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EX-23.1 - CYBERDEFENDER CORPv163097_ex23-1.htm
EX-5.1 - CYBERDEFENDER CORPv163097_ex5-1.htm

As filed with the Securities and Exchange Commission on October 19, 2009
Registration Statement No. 333-161790

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
AMENDMENT NO. 1

TO

FORM S-1
 
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
 
CyberDefender Corporation
(Exact name of registrant as specified in its charter)

California
 
7372
 
65-1205833
(State or other jurisdiction
of incorporation or organization)
 
(Primary Standard Industrial
Classification Code Number)
 
(I.R.S. Employer
Identification No.)

617 West 7th Street, Suite 401
Los Angeles, California 90017
(213) 689-8631
(Address, including zip code, and telephone number, including area code,
of registrant’s principal executive offices)
 
Gary Guseinov
Chief Executive Officer
CyberDefender Corporation
617 West 7th Street, Suite 401
Los Angeles, California 90017
(213) 689-8631
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
 
Copy to:
Kevin Friedmann, Esq.
RICHARDSON & PATEL LLP
152 W. 57th St., 4th Floor
New York, New York 10019
(212) 561-5559

Approximate date of commencement of proposed sale to the public: From time to time after the effective date of this Registration Statement. 
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. x
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer ¨
Accelerated filer ¨
   
Non-accelerated filer ¨
Smaller reporting company x

CALCULATION OF REGISTRATION FEE
Title of each class of securities to
be registered
 
Amount to be 
Registered
   
Proposed maximum offering
price per share
   
Proposed maximum
aggregate offering price
   
Amount of registration
fee(1)
 
Common Stock, no par value per share, to be issued upon exercise of warrants
   
5,896,755
   
$
2.20
   
$
12,972,861.00
   
$
723.89
 
Common Stock, no par value per share
   
3,829,312
   
$
2.20
   
$
8,424,486.40
   
$
470.09
 
                                 
Total
   
9,726,067
   
$
2.20
   
$
21,397,347.40
   
$
1,193.98
 
(1) Calculated in accordance with Rule 457(c) of Regulation C promulgated under the Securities Act of 1933 as of August 31, 2009.

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE.

 
 

 

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

Subject to Completion, dated October 19, 2009
 
Prospectus

 
9,726,067 Shares of Common Stock
 
This prospectus covers the resale by the selling shareholders named on page 53 of up to 9,726,067 shares of our common stock which include:
 
· 
1,975,360 shares of common stock sold pursuant to Securities Purchase Agreements dated June 3, 2009 through July 21, 2009;
 
·
4,621,221 shares of common stock underlying common stock purchase warrants issued to two consultants for services provided to the Company and for the payment of interest on money advanced;

·
15,000 shares of common stock issued pursuant to the cash exercise of common stock purchase warrants issued to a consultant for services provided to the Company;

·
148,000 shares of common stock underlying common stock purchase warrants issued pursuant to various Securities Purchase Agreements dated from November 13, 2008 to January 28, 2009;

·
1,838,952 shares of common stock issued pursuant to the cash exercise of common stock purchase warrants pursuant to a warrant tender offer that terminated on August 17, 2009; and

·
1,127,534 shares of common stock underlying amended common stock purchase warrants issued pursuant to a warrant tender offer that terminated on August 17, 2009.

This offering is not being underwritten.  Our common stock is quoted by the Over-the-Counter Bulletin Board under the symbol “CYDE.”  On October 9, 2009, the price per share of our common stock was $2.88.
 
We will not receive any of the proceeds from the sale of these shares.  However, we may receive up to $7,183,728 to the extent the warrants are exercised for cash.  If some or all of the warrants are exercised for cash, the money we receive will be used for general corporate purposes, including working capital requirements.  We will pay all expenses incurred in connection with the offering described in this prospectus, with the exception of the brokerage expenses, fees, discounts and commissions which will all be paid by the selling shareholders.  Our common stock and warrants are more fully described in the section of this prospectus titled “Description of Securities.”

 
 

 

AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE “RISK FACTORS” BEGINNING AT PAGE 6.
 
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS.  ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
 
You should rely only on the information contained in this prospectus to make your investment decision.  We have not authorized anyone to provide you with different information.  This prospectus may be used only where it is legal to sell these securities.  You should not assume that the information in this prospectus is accurate as of any date other than the date on the front page of this prospectus.
 
The following table of contents has been designed to help you find important information contained in this prospectus. We encourage you to read the entire prospectus carefully.
 
The date of this prospectus is ___________, 2009

 
 

 

Table of Contents
 
Prospectus Summary
 
 1
Risk Factors
 
6
Special Note Regarding Forward-Looking Statements
 
12
Use of Proceeds
 
13
Market for Common Equity and Related Shareholder Matters
 
13
Management’s Discussion and Analysis or Plan of Operation
 
14
Description of Business
 
30
Directors, Executive Officers, Promoters and Control Persons
 
40
Executive Compensation
 
42
Certain Relationships and Related Transactions
 
49
Selling Shareholders
 
52
Plan of Distribution
 
58
Security Ownership of Certain Beneficial Owners and Management
 
60
Description of Securities
 
61
Disclosure of Commission Position on Indemnification for Securities Act Liabilities
 
65
Where You Can Find More Information
 
67
Experts
 
67
Legal Matters and Interests of Named Experts
 
68
Financial Information
 
F-1

 
1

 

Prospectus Summary

This summary highlights material information contained elsewhere in this prospectus. You should read the entire prospectus carefully, including the section titled “Risk Factors” and our consolidated financial statements and the related notes.

Our Company

Networks such as the Internet can enable rapid communication of information between computers.  Unfortunately, the capability of computers to communicate is often used to victimize computer systems and their users.  A variety of known threats, such as computer viruses, spam and phishing schemes, are spread using the Internet.

We are a California corporation that provides Internet security through our proprietary Web 2.0 Collaborative Internet Security Platform called the CyberDefender earlyNETWORK™.

Our product line of Internet security products includes CyberDefender Early Detection Center, CyberDefenderFREE 2.0, CyberDefenderULTIMATE, CyberDefender Registry Cleaner, MyIdentityDefender and Identity Protection Services.  CyberDefender Early Detection Center is a complete Internet security suite that protects computer users against spyware, viruses and identity theft.  The CyberDefender Early Detection Center is available in various versions including CyberDefenderFREE 2.0, which is a free security suite supported by advertising, CyberDefender FamilyPak, which supports up to five computer users, and CyberDefenderULTIMATE, which comes with year round live technical support for any personal computer problem.  The annual licensing fees range from $12.99 to $299.99, depending on the version of the product being licensed and the marketing and distribution channels that we use. CyberDefender Registry Cleaner eliminates clutter and junk that builds up within a computer's registry due to the installation and removal of programs, deletion and creation of files and cached records from Web surfing.  The annual subscription rate ranges from $19.99 to $39.98, depending on the marketing or distribution channels we use. The Company’s Identity Protection Services monitor a customer’s name, social security number, credit cards and address for fraud.  The customer can also include credit monitoring for an additional fee. The monthly subscription rate ranges from $14.95 to $19.95, depending on the marketing or distribution channels used by the Company.

We also offer the MyIdentityDefender security toolbar, which is an Internet browser plug-in that protects Internet users against identity theft.  The MyIdentityDefender security toolbar allows users to rate sites that they visit, see security and user ratings of search results before visiting a site and get access to trusted sites on the web.  The MyIdentityDefender security toolbar generates revenue through search advertising, as our search ad networks pay us a commission for every qualified visitor that clicks on the search ads.

The CyberDefender earlyNETWORK uses a secure peer-to-peer network to provide protection from on-line threats.  Each user of our software is a “node” on the network.  The node senses potential threats and automatically alerts our threat analysis system, which is referred to in this prospectus as the Early Alert Center (“EAC”).  At the heart of the EAC is a proprietary system that automatically tests and grades all potential threats (with some human help for quality assurance).  The EAC relays the threat signature of every proven threat to the Alert Server, a proprietary software application that we developed to deliver threat signature updates and software updates to users of our software.

Unlike conventional security update networks, the Alert Server does not wait to send out a batch of updates to all computers that are a part of our software network, but instead sends out the update without delay.  We can provide immediate updates because we are not broadcasting to all computers at our expense, but instead we are posting the update to be relayed from computer to computer on a secure basis, which makes use of local user bandwidth.  We have applied for patent protection for this technology with the U.S. Patent and Trademark Office.

 
1

 

Risks Related to Our Business

Our business is subject to a number of risks.  You should be aware of these risks before making an investment decision.  These risks are discussed more fully in the section of this prospectus titled “Risk Factors.”

Information Regarding our Capitalization

As of October 9, 2009, we had 23,596,842 shares of common stock issued and outstanding.   We are also committed to issue the following:

·
171,429 shares of common stock underlying 10% Convertible Promissory Notes issued pursuant to various Securities Purchase Agreements dated from May 1, 2009 to May 7, 2009;
 
·
960,000 shares of common stock underlying 10% Convertible Promissory Notes issued pursuant to Securities Purchase Agreements dated from November 13, 2008 to January 28, 2009;
 
·
8,118,359 shares of common stock upon the exercise of warrants having an exercise price of $1.25 per share;
 
·
324,875 shares of common stock upon the exercise of warrants having an exercise price of $1.20 per share;
 
·
706,341 shares of common stock upon the exercise of warrants having an exercise price of $1.01 per share;
 
·
2,566,298 shares of common stock upon the exercise of warrants having an exercise price of $1.00 per share;
 
·
2,500 shares of common stock upon the exercise of warrants having an exercise price of $1.80 per share;
 
·
125,000 shares of common stock upon the exercise of warrants having an exercise price of $1.83 per share;

 
·
15,000 shares of common stock upon the exercise of warrants having an exercise price of $2.25 per share;
 
·
434,000 shares of common stock upon the exercise of 217,000 outstanding unit purchase options having an exercise price of $1.00 per unit, with each unit consisting of one share of common stock and a warrant to purchase one share of common stock for $1.00 per share;
 
·
148,357 shares of common stock underlying 10% Convertible Debentures issued as payment of interest accrued on the 10% Secured Convertible Debentures issued pursuant to the Securities Purchase Agreement dated September 12, 2006, and payment of liquidated damages accrued under the Registration Rights Agreement dated September 12, 2006;
 
·
371,671 shares of common stock underlying 10% Secured Convertible Debentures issued pursuant to Securities Purchase Agreements dated September 12, 2006;
 
·
2,627,082 shares of common stock included in our Amended and Restated 2006 Equity Incentive Plan, from which options for the purchase of 1,094,227 shares of common stock have been granted; and
 
·
753,609 shares of common stock included in our 2005 Equity Incentive Plan (sometimes referred to as our 2005 Stock Option Plan), from which an option for the purchase of 732,607 shares of common stock has been granted.

The Offering

We are registering 9,726,067 shares of our common stock for sale by the selling shareholders identified in the section of this prospectus titled “Selling Shareholders.” The shares included in the table identifying the selling shareholders consist of:

 
2

 

·
1,975,360 shares of common stock sold pursuant to Securities Purchase Agreements dated June 3, 2009 through  July 21, 2009;
 
·
4,621,221 shares of common stock underlying common stock purchase warrants issued to two consultants for interest and services provided to the Company;
 
·
15,000 shares of common stock issued pursuant to the cash exercise of common stock purchase warrants issued to a consultant for services provided to the Company;
 
·
148,000 shares of common stock underlying common stock purchase warrants issued pursuant to various Securities Purchase Agreements dated from November 13, 2008 to January 28, 2009;
 
·
1,838,952 shares of common stock issued as a result of the exercise of common stock purchase warrants pursuant to a warrant tender offer that terminated on August 17, 2009; and
 
·
1,127,534 shares of common stock underlying amended common stock purchase warrants issued pursuant to a warrant tender offer that terminated on August 17, 2009.

Common Shares

On June 4, 2009, we completed the sale of 1,142,860 shares of common stock to GR Match, LLC (“GRM”) for an aggregate purchase price of $2,000,005, of which $400,000 must be used for the creation and production by Guthy-Renker of television commercials advertising the Company’s products and services, and the balance of which we will use for general working capital (the “GR Transaction”).    Pursuant to the terms of the Securities Purchase Agreement documenting the GR Transaction, GRM has demand and piggyback registration rights with respect to the shares.  

On June 10, 2009, we completed the sale of 632,500 shares of common stock to Shimski, L.P. for an aggregate purchase price of $1,106,875, the proceeds of which we will use for general working capital (the “Shimski Transaction”).  Pursuant to the terms of the Securities Purchase Agreement documenting the Shimski Transaction, Shimski has demand and piggyback registration rights with respect to the shares.  

On July 21, 2009, we completed the sale of 200,000 shares of common stock to 28 accredited investors for an aggregate purchase price of $500,000, the proceeds of which we will use for general working capital.  

There were no underwriting discounts or other commissions paid in conjunction with the aforementioned transactions.

