Raptor Networks Technology Inc – 10-Q – Management’s Discussion And Analysis Or Plan Of Operation.

 "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: this report contains forward-looking statements, including statements concerning future conditions in the network switching industry, our future business, financial condition, operating strategies and operational and legal risks. These forward-looking statements generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance, and can generally be identified by the use of the words "plan," "estimate," "expect," "believe," "should," "would," "could," "anticipate," "may," "forecast," "project," "pro forma," "goal," "continues," "intend," "seek" or variations of those terms and other similar expressions, including their use in the negative. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:                    · our inability to continue as a going concern,                       · our inability to raise additional capital,                        · lower sales and revenues than forecast,               · our inability to carry out our marketing and sales plans,                        · unexpected costs and operating deficits,  

· our failure to establish relationships with and capitalize upon access to new

customers,

        · litigation and administrative proceedings involving us or our products,                          · adverse publicity and news coverage,                              · adverse economic conditions,                         · entry of new and stronger competitors,                · changes in interest rates and inflationary factors, and  

· other specific risks that may be referred to in this report or in other

reports that we have issued.

    These forward-looking statements necessarily depend upon assumptions and estimates that may prove to be incorrect. Although we believe that the assumptions and estimates reflected in the forward-looking statements are reasonable, we cannot guarantee that we will achieve our plans, intentions or expectations. The forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ in significant ways from any future results expressed or implied by the forward-looking statements. Except as required by law, we undertake no duty to update any forward-looking statement after the date of this report, either to conform any statement to reflect actual results or to reflect the occurrence of unanticipated events.  Any of the factors described above, elsewhere in this report, or in the "Risk Factors" section of our most recent annual report on Form 10-K could cause our financial results, including our net income (loss) or growth in net income (loss) to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.  

Current Business Outlook and Going Concern Qualification

  Since inception, the Company has incurred losses and realized negligible revenues from product sales. Our government design services contract, which funded a major portion of the Company's operating expenses, expired in April 2011 and all funds generated from this contract were depleted as of September 2011.   As disclosed in previous filings, the Company shifted its principal operating model from product sales to licensing, enabling a substantial reduction in headcount, footprint and infrastructure that reduced operating expense run rates substantially. This shift in business model has not been successful as the Company has not generated any revenues from licensing agreements until July 5, 2011, at which time the Company entered into an agreement with California Capital Equity, LLC ("CCE") granting CCE an exclusive license (even as to the Company) leaving the Company without any continuing rights in or to its intellectual property.                                          1 --------------------------------------------------------------------------------   As of July 31, 2011, all of our convertible notes payable had fully matured, representing a total principal amount outstanding of $11,112,854 and accrued interest of $779,242 as of September 30, 2011. The Company did not repay these amounts. Consequently, the note holders exercised their right as a secured lender against substantially all of the Company's assets and held a public foreclosure sale of substantially all of the Company's assets and acquired all of these assets at a price of $100,000, which was credited against the outstanding notes on August 1, 2011. As a result of the public sale on August 1, 2011 and the sale of our intellectual property, the Company retains no material assets with which to continue its operations. The Company is seeking companies or businesses with an interest in utilizing the Company as a public shell vehicle and in August 2011 signed a non-binding "Letter of Intent" with an interested party for a possible merger. There can be no assurance, however, that such a transaction will ultimately be consummated.  In light of these factors, management believes that a comprehensive financial restructuring with the utilization of the public shell entity as a reverse merger vehicle for a new entity is the only way to preserve any value for the public shareholders. Should such a transaction be consummated, the resultant debt for equity exchange will most likely result in a near total loss of shareholder value.  Should a restructuring be unachievable, Raptor will permanently cease operations resulting in a total loss of shareholder value.  These conditions, among others, raise substantial doubt about our ability to continue as a going concern and our independent registered public accounting firm has qualified their opinions with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2003 through December 31, 2010.  

Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The accompanying financial statements do not reflect any adjustments which might be necessary if we are unable to continue as a going concern.

