710.42
Waiver and Amendment Agreement dated March 6, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.13
5/11/0710.43
Seventh Additional Issuance Agreement dated March 6, 2007 between Arkados Group, Inc., Crucian Transition, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos and Andreas Typaldos Family Limited Partnership

8-K
0-27587
99.14
5/11/0710.44
Waiver and Amendment Agreement dated May 7, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.15
5/11/0710.45
Eighth Additional Issuance Agreement dated May 30, 2007 between Arkados Group, Inc., Crucian Transition, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos, Andreas Typaldos Family Limited Partnership, Kathryn Typaldos, Herbert H. Sommer and Joel C. Schneider

8-K
0-27587
99.16
6/05/0710.46
Ninth Additional Issuance Agreement dated May 31, 2007 between Arkados Group, Inc., Crucian Transition, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos, Andreas Typaldos Family Limited Partnership, Kathryn Typaldos, Herbert H. Sommer and Joel C. Schneider

8-K
0-27587
99.17
6/05/0710.47
Waiver and Amendment Agreement dated May 30, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.18
6/05/0710.48
Waiver and Amendment Agreement dated May 31, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.19
6/05/07
 
 
 64
 
 10.49*
Limited waiver letter dated October 10, 2006 relating to the Employment Agreement dated as of May 23, 2006 between Arkados Group, Inc. (formerly CDKnet.com, Inc.) and Oleg Logvinov

10-K
0-27587
10.34
10/10/0610.50*
Limited waiver letter dated November 9, 2006 relating to the employment agreement dated as of May 23, 2004 between Arkados Group, Inc. (formerly CDKnet.com, Inc.) and Oleg Logvinov.

10-QSB
0-27587
10.1
1/12/0710.51*
Employment Agreement dated as of December 27, 2007 between Arkados Group, Inc. and Barbara Kane-Burke.

8-K
02-27587
99.1
4/25/0710.52
Solicitation Agreement between Arkados Group, Inc. and Trident Partners, Ltd

8-K
0-27587
99.1
7/17/0710.53
Letter Amendment dated September 10, 2007 to the Consulting Agreement with Andreas Typaldos dated May 21, 2004

10-KSB
0-27587
10.53
9/13/0710.54
Amendment Agreement dated December 6, 2007 between Arkados Group, Inc., Bushido Capital Master Fund, LP, Gamma Opportunity Capital Partners, LP (Classes A and C), Cargo Holdings LLC, Crucian Transition, Inc., Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos Family Limited Partnership, Kathryn Typaldos, Herbert H. Sommer and Joel C. Schneider.

8-K
0-27587
99.1
12/12/0710.55
Tenth Additional Issuance Agreement dated December 15, 2007 between Arkados Group, Inc., Crucian Transition, Inc., Bushido Capital Master Fund, LP, Pierce Diversified Strategy Master Fund, LLC – Series BUS, Andreas Typaldos, Andreas Typaldos Family Limited Partnership, Kathryn Typaldos, Herbert H. Sommer, Joel C. Schneider, Gennaro Vendome and William H. Carson

8-K
0-27587
99.20
12/22/0710.56
Waiver and Amendment Agreement dated December 15, 2007 between Arkados Group, Inc. and Bushido Capital Master Fund, L.P., Gamma Opportunities Capital Partners, LP Class A, Gamma Opportunities Capital Partners, LP Class C and Cargo Holdings LLC

8-K
0-27587
99.21
12/22/0710.57
Waiver and Amendment Agreement dated April 2, 2008 between Arkados Group, Inc., and certain holders of Arkados Group, Inc. 6% secured convertible debentures due December 28, 2008.

8-K
0-27587
99.1
04/08/0810.58
Solicitation Agreement between Arkados Group, Inc. and Trident Partners, Ltd

8-K
0-27587
99.1
07/22/0810.59
Waiver and Amendment Agreement dated April 2, 2008 between Arkados Group, Inc., and certain holders of Arkados Group, Inc. 6% secured convertible debentures due December 28, 2008.

8-K
0-27587
99.1
08/11/08
 
 
 65
 
  14.1
Code of Business Conduct and Ethics

10-K
0-27587
14.1
9/17/0414.2
Code of Ethics for Financial Executives

10-K
0-27587
14.2
9/17/0421
Subsidiaries of the Registrant.





X31.1
Certification of Chief Executive Officer of Periodic Report pursuant to Rule 13a-14a and Rule 15d-14(a).





X31.2
Certification of Chief Financial Officer of Periodic Report pursuant to Rule 13a-14a and Rule 15d-14(a).





X32.1
Certification of Chief Executive Officer of pursuant to 18 U.S.C. - Section 1350.





X32.2
Certification of Chief Financial Officer of pursuant to 18 U.S.C. - Section 1350.





X
 
 *Compensation plans or arrangements in which directors or executive officers are eligible to participate.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 66
 SIGNATURES
 
 In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report on to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 Arkados Group, Inc. (Registrant)By:
/s/ Oleg LogvinovPresident and Chief Executive Officer
 
 
 By:
/s/ Larry L CrawfordChief Financial Officer (Principal

Financial and Accounting Officer)Date:    September 13, 2010
 
 
 
 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
 
 Date:    September 13, 2010
By:  /s/ Oleg LogvinovOleg Logvinov, President, Chief

Executive Officer and a Director
 
 
 
 Date:   September 13, 2010
By: /s/ Gennaro VendomeGennaro Vendome, Director
 
 
 
 Date:    September 13, 2010
By:  /s/ William CarsonWilliam H. Carson, Director
 
 
 
 Date:    September 13, 2010
By:  /s/ Andreas TypaldosAndreas Typaldos, Chairman
 
 
 
 Date:     September 13, 2010
By:  /s/ Harris CohenHarris Cohen, Director
 
 
 
 
 67