Warrants issued to consultants

On October 30, 2008, we executed a letter of intent with GRM to create, market and distribute direct response advertisements to sell our products.  GRM is responsible for creating, financing, producing, testing and evaluating a radio commercial to market our products in exchange for $50,000 and a fully vested warrant to purchase 1,000,000 shares of common stock at a price of $1.25 per share, which we issued in November 2008. The letter also allows the parties the option to elect to have GRM create television commercials to market our products in exchange for an additional warrant to purchase 1,000,000 shares of common stock at a price of $1.25 per share.   On March 24, 2009, we entered into a definitive Media and Marketing Services Agreement with GRM.  Pursuant to the agreement, GRM will provide direct response media campaigns, including radio and television direct response commercials, to promote our products and services and will purchase media time on our behalf. As compensation for GRM’s services, we issued: (i) an amended and restated fully vested five year warrant to purchase 1,000,000 shares of our common stock at an exercise price of $1.25 per share, having both cash and cashless exercise provisions, which superseded and replaced the warrant issued to GRM in November 2008 and (ii) a fully vested five year warrant to purchase 1,000,000 shares of our common stock at an exercise price of $1.25 per share, which may be exercised for cash only. We also issued to GRM a five year warrant to purchase 8,000,000 shares of our common stock at an exercise price of $1.25 per share, to compensate them for providing media placement costs on 45 days terms with us, which may be exercised for cash only, subject to the following vesting condition:  for each $2 of media placement costs advanced by GRM on our behalf, GRM will have the right to purchase one share of our common stock under this warrant.  As of the date of filing this prospectus, 835,295 warrant shares have vested under this last described warrant and, of this amount, 386,221 shares are included in the registration statement of which this prospectus is a part. If GRM terminates the agreement due to a breach by us in our performance or as a result of the Company’s discontinuance, dissolution, liquidation, winding up or insolvency, or if we terminate the agreement for any reason other than as a result of a breach by GRM or our discontinuance, dissolution, liquidation, winding up or insolvency, then, any unexpired and unvested rights of GRM to purchase shares of our common stock pursuant to this last described warrant will immediately vest. We are including the shares underlying the two vested warrants and the vested portion of the last described warrant in the registration statement of which this prospectus is a part.

 
3

 

On November 11, 2008, we entered into a consulting agreement with Newview Consulting L.L.C. (“Newview”). Pursuant to this agreement, Newview provided investor relations services for a period of 6 months in exchange for a warrant to purchase 2,250,000 shares of common stock at an exercise price of $1.25 per share, exercisable for cash only. The right to purchase 900,000 shares vested immediately and the right to purchase 270,000 shares vested on the 1st of each month beginning December 1, 2008 and ending April 1, 2009.  At January 1, 2009, the parties amended the vesting schedule in the Newview warrant to vest the remaining 1,080,000 warrant shares on the first of each month from January 1, 2009 to June 1, 2009 at the rate of 180,000 warrant shares per month.  As of June 1, 2009, the right to purchase all of the warrant shares had vested. Newview assigned warrants to purchase 390,000 shares to four individuals.  One of those individuals exercised his warrant to purchase 15,000 shares of common stock. We are including the 15,000 shares issued and the 2,235,000 shares underlying the warrant in the registration statement of which this prospectus is a part.

10% Convertible Promissory Notes and warrants issued from November 13, 2008 to January 28, 2009

From November 13, 2008 to January 28, 2009 we entered into Securities Purchase Agreements with certain of the selling shareholders to purchase our 10% Convertible Promissory Notes (“2008 Convertible Notes”) in the aggregate principal amount of $1,200,000, which may be converted at the price of $1.25 per share into an aggregate of 960,000 shares of common stock.  In conjunction with the sale of the 2008 Convertible Notes, we issued common stock purchase warrants to purchase an aggregate of 480,000 shares of common stock at an exercise price of $1.25 per share.  Warrants to purchase 132,000 shares of our common stock have been exercised for cash.  Warrants to purchase 200,000 shares of our common stock have been amended pursuant to our tender offer as more fully described below. Warrants to purchase an aggregate of 148,000 shares remain outstanding. We have included 148,000 shares of common stock underlying the warrants in the registration statement of which this prospectus is a part.

Amended warrants issued pursuant to our tender offer

Pursuant to our tender offer that terminated on August 17, 2009, we offered to the holders of warrants issued with “cashless exercise” provisions and/or “down-round” provisions (collectively the “Released Provisions”) the opportunity to increase by 10% the number of shares of common stock covered by their warrants in exchange for eliminating the Released Provisions from the warrants. In order to take advantage of the offer, the warrant holders must have exercised a portion of their warrant(s) and purchased for cash no less than 30% of the shares of common stock covered by their warrant(s), after giving effect to the increase. A total of 50 warrant holders exercised 86 warrants covering 1,838,952 shares of common stock in accordance with the terms of the offer. We also issued amended warrants covering 1,127,534 shares of common stock in accordance with the terms of the offer. We have included 2,966,486 shares of common stock, representing the shares issued to the warrant holders and the shares underlying the amended warrants, in the registration statement of which this prospectus is a part.

Shares outstanding after this offering

After this offering, assuming the issuance of all shares of common stock underlying the warrants described above, we would have 29,469,533 shares of common stock outstanding.  This amount does not include the shares of common stock that we are committed to issue, as described in the section of this prospectus titled “Prospectus Summary - Information Regarding our Capitalization”.

 
4

 

Information about Our Securities

Information regarding our common stock and outstanding warrants is included in the section of this prospectus titled “Description of Securities.”

Corporate Information

We maintain our principal offices at 617 West 7th Street, Suite 401, Los Angeles, California 90017.  Our telephone number at that address is (213) 689-8631.  Our web address is www.cyberdefender.com.  Information included on our website is not part of this prospectus.

 
5

 

Risk Factors

You should carefully consider the risks described below before making an investment decision.  Our business could be harmed by any of these risks.  The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.  In assessing these risks, you should also refer to the other information contained in this prospectus, including our financial statements and related notes.

Risks Related to Our Business

We have been in business only since August 2003.  Our limited operating history makes evaluation of our business difficult.

We were incorporated in the State of California as Network Dynamics in August 2003 and have limited historical financial data upon which to base planned operating expenses or to accurately forecast our future operating results. We have a limited operating history which makes it difficult to evaluate our performance. You must consider our prospects in light of the risks, expenses and difficulties we face as an early stage company with a limited operating history. These risks include uncertainty as to whether we will be able to:

·
increase revenues from sales of our suite of Internet security products;
 
·
successfully protect our earlyNetwork™ from all security attacks;
 
·
successfully protect personal computers or networks against all Internet threats;
 
·
respond effectively to competitive pressures;
 
·
protect our intellectual property rights;
 
·
continue to develop and upgrade our technology; and
 
·
continue to renew our customers’ subscriptions to current and future products.

We incurred net losses for our last three fiscal years and for the first six months of the 2009 fiscal year.  We are not certain that our operations will ever be profitable.

We incurred a net loss of $5,507,600 for the fiscal year ended December 31, 2006, a net loss of $5,866,123 for the fiscal year ended December 31, 2007 and a net loss of $11,251,772 for the fiscal year ended December 31, 2008.  We had a net loss of $9,632,618 for the six months ended June 30, 2009.
 
We can provide no assurance as to when, or if, we will be profitable in the future.  Even if we achieve profitability, we may not be able to sustain it.

We may be unable to continue as a going concern.

Our financial statements have been prepared on a going concern basis which assumes that we will be able to realize our assets and discharge our liabilities in the normal course of business for the foreseeable future.  We generated a net loss of $9,632,618 and used cash in operating activities of $4,311,066 for the six months ended June 30, 2009.  At this date, we had negative working capital of $6,950,306.  At June 30, 2009 we had an accumulated deficit of $34,721,412 and our stockholders’ deficit was $7,434,939.
 
Our ability to continue as a going concern is in substantial doubt as it is dependent on a number of factors including, but not limited to, the receipt of continued financial support from our investors, our ability to control and possibly reduce our expenses, our ability to raise equity or debt financing as we need it, and whether we will be able to use our securities to meet certain of our liabilities as they become payable. The outcome of these matters is dependent on factors outside of our control and cannot be predicted at this time.

Regulations under the Securities Exchange Act of 1934 require public companies to maintain “disclosure controls and procedures.” Our disclosure controls and procedures are not effective at the reasonable assurance level due to several material weaknesses. Additionally, we have been unable to maintain effective internal controls over our financial reporting in accordance with section 404 of the Sarbanes-Oxley Act of 2002.  This could have a material adverse effect on our business and stock price.

We reported several material weaknesses in our internal controls and concluded that we did not have effective disclosure controls and procedures in place and additionally did not have effective internal control over financial reporting as of December 31, 2008 and June 30, 2009.  Implementing any changes to remedy these deficiencies will likely require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems (such as recruiting and hiring additional employees to assist with accounting functions, purchasing, installing and training employees in the use of special software, paying for the costs of continuing education for our employees involved with accounting functions, etc.), and take a significant period of time to complete.  If we fail to remediate the material weaknesses, we will not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act, as such standards are modified, supplemented or amended from time to time.  Failure to achieve and maintain an effective internal control environment could have a material adverse effect on our stock price and could result in our financial statements being unreliable or loss of investor confidence in our financial reports.  Additionally, failure to maintain effective internal control over our financial reporting could result in government investigation or sanctions by regulatory authorities.

 
6

 

We sell our products over the Internet, however such activities may not be secure. If a breach of security occurred, our reputation could be damaged and our business and results of operations could be adversely affected.

A significant barrier to online commerce and communications is the secure transmission of confidential information over public networks.  Our customers authorize us to bill their credit card accounts directly for the purchase price of our products.  We rely on encryption and authentication technology licensed from third parties to provide the security and authentication technology to effect secure transmission of confidential information, including customer credit card numbers.  There can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography, or other events or developments will not result in a compromise or breach of the technology used by us to protect customer transaction data.  If any such compromise of our security were to occur, it could have a material adverse affect on our reputation and, therefore, on our business and results of operations.

During the past 18 months our business has grown rapidly. If we do not manage this growth carefully, our business and results of operations could be adversely affected.

Since January 1, 2008, our business has grown rapidly.  During the 6 months ended June 30, 2009, our sales increased 41% over our sales during the 12 months ended December 31, 2008.  Also, the number of full-time employees and consultants we employ grew from 35 full-time employees and 3 independent contractors in March 2009 to 61 full-time employees and 14 independent contractors as of the date of this prospectus.  Growth of our business at this pace places a strain on our management and resources and has required, and may continue to require, the implementation of new operating systems, procedures and controls and the expansion of our facilities.  Our failure to manage our growth and expansion could adversely affect our business, results of operations and financial condition.  Failure to implement new systems effectively or within a reasonable period of time could adversely affect our business and results of operations.

We have made a significant investment in personnel and overhead in anticipation that our growth will continue. If the projections about our growth are mistaken, our operating results could be adversely affected.

During the past 18 months we have experienced significant growth and we believe that our growth will continue for the immediate future.   For that reason we have made significant investments in personnel and overhead.  If our growth does not continue, our operating expenses will continue to exceed our revenue, significantly affecting our ability to continue operating.  Although we may be able to eliminate or reduce some of the expenses through a reduction in workforce or a reduction in costs, some costs such as rent could not be easily reduced. As a result, our operating results could be adversely affected.

Our Media and Marketing Services Agreement with GRM could be terminated. The termination of this agreement could adversely affect our operating results.
 
Although we are not currently generating significant revenue from the Media and Marketing Services Agreement with GRM, we believe that the services provided to us by GRM will eventually produce significant revenues.  Pursuant to the terms of the agreement GRM may terminate the agreement if there is a breach or default in performance of any obligation, unless the breach or default is cured within 15 business days following receipt of written notice from the non-breaching party; upon the discontinuance, dissolution, liquidation or winding up of the other party’s business or the insolvency of the other party; or by either party for any reason by giving the other party written notice of the termination at least 30 days prior to the effective date of termination. Additionally, after May 30, 2009, GRM is entitled to terminate the agreement upon 5 days written notice to us in the event that the average media placement costs for any 3 consecutive months during the term are less than $250,000 per month.  If we earn significant revenues from our agreement with GRM, but GRM decides to terminate the agreement, our operating results could be adversely affected.

 
7

 

We may be required to pay GRM royalty payments. This could adversely affect our operating results.

If the average closing price of our common stock as reported by Bloomberg LP for the 20 trading days preceding January 1, 2010 is not at least $3.00 per share or if our common stock is not publicly traded on any stock exchange or over-the-counter market as of December 31, 2009, then we will be required to pay a monthly royalty to GRM.  The royalty will be equal to 20% of gross renewal revenue, which is defined as the aggregate gross revenue, net of refunds and chargebacks, earned by us as a result of renewals and/or re-orders of our products by our customers who both (i) became customers during the period commencing on March 1, 2009 and ending upon the earlier of (A) the termination date of the Media and Marketing Services Agreement or (B) the date following January 1, 2010 when the average closing price of our common stock as reported by Bloomberg LP for the 20 trading days preceding that date was at least $5.00 per share and (ii) initially purchased any of our products from any direct response websites.  Our obligation to pay these royalties will survive the expiration or termination of the agreement. If we are required to pay this royalty, our expenses may increase significantly, which could have an adverse affect on our operating results.

We face intense competition from other providers of Internet security software.  If we cannot offer consumers a reason to use our software instead of the software marketed by our competitors, our business and the results of our operations will be adversely affected.

We have many competitors in the markets for our products.  Our competitors include software companies that offer products that directly compete with our products or that bundle their software products with Internet security software offered by another company.  End-user customers may prefer purchasing Internet security software that is manufactured by the same company that provides its other software programs because of greater product breadth offered by the company, perceived advantages in price, technical support, compatibility or other issues.