  For further details on the above, see the language included under "risk factors" starting on page 8 of our annual report on Form 10-K for the year ended December 31, 2010, "conclusion on capital resources and liquidity" on page 10 of this Form 10-Q, "presentation as a going concern" beginning on page F-6 of this form 10-Q, Note 2 beginning on on page F-7 of this Form 10-Q, and the Forms 8-K filed on July 11, 2011 and August 4, 2011.  

Overview

  Prior to the sale of our intellectual property, we designed, produced and sold standards-based, proprietary high-speed network switching and related "virtualized fabric" technologies. Our "distributed hybrid fabric" networking and integrated systems' technologies allow users to upgrade both their traditional networks as well as their server and storage arrays with our products to allow for more efficient management of high-bandwidth transport, applications and security. The implementation of our products in a user's network provides architectural solution alternatives, at a systems level, unavailable from existing switching, routing and server technologies.  

RISK FACTORS

  Except as noted above in the "current business outlook" section, the Risk Factors included in our annual report on Form 10-K for the fiscal year ended December 31, 2010 have not materially changed and are incorporated by reference into this Form 10-Q.                                          2

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CRITICAL ACCOUNTING POLICIES

Critical Accounting Estimates and Judgments

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

Derivative Financial Instruments

  Our senior convertible notes are classified as non-conventional convertible debt. In the case of non-conventional convertible debt, we bifurcate our embedded derivative instruments and record them at their fair value as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives is higher at the subsequent balance sheet date, we will record a non-operating, non-cash charge. If the fair value of the derivative is lower at the subsequent balance sheet date, we will record non-operating, non-cash income.  To determine the fair value of the derivative instruments, we make certain assumptions regarding the expected term of exercise. Because the expected term of the warrants impacts the volatility and risk-free interest rates used in the Black-Scholes calculations, these must be selected for the same time period as the expected term of the warrants.  

Deferred Income Taxes

  We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. We have considered estimated future taxable income an ongoing tax planning strategies in assessing the amount needed for the valuation allowance.                                          3 --------------------------------------------------------------------------------

RESULTS OF OPERATIONS

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

  The following table sets forth selected financial data regarding our financial position and operating results for the three and nine months ended September 30, 2011 and 2010. This data should be read in conjunction with our consolidated financial statements and related notes thereto beginning on page F-1 of this report.                                       For the Three Months Ended                         For the Nine Months Ended                                             September 30,                                     September 30,                                                                 Change                                             Change                                 2011            2010             ($)              2011             2010             ($) Continuing Operations: OPERATING EXPENSES General and administrative              $        529     $     2,646     $     (2,117 ) 

$ 39,902$ 61,572 $ (21,670 ) Total operating expenses

              529           2,646           (2,117 )         39,902           61,572          (21,670 ) Loss from operations                (529 )        (2,646 )          2,117          (39,902 )        (61,572 )         21,670 OTHER INCOME (EXPENSE) Interest income                        -               1               (1 )              5                5                - Change in fair value of conversion option and warrant liabilities           (3,556,756 )     2,679,949       (6,236,705 )

(7,267,374 ) 1,522,861 (8,790,235 ) Amortization of discount on convertible debt

                (8,165 )      (318,059 )        309,894         (192,247 )     (1,956,431 )      1,764,184 Interest expense                (265,013 )      (260,642 )         (4,371 ) 

(799,516 ) (762,744 ) (36,772 ) Total other income (expense)

                      (3,829,934 )     2,101,249       (5,931,183 )     (8,259,132 )     (1,196,309 )     (7,062,823 ) Income (loss) before income taxes                  (3,830,463 )     2,098,603       (5,929,066 )     (8,299,034 )     (1,257,881 )     (7,041,153 ) Income tax benefit                     -               -                -                -                -                - Income (loss) from continuing operations         (3,830,463 )     2,098,603       (5,929,066 )     (8,299,034 )     (1,257,881 )     (7,041,153 ) Discontinued operations: Gain on disposal of discontinued operations              612               -              612          523,980           86,619          437,361 Loss from discontinued operations                      (164,749 )       (17,239 )       (147,510 ) 

(372,446 ) (214,272 ) (158,174 ) Loss from discontinued operations, net of tax (164,137 ) (17,239 ) (146,898 )

         151,534         (127,653 )        279,187 NET INCOME (LOSS)           $ (3,994,600 )   $ 2,081,364     $ (6,075,964 )   $ (8,147,500 )   $ (1,385,534 )   $ (6,761,966 )                                            4

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Operating Expense

  The decrease in operating expenses for the nine months ended September 30, 2011 as compared to the same period in 2010 is the result of a decrease in audit fees of $19,578 for the nine months ended September 30, 2011 as compared to the same period in 2010. In 2011, the fees for our quarterly filings were paid by the company with which we signed the letter of intent for a merger. In 2010, the Company paid all of its audit fees.  

Net Other Income (Expense)

  Net other expense was $3,829,934 for the three months ended September 30, 2011 as compared to net other income of $2,101,249 for the same period in 2010. Net other expense was $8,259,132 for the nine months ended September 30, 2011 compared to $1,196,309 compared to the same period in 2010. This change resulted from the following.  For the three months ended September 30, 2011, the fair values of our conversion option and warrant liabilities increased by $3,556,756 compared to a decrease in their fair value of $2,679,949 for the three months ended September 30, 2010. For the nine months ended September 30, 2011, the fair values of our conversion option and warrant liabilities increased by $7,267,374 compared to a decrease of $1,522,861 for the comparable period in 2010. The reasons for these changes are substantially lower stock prices and substantially higher volatilities in 2011 compared to 2010. In 2010, our stock price increased from $0.17 at December 31, 2009 to $0.28 at September 30, 2010 and decreased to $0.17 at September 30, 2010. In 2011, our stock price decreased from $0.10 at December 31, 2010 to less than $0.01 at June 30 and September 30, 2011. Additionally, in the third quarter of 2011, volatilities increased sharply, from a range of 207%-302% at June 30, 2011 to a range of 277%-533% at September 30, 2011. For the nine months ended September 30, 2011, volatilities increased from a range of 111%-150% at December 31, 2010 to a range of 277%-533% at September 30, 2011.  Amortization of the discount on convertible debt was $8,165 for the three months ended September 30, 2011 as compared to $318,059 for comparable period in 2010. Amortization of the discount on convertible debt was $192,247 for the nine months ended September 30, 2011 as compared to $1,956,431 for the comparable period in 2010. The decreases result primarily from all of the notes except the July 2010 Note becoming fully amortized by December 31, 2010. Additionally, in the second quarter of 2011, the note holders no longer allowed the Company to add the accrued interest payable to the principal balance of the Notes. Since all of the Notes, except the July 2010 Notes were past due, the increase in the fair value of the conversion feature due to the increased principal was being amortized immediately through March 31, 2011. During the three and nine months ended September 30, 2011, the principal balance of the Notes did not increase and consequently, additional amortization expense was not recorded.  Interest expense increased by 2% and 5%, respectively, for the three and nine months ended September 30, 2011 as compared to the comparable periods in 2010. The slight increase is attributable to the July 2010 Note entered into in the third quarter of 2010 and increased principal balances due to the addition of accrued interest added to principal through March 31, 2011.                              DISCONTINUED OPERATIONS

Loss on Discontinued Operations

  The change in loss from discontinued operations for the three and nine months ended September 30, 2011 compared to the comparable periods in 2010 was the result of the following changes. "See the table on page F-8, Results Included in Discontinued Operations."                                          5

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Net Revenues

  Net revenues decreased by $512,886 for the three months ended September 30, 2010 to $13,731 for the three months ended September 30, 2011. Net revenues decreased by $979,293 for the nine months ended September 30, 2010 to $367,012 for the nine months ended September 30, 2011. By 2010, the Company had become largely dependent on U.S. Government contracts as its source of revenue. In March 2011, funding for government contracts ran out because the government had not approved its budget for fiscal 2011. In addition, the Company was unable to generate significant commercial business due to its lack of sales resources. In July 2011, the Company sold an exclusive license (even as to the Company) to its intellectual property, leaving the Company with no continuing rights in or to its intellectual property. Additionally, on August 1, 2011, the note holders of our convertible notes exercised their rights as a secured lender and foreclosed on substantially all of our assets, including all of our inventory, leaving the Company with no ability to generate future revenues in its current line of business.  