Some of our competitors include WebRoot Software, Kaspersky Labs and Sunbelt Software. Many of our competitors, such as TrendMicro, McAfee and Norton have greater brand name recognition and financial, technical, sales, marketing and other resources than we do and consequently may have an ability to influence customers to purchase their products rather than ours. Our future and existing competitors could introduce products with superior features, scalability and functionality at lower prices than our products and could also bundle existing or new products with other more established products in order to compete with us. Our competitors could also gain market share by acquiring or forming strategic alliances with our other competitors. Finally, because new distribution methods offered by the Internet and electronic commerce have removed many of the barriers to entry historically faced by start-up companies in the software industry, we may face additional sources of competition in the future.
 
We rely on the services of QResolve to provide tech-on-call services. If we were to lose the services of QResolve, this portion of our business could be disrupted.

For an annual fee, CyberDefenderULTIMATE provides year round tech-on-call services for any software or hardware connected to a subscriber’s computer. These tech-on-call services are provided by QResolve, a business partner. If we lose our working relationship with QResolve and are unable to replace it with an equally competent tech-on-call service provider at competitive pricing, or if the quality of QResolve’s services deteriorates for any reason, our ability to service customers may suffer and our revenues from CyberDefenderULTIMATE could be adversely affected. We would also be required to spend a significant amount of time and effort to find and train a new service provider, which would take management’s attention away from the day-to-day operations of our business. We could also be required to file a legal action to recover money paid in advance for services that were never provided. This could have a material adverse effect on our business and results of operations.

 
8

 

If we are unable to develop and maintain new and enhanced Internet security or identity protection products and services to meet emerging industry standards, our operating results could be adversely affected.

Our future success depends on our ability to address the rapidly changing needs of our customers by developing, acquiring and introducing new products, product updates and services on a timely basis. For example, in September 2007, we launched CyberDefenderULTIMATE™ and CyberDefenderCOMPLETE™. These are enhanced versions of our Internet security software. In August 2008, we launched our Identity Protection Services.  These services monitor a customer’s name, social security number, credit cards and address for fraud.  The customer can also include credit monitoring for an additional fee. In November 2008, we released CyberDefender Registry Cleaner™.  The CyberDefender Registry Cleaner™ eliminates clutter and junk that builds up within a computer's registry due to the installation and removal of programs, deletion and creation of files and cached records from Web surfing.  The success of our business depends on our ability to keep pace with technological developments and emerging industry standards. We intend to commit a portion of our resources to developing new applications for threat research and new security applications for Web 2.0 and social networking environments. However, if we are unable to successfully develop such products or if we develop these products but demand for them does not materialize or occurs more slowly than we expect, we will have expended resources (such as personnel and equipment) and capital without realizing sufficient revenue to recover these costs, and our operating results could be adversely affected.

If we fail to adapt our technologies to new Internet technologies, we could lose customers and key technology partners.  This would have a material adverse effect on our revenues, our business and the results of our operations.

Internet technology is constantly evolving to make the user's experience easier and more comprehensive. Our products use Internet technologies. We must constantly monitor new technologies and adapt our technologies to them as appropriate. If we fail to keep our products compatible with the latest Internet technologies, they may not perform adequately and we may lose not only our customers, but those suppliers and partners whose Internet technologies support our products. The loss of our customers or our suppliers and partners would have a material adverse effect on our revenues, our business and the results of our operations.

Because of the constant development of new or improved products in the software industry, we must continually update our products or create new products to keep pace with the latest advances.  While we do our best to test these products prior to their release, they may nevertheless contain significant errors and failures, which could adversely affect our operating results.

With the constant changes in the software industry as new standards and processes emerge, we are required to continually update our suite of Internet security products.  While we do our best to test these products prior to their release, due to the speed with which we are required to release new or updated products to remain competitive, they could be released with errors or they may fail altogether.  These errors or failures may put the users of our software at risk because their computers will not be adequately protected against spyware, viruses, spam or phishing attacks. We try to reduce this risk by constantly upgrading our software and by working closely with the creators of the operating platforms, particularly Microsoft, to make sure that our software works with the operating platform. However, if our existing suite of Internet security products and our future products fail to perform adequately or fail entirely, our operating results could be adversely affected.

Loss of any of our key management personnel, particularly Gary Guseinov, could negatively impact our business and the value of our common stock.

Our ability to execute our business strategy will depend on the skills, experience and performance of key members of our management team. We depend heavily on the services of Gary Guseinov, our Chief Executive Officer, Igor Barash, our Chief Information Officer and Secretary and Kevin Harris, our Chief Financial Officer. We believe that the skills of Mr. Guseinov would be particularly difficult to replace. We have long-term employment agreements with Gary Guseinov and Kevin Harris. We have entered into an employment agreement with Mr. Barash, but it is “at-will” and does not preclude him from leaving us.

 
9

 

If we lose members of our key management personnel, we may be forced to expend significant time and money in the pursuit of replacements, which could result in both a delay in the implementation of our business plan and the diversion of limited working capital. We cannot assure you that we will find satisfactory replacements for these key management personnel at all, or on terms that are not unduly expensive or burdensome to our company. We only maintain a key man insurance policy on the life of Gary Guseinov.

To date, our business has been developed assuming that laws and regulations that apply to Internet communications and e-commerce will remain minimal.  Changes in government regulation and industry standards may adversely affect our business and operating results.

We have developed our business assuming that the current state of the laws and regulations that apply to Internet communications, e-commerce and advertising will remain minimal.  At this time, complying with these laws and regulations is not burdensome.  However, as time exposes various problems created by Internet communications and e-commerce, laws and regulations may become more prevalent.  These regulations may address issues such as user privacy, spyware, pricing, intellectual property ownership and infringement, taxation, and quality of products and services.  This legislation could hinder growth in the use of the Internet generally and decrease the acceptance of the Internet as a communications, commercial and advertising medium.  Changes in current regulations or the addition of new regulations could affect the costs of communicating on the Internet and adversely affect the demand for our products or otherwise harm our business, results of operations and financial condition.

Our business is the development and distribution of software. If we do not protect our proprietary information and prevent third parties from unauthorized use of our technology, our business could be harmed.

We rely on a combination of copyright, patent, trademark and trade secret laws, confidentiality procedures, contractual provisions and other measures to protect our proprietary information, especially our software codes. All of these measures afford only limited protection. These measures may be invalidated, circumvented or challenged, and others may develop technologies or processes that are similar or superior to our technology. We may not have the proprietary information controls and procedures in place that we need to protect our proprietary information adequately. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy our software or obtain or use information that we regard as proprietary, which could harm our business.

Third parties claiming that we infringe their proprietary rights could cause us to incur significant legal expenses and prevent us from selling our products.

As the number of products in the software industry increases and the functionality of these products further overlap, we believe that we may become increasingly subject to infringement claims, which could include patent, copyright and trademark infringement claims. In addition, former employers of our former, current or future employees may assert claims that such employees have improperly disclosed to us the confidential or proprietary information of these former employers. Any such claim, with or without merit, could:

·
be time consuming to defend;
 
·
result in costly litigation;
 
·
divert management’s attention from our core business;
 
·
require us to stop selling, delay providing or redesign our product; and
 
·
require us to pay monetary amounts as damages or for royalty or licensing arrangements.

Risks Related to Ownership of Our Securities

Our common stock began to be quoted on the OTC Bulletin Board on August 2, 2007. We cannot assure you that an active public trading market for our common stock will develop or be sustained. Even if an active market develops, it may not be possible to sell shares of our Common Stock in a timely manner.

 
10

 

While our common stock began to be quoted on the OTC Bulletin Board on August 2, 2007, to date an active trading market has not developed and we cannot guarantee you that an active trading market will ever develop. This situation may be attributable to a number of factors, including the fact that we are a small company that is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume, and that even if we came to the attention of such persons, they tend to be risk averse and may be reluctant to follow a relatively unproven company such as ours or purchase or recommend the purchase of our shares until such time as we became more seasoned and viable. As a consequence, even though our common stock is quoted on the OTC Bulletin Board, there may be periods of several days or more when trading activity in our shares is minimal or nonexistent, as compared to a seasoned issuer that has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. Because an active trading market may not develop, it may not be possible to sell shares of our common stock in a timely manner.

Our common stock is considered a “penny stock”. The application of the “penny stock” rules to our common stock could limit the trading and liquidity of the common stock, adversely affect the market price of our common stock and increase transaction costs to sell those shares.

Our common stock is a “low-priced” security or “penny stock” under rules promulgated under the Securities Exchange Act of 1934. In accordance with these rules, broker-dealers participating in transactions in low-priced securities must first deliver a risk disclosure document which describes the risks associated with such stocks, the broker-dealer’s duties in selling the stock, the customer’s rights and remedies and certain market and other information. Furthermore, the broker-dealer must make a suitability determination approving the customer for low-priced stock transactions based on the customer’s financial situation, investment experience and objectives. Broker-dealers must also disclose these restrictions in writing to the customer, obtain specific written consent from the customer, and provide monthly account statements to the customer. The effect of these restrictions will probably decrease the willingness of broker-dealers to make a market in our common stock, will decrease liquidity of our common stock and will increase transaction costs for sales and purchases of our common stock as compared to other securities.

The stock market in general and the market prices for penny stocks, in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad fluctuations may be the result of unscrupulous practices that may adversely affect the price of our stock, regardless of our operating performance.

Shareholders should be aware that, according to SEC Release No. 34-29093 dated April 17, 1991, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. The occurrence of these patterns or practices could increase the volatility of our share price. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management's attention and resources.

Our executive officers and directors, along with their friends and family, own or control approximately 35% of our issued and outstanding common stock, which makes it more difficult for our non-management shareholders to determine the outcome in matters requiring shareholder approval.  Additionally, this concentration of ownership could discourage or prevent a potential takeover that might otherwise result in our shareholders receiving a premium over the market price for our common stock.

 
11

 

Approximately 35% of the issued and outstanding shares of our common stock is owned and controlled by a group of insiders, including current directors and executive officers and their friends and family.  Mr. Gary Guseinov, our Chief Executive Officer and President, owns approximately 27% of our issued and outstanding common stock.  These insiders may be able to exert significant influence in matters requiring approval by our shareholders, including the election of directors, mergers or other business combinations.  Such concentrated ownership may also make it difficult for our shareholders to receive a premium for their shares of our common stock in the event we merge with a third party or enter into other transactions that require shareholder approval.  These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock.

We do not expect to pay dividends for the foreseeable future, and we may never pay dividends.

We currently intend to retain any future earnings to support the development of our business and do not anticipate paying cash dividends in the foreseeable future. Our payment of any future dividends will be at the discretion of our board of directors after taking into account various factors, including but not limited to our financial condition, operating results, cash needs, growth plans and the terms of any credit agreements that we may be a party to at the time. In addition, our ability to pay dividends on our common stock may be limited by California state law. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize a return on their investment. Investors seeking cash dividends should not purchase our common stock.

Limitations on director and officer liability and our indemnification of officers and directors may discourage shareholders from bringing suit against a director.

Our articles of incorporation and bylaws provide that the liability of our directors for monetary damages shall be eliminated to the fullest extent under California law. These provisions may discourage shareholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by shareholders on our behalf against a director. In addition, our bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by California law. We have also entered into indemnity agreements with each of our officers and directors which are more fully described in the section of this prospectus titled “Certain Relationships and Related Transactions”.

Future sales of our common stock could put downward selling pressure on our shares, and adversely affect the stock price. There is a risk that this downward pressure may make it impossible for an investor to sell his shares at any reasonable price, if at all.

Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could put downward selling pressure on our shares, and adversely affect the market price of our common stock.
 
Special Note Regarding Forward-Looking Statements
 
This prospectus, including the sections titled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Description of Business,” contains forward-looking statements. These are statements regarding financial and operating performance and results and other statements that are not historical facts. The words “expect,” “project,” “estimate,” “believe,” “anticipate,” “intend,” “plan,” “forecast,” and similar expressions are intended to identify forward-looking statements. Certain important risks could cause results to differ materially from those anticipated by some of the forward-looking statements. Some, but not all, of these risks include, among other things:

·
our lack of capital and whether or not we will be able to raise capital when we need it;
 
·
changes in local, state or federal regulations that will adversely affect our business;
 
·
our ability to market and distribute or sell our products;
 
·
our ability to protect our intellectual property and operate our business without infringing on the intellectual property rights of others;

 
12

 

·
whether we will continue to receive the services of certain officers and directors; and
 
·
other uncertainties, all of which are difficult to predict and many of which are beyond our control.

These statements relate to future events or our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We do not intend to update any of the forward-looking statements after the date of this prospectus or to conform these statements to actual results.  You should refer to and carefully review the information in future documents we file with the Securities and Exchange Commission.

Use of Proceeds

We will not receive any proceeds from the sale of the shares by the selling shareholders.  All proceeds from the sale of the shares being offered will be for the account of the selling shareholders, as described below in the sections titled “Selling Shareholders” and “Plan of Distribution.”  However, we may receive up to $7,183,728 upon exercise of warrants for cash, the underlying shares of which are included in the registration statement of which this prospectus is a part.  If received, these funds will be used for general corporate purposes, including working capital requirements.  With the exception of any brokerage fees and commissions which are the obligation of the selling shareholders, we are responsible for the fees, costs and expenses of this offering which are estimated to be $35,194, inclusive of our legal and accounting fees, printing costs and filing and other miscellaneous fees and expenses.

Market for Common Equity and Related Shareholder Matters

On August 2, 2007 our common stock was approved for quotation on the OTC Bulletin Board under the symbol “CYDE”.  As of October 9, 2009 we had 23,596,842 shares of common stock issued and outstanding. As of October 9, 2009 we had 167 record holders of our common stock.  This does not include an indeterminate number of shareholders whose shares are held by brokers in street name.

The following table sets forth, for the periods indicated, the high and low bid information per share of our common stock as reported by the OTC Bulletin Board.  These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions

   
PERIOD
 
HIGH
   
LOW
 
                 
Fiscal Year Ended December 31, 2009
 
First Quarter
 
$
1.28
   
$
0.51
 
   
Second Quarter
 
$
3.49
   
$
1.15
 
   
Third Quarter
 
$
3.30
   
$
1.80
 
   
Fourth Quarter through October 9, 2009
 
$
3.00
   
$
2.10
 
                     
Fiscal Year Ended December 31, 2008
 
First Quarter
 
$
1.06
   
$
0.61
 
   
Second Quarter
 
$
2.00
   
$
0.63
 
   
Third Quarter
 
$
1.77
   
$
0.75
 
   
Fourth Quarter
 
$
1.40
   
$
0.70
 
                     
Fiscal Year Ended December 31, 2007(1)
 
First Quarter
 
$
0
   
$
0
 
   
Second Quarter
 
$
0
   
$
0
 
   
Third Quarter
 
$
0.90
   
$
0.90
 
   
Fourth Quarter
 
$
0.48
   
$
1.56
 
 
(1) Our common stock did not trade during the first and second quarters of the 2007 fiscal year. Our common stock began to trade on August 2, 2007.

 
13

 

After this offering, assuming the issuance of all shares of common stock underlying the warrants described in this prospectus under the section titled “Prospectus Summary - The Offering”, we would have 29,493,597 shares of common stock outstanding.  This amount does not include a total of 1,651,457 shares of common stock that are underlying our convertible promissory notes and debentures, 6,395,618 shares of common stock that would be issued upon the exercise of warrants or unit purchase options and 3,380,691 shares of common stock reserved for issuance under our Amended and Restated 2006 Equity Incentive Plan and our 2005 Equity Incentive Plan (sometimes referred to as our 2005 Stock Option Plan).  See the discussion in the section of this prospectus titled, “Prospectus Summary – The Offering – Shares outstanding after this offering.”

We have outstanding 15,347,920 shares of restricted common stock, of which 4,130,209 shares may be sold pursuant to Rule 144, promulgated under the Securities Act of 1933.

Dividends

During the year ended December 31, 2005, our Board of Directors authorized the payment of a dividend of $0.05 per share. The total amount of the dividend was $31,400.  The dividend was paid to all of our shareholders, with the exception of shareholders who were also officers and directors.  However, we anticipate that any future earnings will be retained for the development of our business and we do not anticipate paying any dividends on our common stock in the foreseeable future.

Sections 500 through 503 of the California Corporations Code place restrictions upon the ability of California corporations to pay dividends.  Pursuant to these sections, in general, a California corporation may not make any distribution to the corporation’s shareholders (i) unless the amount of the retained earnings of the corporation immediately prior to the distribution equals or exceeds the amount of the proposed distribution; (ii) if the corporation is, or as a result of the distribution would be, likely to be unable to meet its liabilities as they mature; (iii) if, after giving effect to the distribution, the excess of the corporation’s assets over its liabilities would be less than the liquidation preference of all shares having a preference on liquidation over the class or series to which the distribution is made; or (iv) unless the amount of the retained earnings of the corporation immediately prior to the distribution equals or exceeds the amount of the proposed distribution plus the aggregate amount of the cumulative dividends in arrears on all shares having a preference with respect to payment of dividends over the class or series to which the distribution is made.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the notes to those statements included elsewhere in this prospectus.  In addition to the historical financial information, the following discussion and analysis contains forward-looking statements that involve risks and uncertainties.  Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We have developed a Collaborative Internet Security Network, which we refer to as the “CISN” or the “earlyNETWORK”, which is based on certain technology principles commonly found in a peer-to-peer network infrastructure.  A peer-to-peer network does not have the notion of clients or servers, but only equal peer nodes that simultaneously function as both “clients” and “servers” to the other nodes on the network.  This means that when a threat is detected from a computer that is part of the earlyNETWORK, the threat is relayed to our Early Alert Center.  The Early Alert Center tests, grades and ranks the threat, automatically generates definition and signature files based on the threat, and relays this information to the Alert Server, in some cases after a human verification step.  The Alert Server will relay the information it receives from the Early Alert Center to other machines in the earlyNETWORK, and each machine that receives the information will, in turn, relay it to other machines that are part of the earlyNETWORK.  This protocol allows us to rapidly distribute alerts and updates regarding potentially damaging viruses, e-mails and other threats to members of the earlyNETWORK, without regard for the cost of the bandwidth involved.  Because cost is not a factor, updates can be continuous, making our approach significantly faster than the client/server protocols used by traditional Internet security companies that provide manual broadcast-updated threat management systems.  Computer users join the earlyNETWORK simply by downloading and installing our software.

 
14

 

Historically, our revenues were derived from the sales of, and ongoing subscriptions for, a single product, CyberDefender Anti-Spyware 2006. The product was sold at a price of $39.99, which included the initial download and one year of updates.  The license to use the software was renewed annually, also at $39.99, with incentives for early renewals.  On November 20, 2006 we stopped licensing this product to new subscribers (although we continue to support and upgrade it for existing users).  We now offer a full line of Internet security products, which includes CyberDefender Early Detection Center V2.0 and CyberDefender Free V2.0, as well as upgrades to these products.  CyberDefender Early Detection Center V2.0 and CyberDefender Free V2.0 are complete Internet security suites that protect home computer users against spam, spyware, viruses and scams.  The software programs are identical but are distributed in one of two ways.  If the subscriber chooses the free version (CyberDefender Free V2.0), he will receive the software with advertising banners in it.  If the subscriber does not wish to receive the advertising, he may pay to purchase a license for CyberDefender Early Detection Center V2.0.  The annual licensing fee can be as low as $12.99 or as high as $49.99, depending on the marketing and distribution channels that we use.

Additionally on September 27, 2007, we announced the launch of CyberDefenderULTIMATE and CyberDefenderCOMPLETE.  These are enhanced versions of our security software.  For an annual fee, CyberDefenderULTIMATE provides year round support for any software or hardware connected to a subscriber’s computer while CyberDefenderCOMPLETE provides year-round unlimited anti-malware support for a subscriber’s computer with a one time live technical support call.  These new security suites also include 2 gigabytes of online backup.  These products are sold for $99.99 to $299.99 per year.  We also offer a free Internet security toolbar called MyIdentityDefender (“MyID”).  MyID is free to use and generates revenue through search advertising. In August 2008, we announced the launch of our Identity Protection Services.  These services monitor a customer’s name, social security number, credit cards and address for fraud.  The customer can also include credit monitoring for an additional fee. The monthly subscription rate ranges from $14.95 to $19.95, depending on the marketing or distribution channels we use. On November 20, 2008, the Company announced the launch of CyberDefender Registry Cleaner.  CyberDefender Registry Cleaner eliminates clutter and junk that builds up within a computer's registry due to the installation and removal of programs, deletion and creation of files and cached records from Web surfing.  The annual subscription rate ranges from $19.99 to $39.98, depending on the marketing or distribution channels we use. 

In the past, we acquired new users primarily with an online direct purchase offer.  The offer, to scan a computer for spyware and then pay for removal of the spyware found, was broadcast in e-mails, banners and search ads.  We are now partnering with other online businesses, such as those providing search engine marketing services and distribution services, as well as pursing other advertising channels such as television, radio and retail, for the purpose of generating new users of our software.  These new partnerships will offer additional avenues for distribution of our products and are mainly revenue sharing partnerships, whereby our partner retains a portion of the revenue for every item sold.  This allows us to incrementally increase revenue while not incurring additional marketing and advertising expenses.

The following table summarizes our revenue for the sale of our products during each quarter of the two most recently completed fiscal years as well as the first two quarters of 2009.  Sales include renewals of our CyberDefender Anti-Spyware 2006 product, as well as sales of our CyberDefender Early Detection Center V2.0, CyberDefenderULTIMATE™, CyberDefenderCOMPLETE™ and CyberDefender Registry Cleaner™ products and advertising revenue derived from our CyberDefender FREE V2.0 product and the MyID toolbar.

 
15

 


Quarter Ended
 
Sales
 
31-Mar-07
 
$
666,136
 
30-Jun-07
 
$
628,443
 
30-Sep-07
 
$
544,956
 
31-Dec-07
 
$
380,619
 
Fiscal Year 2007 Totals
  
$
2,220,154
 
         
31-Mar-08
 
$
475,046
 
30-Jun-08
 
$
742,862
 
30-Sep-08
 
$
1,202,715
 
31-Dec-08
 
$
2,467,136
 
Fiscal Year 2008 Totals
 
$
4,887,759
 
         
31-Mar-09
 
$
3,191,630
 
30-Jun-09
 
$
3,686,644
 
Fiscal Year 2009 Totals
 
$
6,878,274
 

CyberDefender Early Detection Center V2.0 is typically offered to consumers on a trial basis. The consumer downloads a limited version of the software from the Internet.  Using the trial version, the consumer scans his computer for threats and then has the option to upgrade to a fully featured version of the software for a fee.  Typically, the trial version is limited to a simple security scan. Once upgraded, users are able to remove the threats from their PCs.

CyberDefenderFREE is offered to consumers at no cost.  CyberDefenderFREE generates revenue through banner advertisements and upgrades.  There is no trial period for using the CyberDefender FREE V2.0 software.  Once a subscriber downloads the software, it is his to keep and we receive payment from the advertisers.

By providing the software with and without advertising, we generate revenues from either the advertiser or the subscriber.  This business model allows any computer user to obtain protection against Internet threats, regardless of his ability to pay.  We made this change because we believe that the advertising revenue we may receive, in conjunction with the licensing fees we receive, could be substantial.  We obtain the ads from ad networks, which are plentiful.  Ad networks provide advertising for a website and share advertiser revenue each time the website visitors click on the ads.  During the month that the ads are displayed on a subscriber’s computer, revenues will be earned from the ad networks each time an ad is shown (per impression) or when an ad is clicked (per click) or for each action taken by the subscriber after he clicks on the ad and visits the advertiser’s website (per action).

While we were developing CyberDefender Early Detection Center/CyberDefender FREE 2.0, we slowed down our efforts in marketing our CyberDefender Anti-Spyware 2006 software so that we could devote more of our financial resources to the development of our new product.  The expense of turning our business from a marketer of a single software product into a developer of a suite of Internet security products exceeded our revenues.  During this period, our new user marketing was restricted to experimental activities.  Therefore, as and when we needed cash, we sold our securities.  To date, we have received $5,775,000 from the sale of our convertible debt securities, $800,000 from the sale of our 7.41% Original Issue Discount Notes, $160,000 from the issuance of a note payable to a shareholder, $4,916,880 from the sale of our common stock and units consisting of our common stock and warrants and $2,081,016 from the exercise of warrants in connection with a warrant tender offer.

We are continuing to roll-out our CyberDefender Early Detection Center V2.0/CyberDefender FREE V2.0, CyberDefenderULTIMATE, CyberDefender Identity Protections Services, MyIdentityDefender and CyberDefender Registry Cleaner products and, to date, revenues we receive from advertising or from those who license the products have not been adequate to support our operations.  We stopped selling CyberDefenderCOMPLETE, which we launched in September 2007 and which provided a one-time fix and year-round unlimited anti-malware support for a subscriber’s computer, in July 2009. We expect that our expenses will continue to exceed our revenues for at least the next two to three months.  We currently believe that we have enough cash to fund our operations through June 2010.  In order to fund our operations beyond that date, we will be required to borrow money or to find other sources of financing.  We do not have any commitments for financing at this time and we cannot guarantee that we will be able to find financing when we need it.  If we are unable to find financing when we need it we may be required to curtail, or even to cease, our operations.

 
16

 

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses for each period.  The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue recognition.  We recognize revenue from the sale of software licenses under the guidance of SOP No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” and SEC Staff Accounting Bulletin (SAB) 104.

Specifically, we recognize revenues from our CyberDefender Anti-Spyware 2006, CyberDefender Early Detection Center, CyberDefenderULTIMATE and CyberDefenderCOMPLETE products when all of the following conditions for revenue recognition are met:

· 
persuasive evidence of an arrangement exists,
 
· 
the product or service has been delivered,
 
· 
the fee is fixed or determinable, and
 
· 
collection of the resulting receivable is reasonably assured.
 
We currently sell four products, CyberDefender Early Detection Center (“EDC”), an antivirus and anti spyware software, CyberDefender Registry Cleaner, CyberDefenderULTIMATE and Identity Protection Services, over the Internet. We also offer a backup CD-ROM of the EDC software for an additional fee.  CyberDefenderCOMPLETE offered customers one-time technical support and a license for EDC, while CyberDefenderULTIMATE offers customers unlimited technical support for a specified period and a license for EDC.  Customers order the product and simultaneously provide their credit card information to us.  Upon receipt of authorization from the credit card issuer, we provide technical support if the customer purchased CyberDefenderULTIMATE or CyberDefenderCOMPLETE and a license allowing the customer to download EDC over the Internet.  As part of the sales price, we provide renewable product support and content updates, which are separate components of product licenses and sales.  Term licenses allow customers to use our products and receive product support coverage and content updates for a specified period, generally twelve months.  We invoice for product support, content updates and term licenses at the beginning of the term.  These revenues contain multiple element arrangements where “vendor specific objective evidence” (“VSOE”) may not exist for one or more of the elements.  EDC and CyberDefenderULTIMATE are in substance a subscription and the entire fee is deferred and is recognized ratably over the term of the arrangement according to the guidance in SOP 97-2 paragraph 49.  Revenue is recognized immediately for the sale of the backup CD-ROM and CyberDefender Registry Cleaner as we believe that all of the elements necessary for revenue recognition have occurred.  We stopped selling CyberDefenderCOMPLETE in July 2009.   We recognized the portion of the sale of CyberDefenderCOMPLETE that related to the one-time technical support immediately upon the sale of the product.