Gross Profit

  Gross profit for the three months ended September 30, 2010 was $238,210 as compared to gross profit of $9,932 for the three months ended September 30, 2011. Gross profit was $144,724 for the nine months ended September 30, 2011 as compared to $598,648 in the comparable period of 2010. The change from 2010 is mainly attributable to lower revenues. Additionally, the Company wrote off $16,425 of license fees in the first two quarters of 2011 due to lower revenue expectations, wrote off $5,676 of inventory on loan to third parties that we were unable to get back and charged $4,000 related to post-sales support and royalty settlements with third parties. Cost of good sold in 2010 was attributable to normal margins on our products and services.  

Operating Expenses

   The decrease in operating expenses in the third quarter of 2011 compared to the same period of 2010 was $80,768 or 32%. The decrease in operating expenses for the nine months ended September 30, 2011 compared to the same period of 2010 was $295,750 or 36%. These decreases resulted from the following.  

Salary Expenses

  Salary and salary-related expenses decreased by $11,469 in the third quarter of 2011 compared to the same period in 2010, an 8% decrease and by $162,267 in the nine months ended September 30, 2011compared to the same period in 2010, a 31% decrease. The decrease of expenses incurred in 2011 partially resulted from the complete vesting of stock-options in the fourth quarter of 2010, resulting in no stock-based compensation costs in 2011. Stock-based compensation costs were approximately $100,000 in 2010. Additionally, effective March 31, 2011, due to the lack of revenues, the Company terminated 4 of its engineering and R&D personnel due to lack of revenues.  

Research and Development

Research and development expenses were immaterial for the three and nine months ended September 30, 2011 and 2010.

Marketing and Selling

  For the three and nine months ended September 30, 2010, marketing expenses were $48,945 and $60,808, respectively. These costs consisted primarily of sales commissions and the write-off of equipment loaned to a company for a two-year period. We believe that at the end of the two-year period, the equipment will have no residual value and we expensed the cost as marketing expenses in the first quarter of 2010. We did not incur any marketing expense in 2011.  

General and Administrative

  General and administrative expenses (G&A) decreased from $60,291 in the third quarter of 2010 to $42,930 in the third quarter of 2011. G&A decreased from $216,512 to $158,435 for the nine months ended September 30, 2011 compared to the same period of 2010 and resulted from the following:                                          6 --------------------------------------------------------------------------------   Consulting expenses were $44,430 for the nine months ended September 30, 2010. In the first quarter of 2010, we issued shares of our common stock valued at $42,000 to a consultant for investment banking services. We did not incur these expenses in 2011.  Accounting fees decreased by $2,512 and $8,274, respectively, for the three and nine months ended September 30, 2011 compared to the same periods in 2010. The decrease is attributable to less time incurred by our consultant due to familiarity and no financings in 2011. Additionally, the Company was able to negotiate a lower rate in 2011 over 2010.  Travel expenses decreased by $7,091 in the third quarter of 2011 compared to the same period in 2010 and decreased by $13,515 for the first three quarters of 2011 compared to the same period in 2010. The decrease resulted from a lower headcount and less trips taken in 2011 as a result of lower product sales and other cost-cutting measures.  Insurance expense decreased by $6,516 for the third quarter of 2011 compared to the third quarter of 2010 due to the cancellation of all of our existing insurance policies in the third quarter of 2011 as these policies were no longer required considering the Company's employees, assets and technology. Effective April 1, 2011, the Company had a tail D&O policy that was purchased in the third quarter of 2011 which protects the Company's officers for a two-year period. This coverage was $14,000 less expensive than the previous D&O policy.  The above decreases were offset partially by an increase in legal fees of $3,875 and $16,429 for the three and nine months ended September 30, 2011, respectively, compared to the same periods in 2010. The increase in 2011 resulted from legal assistance needed in 2011 related to review of documents relating to the sale of our intellectual property and foreclosure of our assets and the resultant 8-K filings. These events did not occur in 2010.  