We also use third parties to sell our software and therefore we evaluate the criteria of Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent”, in determining whether it is appropriate to record the gross amount of revenue and related costs or the net amount earned as commissions.  We are the primary obligor, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, establish product specifications, and have the risk of loss as it relates to cargo losses.  Accordingly, our revenue is recorded on a gross basis.

 
17

 

We also offer two products which are free to the subscriber, CyberDefender FREE 2.0 and MyIdentityDefender Toolbar. Revenues are earned from advertising networks which pay the Company to display advertisements inside the software or through the toolbar search. Under the guidance of SAB 104, we recognize revenue from the advertising networks monthly based on a rate determined either by the quantity of the ads displayed or the performance of the ads based on the amount of times the ads are clicked by the user. Furthermore, advertising revenue is recognized provided that no significant obligations remain at the end of a period and collection of the resulting receivable is probable. Our obligations do not include guarantees of a minimum number of impressions.

Deferred charges. We use a third party service provider for the technical support services provided as part of our CyberDefenderCOMPLETE and CyberDefenderULTIMATE products.  The costs associated with this service are deferred and expensed over the same period as the related revenue.

We use third parties to process a portion of our product renewal sales.  We pay a direct acquisition fee to the processors for each completed sale.  These direct acquisition fees are deferred and recognized ratably over the term of the arrangement of the associated sale in accordance with FASB Technical Bulletin 90-1, “Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts”.  The third party processors refund any direct acquisition cost paid to it on any credit card chargeback or on any product that is returned. The refunds are matched against the associated chargebacks and product returns.

Reserves for product returns. The Company’s policy with respect to product returns is defined in its End User License Agreement (“EULA”), which states “...products purchased that are downloadable are refundable within the first 30 days after the date of purchase.” Product returns are generally received within 30 days of the original sale and are charged against the associated sale upon receipt of the return.  A chargeback occurs when a customer contacts their issuing credit card company directly to request a refund instead of contacting the Company.  The Company’s third party processor is usually notified within 30 days of any chargebacks by the issuing credit card company.  The third party processor reduces the amounts due to the Company as a result of any chargeback during the preceding 30 day period.  As a result, a majority of chargebacks occur within 30 days of the sale event and are recorded prior to closing the previous month’s accounting records.  The Company may voluntarily accept returns from a customer after 30 days of purchase. The returns are charged against revenues upon receipt. As of June 30, 2009 and 2008, the Company had $0 accrued for customer returns and chargebacks, based on historical returns.

Software Development Costs.  We account for software development costs in accordance with SFAS No. 86, “Computer Software to Be Sold, Leased, or Otherwise Marketed”.  Such costs are expensed prior to achievement of technological feasibility and thereafter are capitalized.  We have had very limited software development costs incurred between the time the software and its related enhancements have reached technological feasibility and its general release to customers.  As a result, all software development costs have been charged to product development.

Stock Based Compensation and Fair Value of our Shares.  We adopted SFAS No. 123 (Revised 2004), “Share Based Payment” (“SFAS No. 123R”), under the modified-prospective transition method on January 1, 2006.  SFAS No. 123R requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value.  Share-based compensation recognized under the modified-prospective transition method of SFAS No. 123R includes share-based compensation based on the grant date fair value determined in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, for all share-based payments granted prior to and not yet vested as of January 1, 2006 and share-based compensation based on the grant-date fair-value determined in accordance with SFAS No. 123R for all share-based payments granted after January 1, 2006.

Derivative Instruments. Effective January 1, 2009, the Company adopted the provisions of EITF 07-5, "Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. As a result of adopting EITF 07-5, as of January 1, 2009, 7,134,036 of the Company’s issued and outstanding common stock purchase warrants previously treated as equity pursuant to the derivative treatment exemption were no longer afforded equity treatment. In addition, amounts related to the embedded conversion feature of convertible notes issued previous to January 1, 2009 and treated as equity pursuant to the derivative treatment exemption were also no longer afforded equity treatment. As such, effective January 1, 2009, the Company reclassified the fair value of these common stock purchase warrants and the fair value of the embedded conversion features, which both have exercise price reset features, from equity to liability status as if these warrants and embedded conversion features were treated as a derivative liability since the earliest date of issue in September 2006. On January 1, 2009, the Company reclassified from additional paid-in capital, as a cumulative effect adjustment, $7,065,940 to beginning additional paid in capital, $723,930 to opening retained earnings and $6,342,010 to a long-term derivative liability to recognize the fair value of such warrants and embedded conversion features on such date.

 
18

 

During the three and six months ended June 30, 2009, the Company issued 0 and 1,192,000 common stock purchase warrants that contained features that required the Company to record their fair value as a derivative liability.  In addition, the value related to the embedded conversion feature of convertible notes issued during the three and six months ended June 30, 2009 were also recorded as a derivative liability. The fair value of these common stock purchase warrants and the embedded conversion feature on their respective value date for the three and six months ended June 30, 2009 was $0 and $906,805.  We recognized a gain of $0 and $109,058 from the change in fair value of the outstanding warrants and embedded conversion feature for the three and six months ended June 30, 2009.

Subsequent to June 30, 2009, the Company obtained waivers from the majority of warrant and note holders as defined in their respective agreements, pursuant to which the warrant and note holders forever waived, as of and after April 1, 2009, any and all conversion or exercise price adjustments that would otherwise occur, or would have otherwise occurred on or after April 1, 2009, as a result of the price reset provisions included in the warrants and notes. As a result of obtaining the waivers, the warrants and notes are now afforded equity treatment under EITF 07-5, resulting in the elimination of the derivative liabilities of $7,139,757 and a corresponding increase in additional paid-in-capital.

Fair Value Measurements In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. In February 2008, the FASB deferred the effective date of SFAS 157 by one year for certain non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). On January 1, 2008, the Company adopted the provisions of SFAS 157, except as it applies to those nonfinancial assets and nonfinancial liabilities for which the effective date has been delayed by one year, which we adopted on January 1, 2009. The adoption of SFAS 157 did not have a material effect on the Company’s financial position or results of operations. The book values of cash, accounts receivable and accounts payable approximate their respective fair values due to the short-term nature of these instruments.

The fair value hierarchy distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

 
Level one — Quoted market prices in active markets for identical assets or liabilities;

 
Level two — Inputs other than level one inputs that are either directly or indirectly observable; and

 
Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter. The Company has no assets or liabilities that are measured at fair value on a recurring basis. There were no assets or liabilities measured at fair value on a non-recurring basis during the six months ended June 30, 2009.

 
19

 

Contractual Obligations

We are committed under the following contractual obligations as of June 30, 2009:

Contractual Obligations
 
Payments Due By Period
 
  
 
Total
   
Less than 1 year
   
1 to 3 Years
   
3 to 5 Years
   
Over 5 Years
 
Long-term debt obligations
 
$
2,034,259
   
$
2,034,259
   
$
-
   
$
-
   
$
-
 
Capital lease obligations
 
$
35,854
   
$
19,533
   
$
13,507
   
$
2,814
   
$
-
 
Operating lease obligations
 
$
626,494
   
$
164,381
   
$
326,484
   
$
135,629
   
$
-
 

Off-Balance Sheet Arrangements

We do not have off-balance sheet arrangements.  As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, often established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Indemnities

During the normal course of business, we have agreed to certain indemnifications.  In the future, we may be required to make payments in relation to these commitments.  These indemnities include agreements with our officers and directors which may require us to indemnify these individuals for liabilities arising by reason of the fact that they were or are officers or directors.  The duration of these indemnities varies and, in certain cases, is indefinite.  There is no limit on the maximum potential future payments we could be obligated to make pursuant to these indemnities.  We hedge some of the risk associated with these potential obligations by carrying general liability insurance.  Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these indemnities in our financial statements.

Trends, Events and Uncertainties

As described above in the discussion of revenue recognition, we receive payment upon the sale of our products and defer the revenue over the life of the license agreement, which is generally one year.  We have disclosed in the table below the total number of licenses sold (net of returns and chargebacks), gross dollar sales (net of returns and chargebacks) before deferral for the most recent eighteen months and the percentage change of each compared to the preceding month.

  
 
Total # of
Licenses
   
% Change
   
Gross Sales $
   
% Change
   
Avg. $ Sale
   
% Change
 
                                     
January 2008
   
1,043
     
-
   
$
38,791
     
-
   
$
37.19
     
-
 
February 2008
   
1,695
     
62.5
%
 
$
67,040
     
72.8
%
 
$
39.55
     
6.3
%
March 2008
   
2,761
     
62.9
%
 
$
110,190
     
64.4
%
 
$
39.91
     
0.9
%
April 2008
   
4,811
     
74.2
%
 
$
225,306
     
104.5
%
 
$
46.83
     
17.3
%
May 2008
   
7,503
     
56.0
%
 
$
352,269
     
56.4
%
 
$
46.95
     
0.3
%
June 2008
   
8,634
     
15.1
%
 
$
403,970
     
14.7
%
 
$
46.79
     
-0.3
%
July 2008
   
14,207
     
64.5
%
 
$
711,236
     
76.1
%
 
$
50.06
     
7.0
%
August 2008
   
18,458
     
29.9
%
 
$
928,789
     
30.6
%
 
$
50.32
     
0.5
%
September 2008
   
17,358
     
-6.0
%
 
$
866,509
     
-6.7
%
 
$
49.92
     
-0.8
%
October 2008
   
18,908
     
8.9
%
 
$
992,526
     
14.5
%
 
$
52.49
     
5.2
%
November 2008
   
28,663
     
51.6
%
 
$
1,342,556
     
35.3
%
 
$
46.84
     
-10.8
%
December 2008
   
25,086
     
-12.5
%
 
$
1,265,459
     
-5.7
%
 
$
50.44
     
7.7
%
January 2009
   
33,754
     
34.6
%
 
$
1,829,638
     
44.6
%
 
$
54.21
     
7.5
%
February 2009
   
30,169
     
-10.6
%
 
$
1,764,773
     
-3.5
%
 
$
58.50
     
7.9
%
March 2009
   
35,881
     
18.9
%
 
$
1,947,074
     
10.3
%
 
$
54.26
     
-7.2
%
April 2009
   
37,192
     
3.7
%
 
$
2,174,006
     
11.7
%
 
$
58.45
     
7.7
%
May 2009
   
29,126
     
-21.7
%
 
$
1,696,597
     
-22.0
%
 
$
58.25
     
-0.3
%
June 2009
   
31,033
     
6.5
%
 
$
1,706,008
     
0.6
%
 
$
54.97
     
-5.6
%

 
20

 

The table above indicates an overall upward trend in the number of licenses sold as well as the average dollar sale.  The general upward trend is a result of our focus on promoting our new products that were released in late 2007 and an increase in the amount of money spent on advertising, as discussed below.  Any fluctuation from month to month is the result of our efforts to optimize profits while continuing to increase revenues. We cannot guarantee that this upward trend will continue, even with increased spending on advertising, or that the margins will remain beneficial to us.  The table above does not include advertising revenue.

We have disclosed in the table below total renewable sales by month and the corresponding year in which those sales will be renewed.  Management currently believes, based on historical trends, that approximately 50% of these initial sales will be renewed at the end of the initial license term.  The Company currently licenses its products and services over one, two and three years.

  
 
Renewable in year
       
Month of initial sale
 
2009
   
2010
   
2011
   
2012
 
January 2008
 
$
37,101
     
120
     
-
     
-
 
February 2008
 
$
64,360
     
-
     
-
     
-
 
March 2008
 
$
105,978
     
1,164
     
768
     
-
 
April 2008
 
$
196,740
     
13,400
     
9,316
     
-
 
May 2008
 
$
303,376
     
26,144
     
15,449
     
-
 
June 2008
 
$
347,341
     
29,366
     
20,912
     
-
 
July 2008
 
$
580,488
     
71,284
     
45,834
     
-
 
August 2008
 
$
750,081
     
107,022
     
58,106
     
-
 
September 2008
 
$
723,378
     
87,587
     
44,904
     
-
 
October 2008
 
$
780,717
     
132,116
     
50,783
     
-
 
November 2008
 
$
1,042,528
     
142,115
     
96,733
     
-
 
December 2008
 
$
904,841
     
188,291
     
106,177
     
-
 
January 2009
 
$
-
     
1,121,165
     
361,205
     
164,306
 
February 2009
 
$
-
     
1,023,496
     
374,661
     
193,947
 
March 2009
 
$
-
     
1,173,228
     
282,057
     
137,566
 
April 2009
 
$
-
     
1,288,926
     
594,005
     
114,183
 
May 2009
 
$
-
     
1,056,095
     
458,069
     
81,527
 
June 2009
 
$
-
     
1,008,550
     
425,461
     
82,471
 
Total
 
$
5,836,929
     
7,470,069
     
2,944,440
     
774,000
 
Approx Renewal %
   
50
%
   
50
%
   
50
%
   
50
%
Expected Renewal Sales
 
$
2,918,465
     
3,735,035
     
1,472,220
     
387,000
 

Other trends, events and uncertainties that may impact our liquidity are included in the discussion below.