Gain on Disposal of Discontinued Operations

  Loss on foreclosure was $431,034 for the three and nine months ended September 30, 2011 as a result of the foreclosure of our note holders on assets with a net book value of $531,034 in exchange for a reduction in the principal balance of our convertible notes payable of $100,000. No such event occurred in 2010.  Gain on sale of intellectual property was $384,000 for the three and nine months ended September 30, 2011 due to the sale of an exclusive license (even as to the Company) of all of our intellectual property in the third quarter of 2011. No such event occurred in 2010.  Gain on forgiveness of debt increased to $47,646 for the three months ended September 30, 2011. Gain on forgiveness of debt increased to $572,711 from $86,619 for the nine months ended September 30, 2011. In both 2011 and 2010, gain on forgiveness of debt resulted from the write-off of liabilities accrued in prior years to their ultimate settlement amounts.  

Liquidity and Capital Resources

  Our independent registered public accounting firm has qualified their opinion with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2010 and 2009. Reports of independent registered public accounting firms questioning a company's ability to continue as a going concern generally are viewed very unfavorably by analysts and investors. There are a number of risks and challenges associated with such a qualified report including, but not limited to, a significant impediment to our ability to raise additional capital or seek financing from entities that will not conduct such transactions in the face of such increased level of risk of insolvency and loss, increased difficulty in attracting talent and the diversion of the attention of executive officers and other key employees to raising capital or financing rather than devoting time to the day-to-day operations of our business. We urge potential investors to review the report of our independent registered public accounting firm and our consolidated financial statements and related notes beginning on page F-1 of this Report, the cautionary statements included in the "Risk Factors" section of this Report and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us, or to maintain an investment in us.                                          7 --------------------------------------------------------------------------------   For the years ended December 31, 2010 and 2009, we incurred net losses of $468,871 and $12,694,997, respectively. Since our inception, including the year ended December 31, 2010, we have realized negligible revenues and have financed our operations almost exclusively from cash on hand raised through the sale of our securities and borrowings. As of September 30, 2011, we lost an additional $8,147,500 and we had a deficit in working capital of $25,945,101, of which $14,204,522 relates to the fair value of derivative financial instruments.  During 2011, the Company continued its efforts to convert to licensing as a primary business model and in July 2011, the Company sold an exclusive, worldwide, perpetual, irrevocable, fully paid, transferable and sub-licensable right and license in all of the Company's registered patent and patent applications for $384,000. The license is exclusive even to the Company, such that the Company no longer has any rights to its intellectual property.  The Company's service contract with a Government prime contractor was almost depleted as of March 31, 2011 and consequently, revenues for the quarter under review amounted to close to zero.  All of our convertible notes payable have matured and the Company did not pay the principal balances and accrued interest at maturity or thereafter.  The note holders exercised their right as a secured lender against the Company's assets and held a public foreclosure sale of substantially all of the Company's assets and acquired all of these assets at a price of $100,000, which price was credited against the outstanding notes on August 1, 2011.  As a result of the sale of our intellectual property and the public sale on August 1, 2011, the Company retains no material assets with which to continue its operations.  The Company is seeking companies or businesses with an interest in utilizing the Company as a public shell vehicle and in August 2011 signed a non binding "Letter of Intent" with an interested party for a possible merger.  There can be no assurance, however, that such a transaction will ultimately be consummated.  

For further details on these transactions, see the disclosures in the Forms 8-K filed by the Company on July 11, 2011 and August 4, 2011.