 
21

 

RESULTS OF OPERATIONS

Revenue

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                     
Net sales
 
$
3,686,644
   
$
742,862
   
$
2,943,782
     
396
%
 
$
6,878,274
   
$
1,217,908
   
$
5,660,366
     
465
%

This increase in net revenue was due primarily to the increase in new product sales that have resulted from our expanded product offerings as well as an increase in advertising costs associated with customer acquisition.

Cost of Sales

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                     
Cost of Sales
 
$
753,324
   
$
193,240
   
$
560,084
     
290
%
 
$
1,433,028
   
$
267,225
   
$
1,165,803
     
436
%

This increase is due primarily to the increase in sales of our technical support service products which are serviced by a third party, an increase in sales of the CD-ROMs that backup our EDC software and sales of third party products that require a per sale royalty.

Operating Expenses

Advertising

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                     
Advertising
 
$
3,408,307
   
$
1,001,505
   
$
2,406,802
     
240
%
 
$
7,152,001
   
$
1,281,891
   
$
5,870,110
     
458
%

Advertising costs are comprised primarily of media and channel fees, including online and offline advertising and related functional resources. Media and channel fees fluctuate by channel and are higher for the direct online consumer market than for the OEM, reseller and SMB markets.  This increase was primarily due to the launch of our new products, expanding our advertising channels to include traditional media, such as radio and television, and our decision to use advertising as a customer acquisition strategy. Advertising purchased from four vendors accounted for 67% and 78% of the Company’s total advertising expense for the three and six months ended June 30, 2009, respectively. Advertising purchased from three vendors accounted for 92% of the Company’s total advertising expense for the three and six months ended June 30, 2008.

Product Development

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                 
Product Development
 
$
365,497
   
$
93,893
   
$
271,604
     
289
%
 
$
665,234
   
$
203,861
   
$
461,373
     
226
%

 
22

 

Product development expenses are primarily comprised of research and development costs associated with the continued development of our products. This increase is primarily due to the ongoing support and improvement of our existing products.

Selling, General and Administrative

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                     
S,G & A
 
$
1,565,995
   
$
737,176
   
$
828,819
     
112
%
 
$
2,817,552
   
$
1,363,106
   
$
1,454,446
     
107
%

Selling, general and administrative expenses are primarily comprised of executive management salaries, customer service salaries and wages, third party credit card processing fees, legal and professional fees, rent and salaries of our support staff.

The increase was primarily attributable to two factors.  The first is an increase in third party credit card processing fees due to the increase in sales. The second is an increase in customer service salaries and wages due to the increase in staffing required as a result of the increase in sales.  Additionally, there was an overall increase in all areas due to the increased sales activities in the current period.  These expenses have decreased as a percentage of net sales to 41% from 112% for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008. We expect to continue to incur professional fees for audit, legal and investor relations services, and for insurance costs as a result of being a public company. We believe that these costs will remain consistent with costs incurred during the current period.

Investor Relations and Other Related Consulting

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                 
Investor relations and other related consulting
 
$
1,346,207
   
$
-0-
   
$
1,346,207
     
100
%
 
$
2,566,209
   
$
200,000
   
$
2,366,209
     
1,183
%

The increase was primarily attributable to the value of warrants issued to various consultants for investor relation services and creative services during the period as more fully described in the notes to the condensed financial statements.

Other Income/(Expense)

Change in the value of derivative liabilities

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                 
Change in the value of derivative liabilities
 
$
-0-
   
$
-0-
   
$
-0-
     
0
%
 
$
109,058
   
$
-0-
   
$
109,058
     
100
%

 
23

 

As more fully described in the notes to the condensed financial statements, on January 1, 2009 we adopted the provisions of EITF 07-5. EITF 07-5 applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by SFAS No. 133.  As such, we were required to reclassify certain amounts from the equity section of the balance sheet to the liabilities section.  In addition, the value of these instruments must be reassessed by us as of each balance sheet date.  Subsequent to June 30, 2009, the Company obtained waivers from the warrant and note holders that forever waive, as of and after April 1, 2009, any and all conversion or exercise price adjustments that would otherwise occur, or would have otherwise occurred on or after April 1, 2009, as a result of certain anti-dilution provisions included in the warrants and notes. As a result of obtaining the waivers, the warrants and notes are now afforded equity treatment under EITF 07-5. The change in the value of these instruments for the six months ended June 30, 2009 resulted in a gain.

Interest expense

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                 
Interest expense
 
$
1,052,932
   
$
524,913
   
$
528,019
     
101
%
 
$
1,965,441
   
$
1,175,697
   
$
789,744
     
67
%

The increased interest expense was mainly due to an acceleration in the amortization of debt discount and deferred financing costs related to the conversion of approximately $1.9 million of our convertible debt plus the issuance of additional warrants as part of the warrant tender offer offset by the decrease in the interest and amortization expense related to the 7.41% Original Issue Discount Notes that were converted in late 2008.

Loss From Operations

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                 
Loss from operations
 
$
3,762,446
   
$
1,292,780
   
$
2,469,666
     
191
%
 
$
7,775,846
   
$
2,117,831
   
$
5,658,015
     
267
%

Loss from operations increased during the three and six months ended June 30, 2009 due primarily to significant increases in advertising, selling, general and administrative costs and the value of warrants granted for investor relations and consulting services, as more fully described above.

Net Loss

  
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
  
             
Change in
               
Change in
 
  
 
2009
   
2008
   
$
   
%
   
2009
   
2008
   
$
   
%
 
                                                 
Net loss
 
$
4,815,567
   
$
2,034,433
   
$
2,781,134
     
137
%
 
$
9,632,618
   
$
3,510,468
   
$
6,122,150
     
174
%

 
24

 

 Net loss increased during the three and six months ended June 30, 2009 due primarily to significant increases in advertising, selling, general and administrative costs, investor relations and consulting expenses and interest expense, as more fully described above.

Liquidity and Capital Resources

In November 2006 we changed our operating strategy by deciding to introduce a suite of security products instead of just a single product.  We also changed the way in which our core product was offered to consumers.  Rather than just licensing the product and collecting a license fee, we offered consumers a choice.  They could download a free version of the product that included advertising by third parties or they could purchase a license for the product and the product would be free of advertising.  Our advertising revenues are earned each time an ad is shown (per impression) or when an ad is clicked (per click) or for each action taken by the consumer after he clicks on the ad and visits the advertiser’s website (per action).  This change in our business resulted in a significant decrease in our revenues from 2006 to 2007 since we stopped selling our CyberDefender AntiSpyware 2006 product while we developed and rolled-out our new products.  We launched two of our new products in late 2007 and subsequently our revenues have been increasing on a quarterly basis since January 2008, however, our expenses still exceed our revenues.

To help with our cash flow, we occasionally sell our debt or equity securities.  During the six months ended June 30, 2009, the Company received proceeds of $3,106,880 from the sale of its common stock, $1,899,420, net of offering costs of $68,891, from the exercise of warrants in connection with a warrant tender offer and $288,000, net of offering costs of $12,000, from the sale of our 10% Convertible Promissory Notes. As of June 30, 2009, we had outstanding $2,034,259 in principal amount of debt securities.  Of this amount, $534,259 represents the outstanding principal amount of our 10% Secured Convertible Debentures and 10% Convertible Debentures and $1,500,000 represents the outstanding principal amount of our 10% Convertible Promissory Notes.  As of the date of this prospectus there was $69,982 in interest that is accrued and unpaid under these obligations.   As of June 30, 2009, there was $110,212 in interest that is accrued and unpaid under these obligations.  As of the date of this prospectus there was $69,982 in interest that is accrued and unpaid under these obligations. From June 30, 2009 until the date of this prospectus, holders of our 10% Secured Convertible Debentures have converted principal in the amount of $25,000 into 25,000 shares of our common stock and holders of our 10% Convertible Debentures have converted $11,486 of principal into 13,513 shares of our common stock. As of the date of this prospectus, we have also received additional conversion notices from (i) holders of our 10% Secured Convertible Debentures to convert principal in the amount of $371,671 into 371,671 shares of our common stock,(ii) holders of our 10% Convertible Debentures to convert $126,102 of principal into 148,357 shares of our common stock and (iii) holders of our 10% Convertible Promissory Notes to convert $1,500,000 of principal into 1,131,429 shares of our common stock.

At June 30, 2009, we had cash and cash equivalents totaling $2,159,478. In the six months ended June 30, 2009, we generated positive cash flows of $1,380,407.  Cash activity during the six months ended June 30, 2009 included:

Operating Activities

Net cash used in operating activities during the six months ended June 30, 2009 was primarily the result of our net loss of $9,632,618. Net loss for the six months ended June 30, 2009 was adjusted for non-cash items such as amortization of debt discount and deferred financing costs, depreciation and amortization, shares issued for penalties, interest and services, compensation expense from the issuance of stock options, warrants issued in connection with a warrant tender offer and the change in the value of derivative liabilities. Other changes in working capital accounts include an increase in restricted cash, decreases in accounts receivables, prepaid expenses and accounts payable, and increases in deferred charges and deferred revenue as a result of an increase in the sales of our new products. Net cash used in operating activities during the six months ended June 30, 2008 was primarily the result of our net loss of $3,510,468.

 
25

 

Historically, our primary source of operating cash flow is the collection of license fee revenues from our customers and the timing of payments to our vendors and service providers. During the six months ended June 30, 2009, we did not make any significant changes to our payment terms for our customers, which are generally credit card based.

Our operating cash flows, including changes in accounts payable and accrued liabilities, are impacted by the timing of payments to our vendors for accounts payable.  We typically pay our vendors and service providers in accordance with invoice terms and conditions.  The timing of cash payments in future periods will be impacted by the nature of accounts payable arrangements.  In the six months ended June 30, 2009 and 2008, we did not make any significant changes to the timing of payments to our vendors, although our financing activities caused an increase in this category.

Our working capital deficit at June 30, 2009, defined as current assets minus current liabilities, was $(7.0) million as compared to a working capital deficit of $(7.8) million at December 31, 2008.  The increase in working capital of approximately $0.8 million from December 31, 2008 to June 30, 2009 was attributable to an increase in current assets of approximately $2.6 million which was mainly due to an increase in cash from our financing activities and an increase in the current portion of deferred charges offset by an increase in current liabilities of $1.7 million primarily associated with an increase in the current portion of deferred revenue offset by decreases in accounts payable and the current portion of convertible notes payable.

Investing Activities

Net cash used in investing activities during the six months ended June 30, 2009 was approximately $6,500, which was used for property and equipment purchases. We anticipate that we will continue to purchase property and equipment necessary in the normal course of our business. The amount and timing of these purchases and the related cash outflows in future periods is difficult to predict and is dependent on a number of factors, including but not limited to our hiring of employees and the rate of change in computer hardware and software used in our business. No cash was used in investing activities during the six months ended June 30, 2008.

Financing Activities

Net cash provided by financing activities during the six months ended June 30, 2009 was provided to us primarily from the proceeds that we received from the sale of our common stock of approximately $3.1 million, proceeds from the exercise of warrants to purchase our common stock, net of offering costs, of approximately $1.9 million and proceeds of approximately $0.6 million from the issuance of convertible notes payable, net of offering costs. Net cash provided by financing activities during the six months ended June 30, 2008 was primarily from the issuance of a note payable in the amount of $160,000 and the sale of stock in the amount of $529,000, offset by principal payments on notes payable of $189,000.

We expect to meet our obligations through at least December 2010. However, we cannot predict whether our current growth as a developer of a suite of Internet security products will continue or what the effect on our business might be from the competitive environment in which we operate. We anticipate substantial operating cash flows related to renewal receipts from prior year sales of our licensable and renewable products in the fourth quarter of 2009. However, we continue to manage our operating costs and expect to continue to grow so long as we have the working capital and management and support personnel to sustain our growth. To the extent it becomes necessary to raise additional cash in the future, we will seek to raise it through the sale of debt or equity securities, the conversion of outstanding dilutive securities for cash, funding from joint-venture or strategic partners, debt financing or short-term loans, or a combination of the foregoing. We may also seek to satisfy indebtedness without any cash outlay through the private issuance of debt or equity securities. In July 2009, we raised $500,000 from the sale of our common stock. We currently do not have any binding commitments for, or readily available sources of, additional financing. We cannot provide any assurances that we will be able to secure the additional cash or working capital we may require to continue our operations, either now or in the future. If we are unable to secure financing, we may be required to severely curtail, or even to cease, our operations.

 
26

 

Our June 30, 2009 interim financial statements have been presented on the basis that we are a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We incurred net losses of $9,632,618 and $3,510,468 during the six months ended June 30, 2009 and 2008, respectively however, as reflected on the Statements of Cash Flows, our cash used in operations was $4,311,066 and $403,552 during the six months ended June 30, 2009 and 2008, respectively. In addition, at June 30, 2009, we had negative working capital of $7.0 million, of which a large portion relates to deferred revenue, and an accumulated deficit of $35 million, of which a large portion relates to non-cash charges for the value of equity issued over the years. These items raise substantial doubt about our ability to continue as a going concern. We are confident that the recent increases in sales volume, as evidenced by sales receipts in 2009 of more than $10 million, will provide us with a significant renewable revenue stream related to the ongoing license renewals of thousands of customers that we are acquiring every month. However, until these renewals along with new sales of the products provide us with the revenue we need to attain profitability, we intend to continue to raise money for operating capital through sales of our securities or by borrowing money. From inception through the date of this prospectus, we have raised $6,735,000 from debt financing, $4,916,880 from equity financing and $2,081,016 from the exercise of warrants in connection with our warrant tender offer to develop software and to build out a management team capable of delivering our products to market. Our ability to continue as a going concern is dependent upon our ability to develop additional sources of capital. Management cannot assure that any future financing arrangements will be available in amounts or on terms acceptable us. If additional future financing is not available or is not available on acceptable terms, we may be unable to continue our operations. The June 30, 2009 interim financial statements do not include any adjustments that might result from the outcome of these uncertainties.

Fiscal Year Ended December 31, 2008 Compared to the Fiscal Year Ended December 31, 2007

Revenue

Total revenue was $4,887,759 for the fiscal year ended December 31, 2008 as compared to total revenue of $2,220,154 for the fiscal year ended December 31, 2007, an increase of $2,667,605 or approximately 120%.  This increase in total revenue was due primarily to the increase in new product sales. There was a corresponding increase in advertising, as described below.

Cost of Sales

Total cost of sales increased by $587,326, or approximately 327%, to $767,115 during the fiscal year ended December 31, 2008, as compared to $179,789 incurred during the fiscal year ended December 31, 2007. This increase is due primarily to the increase in sales of our technical support service products and to the increase in sales of the CD-ROMs that backup our EDC software.

Operating Expenses

Total operating expenses increased by $8,217,229, or approximately 185%, to $12,668,742 during the fiscal year ended December 31, 2008, as compared to $4,451,513 in operating expenses incurred during the fiscal year ended December 31, 2007.  Operating expenses include advertising, product development, selling, general and administrative expense, the value of equity issued for consulting services, and depreciation and amortization.  A detailed explanation of the increase in operating expenses is provided in the discussion below.

Advertising

Advertising costs are comprised primarily of media and channel fees, including online advertising and related functional resources.  Media and channel fees fluctuate by channel and are higher for the direct online consumer market than for the OEM, reseller and SMB markets.  Advertising expenses increased by $6,491,598, or approximately 1,056%, from $614,857 during the fiscal year ended December 31, 2007 to $7,106,455 during the fiscal year ended December 31, 2008.  This increase was primarily due to the launch of our new products and our decision to use advertising as a customer acquisition strategy. During the fiscal year ended December 31, 2008 and 2007, four vendors accounted for approximately 92% and 47% of our advertising expenses, respectively.

 
27

 

Product Development

Product development expenses are primarily comprised of research and development costs associated with the continued development of our products.  Product development expenses decreased by $7,548, from $537,558 during the fiscal year ended December 31, 2007 to $530,010 during the fiscal year ended December 31, 2008.

Selling, General and Administrative

Selling, general and administrative expenses are primarily comprised of salaries, commissions, rent, stock based compensation and professional fees.

Selling, general and administrative expenses increased by $529,180, from $3,198,073 during the fiscal year ended December 31, 2007 to $3,727,253 during the fiscal year ended December 31, 2008.  The increase is primarily attributable to an increase in outside services of approximately $296,000, mainly public relations and investor relations, an increase in legal expenses of approximately $85,000 relating to the preparation of public filings and the consents and waivers that were signed by holders of our 10% Secured Convertible Debentures, and an increase of approximately $287,000 in credit card fees due to the increase in sales.  These increases were partially offset by a decrease in salaries of approximately $139,000 due to outsourcing.

 Investor relations and other related consulting

Investor relations and other related consulting increased by $788,545 from $477,071 during the fiscal year ended December 31, 2007 to $1,265,616 during the fiscal year ended December 31, 2008. The increase is primarily related to an increased amount paid for investor relations services in the 2008 fiscal year.

Interest expense

Interest expense decreased by $401,493, from $2,887,827 in the fiscal year ended December 31, 2007 to $2,486,334 in the fiscal year ended December 31, 2008.  The decrease in interest expense was primarily due to a decrease of approximately $252,000 in the amortization of deferred financing costs and a decrease of approximately $149,000 in interest associated with our debt which decreased in the 2008 fiscal year.

Public company costs

We expect to incur increased professional fees for audit, legal and investor relations services, and for insurance costs as a result of being a public company.  We also anticipate that we may be required to hire additional accounting personnel as a public company.

Liquidity and Capital Resources

In November 2006 we changed our operating strategy by deciding to introduce a suite of security products instead of just a single product.  Eventually, we also changed the way in which our core product was offered to consumers.  Rather than licensing the product and collecting a license fee, we offered consumers a choice.  They could download the product for free, so long as advertising by third parties was included in the product.  Alternatively, consumers could purchase a license for the product and the product would be free of advertising.  Our advertising revenues are earned each time an ad is shown (per impression) or when an ad is clicked (per click) or for each action taken by the consumer after he clicks on the ad and visits to the advertiser’s website (per action).  This change in our business resulted in a significant decrease in our revenues from 2006 to 2007 since we stopped selling our CyberDefender AntiSpyware 2006 product while we developed and rolled-out our new products.  We launched two of our new products in late 2007 and subsequently our revenues have been increasing on a quarterly basis since January 2008, however our expenses still exceed our revenues.

 
28

 

To help with our cash flow, we occasionally sell our debt or equity securities.  As of December 31, 2008 we had outstanding $3,287,754 in principal amount of debt securities.  Of this amount, $2,001,970 represents the outstanding principal amount of our 10% Secured Convertible Debentures and $440,784 represents the outstanding principal amount of our 10% Convertible Debentures.  As of the date of this prospectus, we have received conversion notices for all of the principal amount remaining under the 10% Secured Convertible Debentures and the 10% Convertible Debentures.  As of the date of this prospectus there was $69,982 in interest that is accrued and unpaid under these obligations.  We also sold a total of $845,000 in principal amount of 10% Convertible Promissory Notes from November 2008 to December 2008.  As of the date of this prospectus, we have received conversion notices from the holders of the 10% Convertible Promissory Notes that will result in the conversion of all of the outstanding principal amount into shares of our common stock.

At December 31, 2008, we had cash and cash equivalents totaling $779,071.  In the fiscal year ended December 31, 2008, we generated positive cash flows of $542,077.  Cash provided/(used) during the fiscal year ended December 31, 2008 included:

Operating Activities

Net cash used in operating activities during the fiscal year ended December 31, 2008 was primarily the result of our net loss of $11,251,772.  Net loss for the fiscal year ended December 31, 2008 was adjusted for non-cash items such as amortization of debt discount of $1,322,379, a loss on registration rights agreement for the effect of partial liquidated damages of $216,540, compensation expense for vested stock options of $252,943 amortization of deferred financing fees of $702,061, shares issued for penalties and interest of $253,081, shares and warrants issued for services of $2,266,783 and depreciation and amortization of $39,408. Other changes in working capital accounts included an increase in prepaid and other assets of $667,593, an increase in deferred charges of $1,010,965, an increase in accounts payable and accrued expenses of $3,059,002 and an increase of $3,923,511 in deferred revenue resulting from higher new customer and renewal sales.

Historically, our primary source of operating cash flow is the collection of license fee revenues from our customers and the timing of payments to our vendors and service providers.  In 2008 and 2007, we did not make any significant changes to our payment terms for our customers, which are generally credit card based.

The increase in cash related to accounts payable, accrued taxes and other liabilities was $3,059,002.  Our operating cash flows, including changes in accounts payable and accrued liabilities, are impacted by the timing of payments to our vendors for accounts payable.  We typically pay our vendors and service providers in accordance with invoice terms and conditions.  The timing of cash payments in future periods will be impacted by the nature of accounts payable arrangements.  In the fiscal years ended December 31, 2008 and 2007, we did not make any significant changes to the timing of payments to our vendors, although our financing activities caused an increase in this category.

Our working capital deficit at December 31, 2008, defined as current assets minus current liabilities, was $(7.8) million as compared to a working capital deficit of $(1.9) million at December 31, 2007.  The decrease in working capital of approximately $5.9 million from December 31, 2007 to December 31, 2008 was primarily attributable to an increase in accounts payable and accrued expenses of approximately $2,750,000, an increase in deferred revenue of approximately $3,396,000 as a result of increased sales, an increase in the current portion of notes payable of approximately $1,716,000, an increase in cash of approximately $542,000, an increase in accounts receivable of approximately $185,000, an increase in prepaid expenses and other assets of approximately $667,000, an increase in deferred charges of approximately $771,000 and a decrease in deferred financing costs of approximately $273,000.

Investing Activities

Net cash used in investing activities during the fiscal year ended December 31, 2008 was approximately $2,000, which was used for property and equipment purchases.  We expect to continue to purchase property and equipment in the normal course of our business.  The amount and timing of these purchases and the related cash outflows in future periods is difficult to predict and is dependent on a number of factors, including but not limited to any increase in the number of our employees and changes in computer hardware and software used in our business.  Net cash used in investing activities during the fiscal year ended December 31, 2007 was approximately $5,000 and also related to the purchase of property and equipment.

 
29

 

Financing Activities

Cash provided by financing activities during the fiscal year ended December 31, 2008 was primarily the result of issuances of notes payable totaling $954,300 and the sale of stock net of offering costs totaling $1,042,743.  Cash used in financing activities was primarily used for payment of notes payable totaling $349,000 and payments on capital lease obligations.  Cash provided by financing activities during the fiscal year ended December 31, 2007 was the result of issuing notes payable totaling $800,000 and the sale of stock totaling $654,500. Cash used in financing activities was primarily used for payments on capital lease obligations.

Description of Business

We were incorporated as Network Dynamics in California on August 29, 2003, and changed our name to CyberDefender Corporation on October 21, 2005.  We are a provider of secure content management (“SCM”) software.  Our mission is to bring to market advanced solutions to protect computer users against identity theft, Internet viruses, spyware and related security threats.  Individuals who use personal computers make up our subscriber base, therefore we are not dependent on any single customer or on a few major customers.  While our product is available for downloading from our website, which makes it available to anyone in the world, we do not have a significant customer base outside of the United States.

Our business was originally built around the sale of a single product, our CyberDefender Anti-spyware.  During the period from our founding through 2004, our primary focus was on marketing and selling this product.  In 2005, we acquired certain assets from Unionway International, LLC, an entity controlled by Mr. Bing Liu, one of our former directors and an advisor.  Among these assets was software that formed the basis for our proprietary Collaborative Internet Security Network, which we refer to as the “CISN” or the “earlyNETWORK™”.

On November 20, 2006, we stopped engaging in new sales of our product, CyberDefender Anti-Spyware 2006 (although we still continue to support the product and will continue upgrading it), and we launched the first of our current product line, a new Internet security suite called CyberDefender Early Detection Center V2.0, which is also provided as CyberDefender FREE V2.0.

We offer CyberDefender FREE V2.0 as a free download in an ad-supported version and CyberDefender Early Detection Center V2.0, without ads, in exchange for the payment of a licensing fee.  There is no trial period and no monthly or annual fee to pay for using CyberDefender FREE V2.0.  Instead, we receive payment from the advertisers, typically at the end of each month.  Subscribers who choose CyberDefender Early Detection Center pay for the license fees via credit card.  The annual subscription rate for this version of the security suite ranges from $12.99 to $49.99, depending on the number of licenses bundled, the term of the license and the marketing and distribution channels that we use.  In addition to these products, we market CyberDefender Registry Cleaner V1.0, CyberDefenderULTIMATE, CyberDefender Identity Protection Service and MyIdentityDefender browser toolbar.  We distribute our software via the Internet and on computer disk.  Prior to July 2009, we also marketed CyberDefenderCOMPLETE.

Once our CyberDefender Early Detection Center V2.0 or CyberDefender FREE V2.0 suite of security products is downloaded, the subscriber becomes a part of our earlyNETWORK™.  We believe that the earlyNETWORK™ provides a unique approach to updating personal computer security.  We have developed the earlyNETWORK™ based on certain technology principles commonly found in a peer-to-peer network infrastructure.  A peer-to-peer network does not have the notion of clients or servers, but only equal peer nodes that simultaneously function as both “clients” and “servers” to the other nodes on the network.  Therefore, as system demands increase, so does the system’s capacity.  Our earlyNETWORK™ is designed to reduce the lag time between the identification of a new security threat by our Early Alert Center and notification to the personal computers that are part of the earlyNETWORK™.   The peer-to-peer network infrastructure allows us to provide a fluid, distributed system for alerts and updates, and to incorporate a universal threat definition system.  This approach is different and, we believe, significantly faster than traditional Internet security companies that provide manual, broadcast-updated threat management systems.

 
30

 

Our earlyNETWORK™ is an adaptive network of machines that defends automatically against a wide spectrum of software attacks and provides users with proprietary automated processes that rapidly identify and quarantine both known and emerging threats.  Our customers obtain access to the earlyNETWORK™ by downloading and installing our security suite (CyberDefender Early Detection Center V2.0 or CyberDefender FREE V2.0) or the MyIdentityDefender toolbar, discussed below.  As additional users are added to well-managed peer networks, the networks work better.  The same is true of our collaborative security network.  With more clients, threats are picked up faster and updates occur faster as well, because users of our software find peers more easily than they could an update server.  Users of our software who cannot connect with other users will always be able to fall back on the CyberDefender Alert Server which is the central source for threat analysis and notification.

The nature of current SCMs, which assume a single point of threat capture, a cumbersome threat analysis system and an intermittent update system, creates a “coverage gap” which can delay alerts on important new infectious attacks for 12 hours or more.  However, our proprietary technology quickly distributes threat updates to all computers that are part of the earlyNETWORK™.  Other SCMs send updates in a scheduled batch.  For example, our system for generating threat reports, the Early Alert Center, first reported the Sasser.E virus at 11:52 p.m. on May 7, 2004.  This was one to two days before other SCM software vendors announced their discoveries of the same virus.  We believe we are the first to provide threat updates in this manner.