2006, 2007 and 2008 Note Financings

  On July 30, 2006, we entered into financing agreements with 3 accredited investors. On January 22, 2007, we subsequently entered into Amendment and Exchange Agreements with the same investors providing certain amendments to the July 30, 2006 agreements and increasing the total financing to $8,804,909. The 2006 Notes, as amended, are convertible into shares of the Company's common stock at the lower of $0.43948 or the optional conversion price, defined as 90% of the arithmetic average of the weighted-average prices of the common stock on each of the five consecutive trading days immediately preceding the applicable optional conversion/redemption date. In the aggregate, we issued series L-1 warrants to purchase an aggregate of 22,754,163 shares of common stock, series L-2 warrants to purchase an aggregate of 7,281,332 shares of common stock, series M-1 warrants to purchase an aggregate of 7,395,103 shares of common stock and series M-2 warrants to purchase an aggregate of 2,366,433 shares of common stock. All these warrants have a strike price of $0.43948. The Company received aggregate gross proceeds from these financings of $6.6 million. These notes bear interest at 9.25% per annum, which increases to 15% in case of a default.                                          8 --------------------------------------------------------------------------------   On July 31, 2007, we entered into a financing agreement with the same investors involved in the June 2006 and January 2007 financings for total gross proceeds of $3.5 million for the issuance of senior secured convertible notes in the aggregate principal amount of $3.5 million, series N warrants to purchase up to an aggregate of 7,000,000 shares of the Company's common stock (includes dilution from the April 1, 2008 financing), series O warrants to purchase up to an aggregate of 4,550,000 shares of the Company's common stock (includes dilution from April 2008 financing) and series P warrants to purchase up to an aggregate of 3,000,000 shares of common stock (includes dilution from April 2008 financing). The agreement also granted the investors a first priority perfected security interest in all of our assets. The secured notes bear interest at 9.25% per annum, which may be increased to 15% in case of default. The initial fixed conversion price of the note was $1.20 but was reduced to $0.50 per share in April 2008. The July 2007 Notes are convertible into shares of the Company's common stock at the lower of $0.50 or the optional conversion price, defined as the lower of (i) 90% of the arithmetic average of the lowest weighted-average price of the common stock during the fifteen consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date and (ii) 90% of the arithmetic average of the lowest weighted average price of the common stock during any three consecutive trading day period during the fifteen consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date. The strike price for the N, O and P warrants was initially $1.20 but was reduced to $0.50 in April 2008. The N and P warrants were immediately exercisable. The O warrants become exercisable on a mandatory conversion called by the Company.  On April 1, 2008, we entered into a financing agreement with the same investors involved in the previous financings. For total gross proceeds of $3.125 million, we issued senior secured convertible notes in the aggregate principal amount of $3.125 million, series Q warrants to purchase up to an aggregate of 6,250,000 shares of the Company's common stock and 3,125,000 shares of our common stock. The agreement grants the investors a first priority perfected security interest in all of the Company's assets. The notes bear interest at 10% per annum, which may be increased to 15% in the event of default. The April 2008 Notes are convertible into shares of the Company's common stock at the lower of $1.00 or the optional conversion price, defined as the lower of (i) 85% of the arithmetic average of the weighted-average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date ("measuring period") and (ii) 85% of the arithmetic average of the weighted average price of the common stock during the first three consecutive trading day period of such measuring period and (iii) the arithmetic average of the weighted average price of the common stock during the last three consecutive trading day period of such measuring period. The Q warrants initially carried a strike price of $1.00 that was reduced to $0.50 in July 2008 and were immediately exercisable.  On July 28, 2008 we entered into a financing agreement with the same investors involved in the 2006, 2007 and April 2008 financings. For total gross proceeds of $1.25 million, we issued senior secured convertible notes in the aggregate principal amount of $1.25 million, series R warrants to purchase up to an aggregate of 2,500,000 shares of the Company's common stock and 1,250,000 shares of the Company's common stock. The agreement grants the investors a first priority perfected security interest in all of the Company's assets. The notes bear interest at 10% per annum, which may be increased to 15% in the event of default. The July 2008 notes are convertible into shares of the Company's common stock at the lower of $1.00 or the optional conversion price, defined as the lower of (i) 85% of the arithmetic average of the weighted-average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date and (ii) 85% of the arithmetic average of the weighted average price of the common stock during the three lowest trading days with the lowest weighted average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date. The R warrants carry a strike price of $0.50 per share and are immediately exercisable.  During July 2011, the note holders of all of the above notes demanded repayment of all principal and accrued interest. The Company was unable to make the payment and, as a result, the note holders foreclosed on substantially all of the Company's assets on August 1, 2011.  

July 2010 Note Financing

  On July 27, 2010, pursuant to the terms of a securities purchase agreement with one of our investors involved in the previous financings, we issued an unsecured convertible note payable in the principal amount of $176,471. We received net proceeds of $150,000 from the note as explained below.  The note bears interest at 15% per annum, which may be increased to 21% upon the occurrence of an event of default, and matures on July 27, 2011. This date may be extended, at the option of the investor, by up to two years. Interest on the notes of $26,471, representing one year of interest, was prepaid to the investors at the closing.                                          9 --------------------------------------------------------------------------------   The 2010 note is convertible into shares of the Company's common stock at the lower of $1.00 or the optional conversion price, defined as the lesser of (i) 85% of the arithmetic average of the weighted-average price of the common stock for the 30 consecutive trading days immediately preceding the conversion date and (ii) 85% of the arithmetic average of the weighted-average price of the common stock for the 3 lowest trading days during the 30 consecutive trading days immediately preceding the conversion date. However, following the disclosure of a SEC event, as defined in the 2010 Notes, the conversion price will be computed using the lowest of (i) 50% of the amounts determined as above; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.  If there is an event of default or a fundamental transaction as defined in the agreement, the investors have the right to redeem all or any portion of the 2010 note, at the greater of (i) up to 125% of the sum of the outstanding principal, interest and late fees, depending on the nature of the default, and (ii) the product of (a) the greater of (1) the closing sale price for the Company's common stock on the date immediately preceding the event of default, (2) the closing sale price for the Company's common stock on the date immediately after the event of default and (3) the closing sale price for the Company's common stock on the date an investor delivers its redemption notice for such event of default, multiplied by (b) 200% of the number of shares into which the Note (including all principal, interest and late fees) may be converted.  The conversion price of the note is subject to customary anti-dilution provisions for stock splits and the like, and are also subject to full-ratchet anti-dilution protection such that if the Company issues or is deemed to have issued certain securities at a price lower than the then applicable conversion or exercise price, then the conversion or exercise price will immediately be reduced to such lower price.  The note contains certain limitations on conversion or exercise, including that a holder of those securities cannot convert or exercise those securities to the extent that upon such conversion or exercise, that holder, together with the holder's affiliates, would own in excess of 4.99% of the Company's outstanding shares of common stock (subject to an increase upon at least 61-days' notice, by the investor to the Company, of up to 9.99%).  

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

On July 31, 2011, the July 2010 Note matured and the Company did not have the funds available to repay the principal.

Conclusion on Capital Resources and Liquidity

  As noted elsewhere within this document, our independent registered public accounting firm continues to qualify their opinion with respect to our consolidated financial statements. Since inception, the Company has incurred losses, realized negligible revenues from product sales and has only been able to generate $384,000 of revenues from licensing. This license agreement terminates the Company's rights to generate any future revenues from our intellectual property. During the quarter ended September 30, 2011, the Company's cash position suffered additional deterioration. The current lenders have demanded repayment in full and since the Company was unable to make the payments, the note holders foreclosed on substantially all of the Company's assets on August 1, 2011.  

In light of these factors, management is in the process of winding down all operations and is seeking companies or businesses with an interest in utilizing the Company as a public shell vehicle and in August 2011 has signed a non-binding "Letter of Intent" with an interested party for a possible merger. There can be no assurance, however, that such a transaction will ultimately be consummated.

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