Using the earlyNETWORK™ infrastructure instead of relying on expensive bandwidth for mass updates means that our updates are relayed securely throughout the earlyNETWORK™ using each local user’s bandwidth.  There is no need to wait for a scheduled update – updates are simply sent to the entire network in approximately one hour as opposed to 12 hours for a conventional network.  The network responds quickly to new threats because it enlists all the machines in the earlyNETWORK™ to act as listening posts for new threats.  Our solution works well with existing security software and can operate as an additional layer of security on a desktop.

Industry Background

Secure Content Management (SCM) Market

According to a report issued by BCC Research, which was published in January 2006, the global Internet security market is expected to rise at an average annual growth rate of 16.0%, reaching $58 billion by 2010.  The high growth rate is attributed to a higher demand for strong security solutions in market verticals such as government installations, financial services, and healthcare.   Firewall and content management currently account for a majority share of the market. However, the increasing need to counter “zero-day” attacks, that is, viruses or other exploits that take advantage of a newly discovered vulnerability in a program or operating system before the software developer becomes aware of the vulnerability or fixes it, along with the increasing popularity of “defense-in-depth” strategies, wherein coordinated uses of multiple security countermeasures are used to protect the integrity of information assets, will bring unified threat management solutions to the forefront.

Currently, the U.S. and Europe account for a major portion of the Internet security market. However, the market for Internet security is expected to grow significantly in the Asia Pacific regions, especially China and India.  Increased e-commerce in these regions and a simultaneously growing security consciousness is expected to drive the market in these areas.

Three specific product areas comprise SCM:

Antivirus software identifies and/or eliminates harmful software and macros by scanning hard drives, email attachments, disks, Web pages and other types of electronic traffic, for example, instant messaging and short message service (“SMS”), for any known or potential viruses, malicious code, trojans or spyware.

Web filtering software is used to screen and exclude from access or availability Web pages that are deemed objectionable or not business related.  Web filtering is used by entities to enforce corporate Internet use policies as well as by schools, universities and home computer owners for parental controls.

Messaging security software is used to monitor, filter and/or block messages from different messaging applications, for example, e-mail, IM, SMS and P2P, containing spam, confidential information and objectionable content.  Messaging security is also used by certain industries to enforce compliance with privacy regulations.

 
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SCM Growth Drivers

Viruses, worms and spyware are serious threats facing businesses and consumers today because these programs can be used to steal personal information, enable identity theft, damage or destroy information stored on a computer and cause damage to legitimate software, network performance and productivity. These types of malicious programs are introduced to computers in a number of ways, including, but not limited to:

 
·
poor browser security as most browsers today are full of security holes that are exploited by hackers and criminals;

 
·
growing use of the Internet and e-mail as a business tool and preferred communication channel;

 
·
increased use of mobile devices to access key data;

 
·
continued rapid increases in spam as the majority of spam sent today originates from zombie machines remotely controlled by spammers;

 
·
explosive growth in spyware causing theft of confidential information, loss of employee productivity, consumption of large amounts of bandwidth, damage to desktops and a spike in help desk calls; and

 
·
flaws in operating systems that contribute to the wide range of current Internet security threats, particularly if users do not update their computers with patches.

As a result of the foregoing factors, the SCM market developed and continues to expand in order to respond to the ever-evolving threats presented by malicious programs.

Current Product Limitations

Many SCM software vendors have attempted to solve Internet security problems with a variety of software applications. Although many products exist today to address such security issues, these solutions face many limitations, including the following:

No Real-Time Security - Most antivirus and antispyware software applications do not protect personal computers against real-time threats. If new viruses or spyware exist on the Internet but do not reside in risk definition databases, most personal computers exposed to the threat will be infected. Typical virus protection software requires frequent downloads and updates to work properly. If a user does not download a patch timely, the user’s system may no longer be safe. By the time a new virus is announced, it may already be too late to take action, and an infection may have occurred. Also, new patches may take hours to install, decreasing work productivity.

Inability to Catch all Viruses and Malicious Content – Current threat analysis systems are not capable of detecting all malicious codes. With current security networks, software alone cannot detect unknown attacks – human involvement is required. Not only are threats not detected, but threats that are detected are resolved untimely due to intermittent update systems delaying user alerts.

Costly Updating - Most antispyware and antivirus software providers use a client-server network infrastructure to distribute new spyware and virus definitions. Such solutions are expensive to maintain because they rely on intensive data centers and networks to deliver updates, thereby using a significant amount of bandwidth, which is expensive to obtain. Also, vendors cannot afford to send threat updates continuously and therefore are slow to distribute them. In fact, many software vendors provide updates on a scheduled basis, rather than as the updates are needed. This may leave the PC vulnerable since threats propagate without a schedule, and therefore a PC which was updated on Monday may be effectively infected on Tuesday.

Every consumer or business using any networked device needs to have some form of Internet security. We provide consumers and business users with a platform of products and services designed to protect against various types of security attacks.

 
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CyberDefender Technology

Conventional Internet security companies use a cumbersome manual process to identify new threats, analyze threats in labs, and distribute threat updates to their user bases. These security companies have to broadcast updates to each personal computer user individually in the network. Serious drawbacks to conventional broadcast updates exist, including the following:

 
·
The expense related to this process; the network cannot be updated in real-time, and instead is updated in batches spaced days apart.

 
·
Because broadcasting servers are a single point of distribution, they are vulnerable to “flooding” attacks that prevent clients from getting the needed updates.

 
·
A threat may block a client computer’s access to the broadcast server, disabling its ability to download an update for the threat.

We have addressed these shortcomings by developing the earlyNETWORKTM to detect, analyze and quarantine new security threats. The earlyNETWORKTM is not a conventional peer-to-peer network because the Alert Server is a required checkpoint for all client activities, thus assuring the integrity of the network. The earlyNETWORKTM is a controlled publishing network that leverages the power of distributed bandwidth. Each client has a controlled role in relaying the threat updates to as many as 20 clients, thus allowing continuous release of threat updates.

Unusual behavior is detected by a personal computer equipped with our CyberDefender Internet security software. The potential threat may be anything from spam to a virus. The program puts the potential threat on standby, and reports it to our Early Alert Center’s Alert Server™. The Alert Server compares the threat to existing threat definitions. If the Alert Server does not recognize the threat, the threat is sent to our AppHunter™ for analysis.

AppHunter is an automated system that manages the threat analysis process. First, AppHunter tests the undefined threat on an isolated computer that is automatically wiped clean after each test. Based on the behavior of the test computer, AppHunter ranks the threat on a scale from one to ten. Rankings of five and above are classified as infectious (viruses). Additionally, AppHunter carries out a confidential set of proprietary verifications to ensure that the threat itself is not an attempt to deceive or hack the network.

As there is a wide set of possible attacks that do not qualify as viruses, our AppHunter is supplemented by a team of human technicians who classify threats that rank below 5 in severity. Threat definitions are added as quickly as possible to our definition database, which is then updated to our users via our earlyNETWORKTM. We continually make changes to our technology to make sure that we address as many security concerns as possible.

We believe that our earlyNETWORKTM may be the only network today that distributes information securely between the individual personal computer users who have installed our software, which we have sometimes referred to as “peers” in this discussion.

Using our peer-to-peer technology, our CyberDefender Alert Server notifies users of our software who, in turn, notify up to 20 other users in an ever-widening circle. This distributed notification process frees up the Alert Server to deal with incoming alerts from clients that have encountered unexpected behavior, and makes the network truly responsive and “in tune” with its users. Because the cost of updating using the earlyNETWORKTM is very small, Alert Server can send out updates as fast as threats are confirmed, resulting in better security coverage. In general, from the time the first client has picked up the new threat to the updating of the network, about an hour passes. We believe that this process occurs roughly ten times faster than the updating of any other competitive system.

Proprietary Technology Overview

The following is a description of our proprietary technologies:

 
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1. Threat Protection Network V1.0 / V2.0 (“TPN”)

Sophisticated threat analysis platform which utilizes CyberDefender’s proprietary threat analysis engine and updating technology.

A patent application covering this technology, serial number 11/234,531 was filed on September 22, 2005.

2. Secure Peer to Peer Network V1.2/V2.0

Dynamic secure peer to peer network which utilizes cloud computing and various proprietary security protocols in order to update PCs against new threats.

A patent application covering this technology, serial number 11/234,868, was filed on September 22, 2005.

3. CyberHunter V1.0

A proprietary web crawling technology which identitifes and collects malware information found on the web and reports it to the TPN.

4. CyberDefender Early Detection Center V2.0

Windows PC Internet security suite designed to protect consumers and small businesses against viruses, spyware, spam and phishing attacks.

5. Web Access Protection – CyberDefender MyIdentityDefender V1.0/V1.5

Proprietary anti-phishing and web access protection technology designed for Windows Internet Explorer and Windows FireFox browsers.

6. CyberDefender Gladiator V1.0

A free tool designed to remove specific malware files from Windows PCs.

Future Technology Projects

The following products are currently in the planning or development stages. We cannot guarantee that any of the following products will be successfully developed and marketed.

1. CyberDefender Real-time World Threat Map

A website dedicated to informing subscribers about emerging threats worldwide. Threat data will be provided by TPN. By utilizing Google Maps or other mapping technologies, this platform will provide real time updates via web or wireless devices. Targeted users will be ISPs and security professionals.

2. CyberDefender Real-time Threat Feed

Scheduled for release in 2010 this service will provide real-time threat data feeds to other Internet security providers and ISPs.

3. CyberDefender Reputation Management Platform V1.0

A business and consumer reputation management system designed to inform and protect online reputation.

4. CyberDefender Mobile Security Platform

 
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Scheduled for Alpha release in 2010, this will be a consumer-based all-in-one security suite for the Apple iPhone, Microsoft Windows mobile, Google Andriod and Nokia Smartphone platforms which will allow them to utilize the power of TPN2 and SPN2.

Products

CyberDefender Early Detection Center V2.0

Early Detection Center V2.0 is a Windows PC Internet security suite designed to protect consumers against spyware, viruses, phishing attacks and spam. CyberDefender Early Detection Center utilizes the earlyNETWORK and retails from $12.99 to $49.99 per single PC user per year. Early subscription includes unlimited threat definition updates.

CyberDefender FREE V2.0

FREE V2.0 has the same technology features as the CyberDefender Early Detection Center V2.0. This version is offered free to consumers and is supported by impeded banner advertising. Users can upgrade to the non-ad supported version (CyberDefender Early Detection Center V2.0) for $12.99 to $49.99. Users will receive unlimited updates as long as the product is available by CyberDefender.

CyberDefender Registry Cleaner V1.0

Registry Cleaner V1.0 is Windows PC optimization software designed to improve performance and speed up PC speed. CyberDefender Registry Cleaner V1.0 fixes common Windows registry errors and is offered to consumers for $19.99 to $39.98 for a 1 year subscription. Users will receive unlimited updates during the 12 month subscription period.

CyberDefender FamilyPak

The FamilyPak offers the same technology as CyberDefender Early Detection Center V2.0. Designed for families with multiple PCs or small businesses running multiple PCs, it is offered at $29.95 to $49.99 per year for a 12 month subscription.

MyIdentityDefender V1.0

A free Windows Internet Explorer browser plug in designed to protect users against phishing attacks and dangerous websites, this product is offered for free and generates revenue through an imbedded search engine powered by InfoSpace.

CyberDefenderULTIMATE

CyberDefenderULTIMATE provides unlimited live premium tech-on-call service 24 hours per day and 7 days per week for assistance with the resolution of any technology problem. The service is offered for $199.99 to $299.99 per user per year.

CyberDefender Identity Protection Service

This is an identity protection service offering users basic ID protection features and a $25,000 identity theft insurance policy. This product is offered at $9.95 to $14.95 per month.

CyberDefender Identity Protection Service with Credit Monitoring

This version of the CyberDefender Identity Protection Services includes credit monitoring. This product is offered at $19.95 to $29.95 per month.

 
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Growth Strategy

Our plan is to continue to grow our business by continuing to purchase effective online advertising and by recruiting new customers and renewing subscriptions from our current customers. Approximately 50% of our customers renew their subscriptions to our products year over year. We believe that this renewal stream will be compounded over time as we continue to add new customers to a growing customer base.

By optimizing price points and adding new products, we believe that we will achieve a higher revenue per user per year and a higher lifetime value. We will continue to optimize our advertising spending in order to achieve higher profitability.

In addition to the above, we believe that our contract with GR Match LLC (“GRM”), a subsidiary of Guthy-Renker, (, as detailed below, will help us market our products effectively by utilizing radio and television advertising. Considering the size of the audience that TV and radio media reach, we believe that this relationship with GRM could be very significant to us.

On March 24, 2009, we entered into a Media and Marketing Services Agreement with GRM. Pursuant to the agreement, GRM will provide direct response media campaigns, including radio and television direct response commercials, to promote the Company’s products and services and will purchase media time on the Company’s behalf. During the term of the agreement, which, after giving effect to an amendment dated June 4, 2009, is to continue until June 1, 2011, subject to certain rights of termination, GRM will be the exclusive provider of all media purchasing and direct response production services. On June 23, 2009, pursuant to the Company’s obligation under the agreement, the Company appointed a representative of GRM, Bennet Van De Bunt, to the Company’s board of directors. This director will continue to serve throughout the term of the agreement and for so long as GRM owns shares of the Company’s common stock or the right to purchase shares of the Company’s common stock which constitute at least 5% of the Company’s issued and outstanding common stock.

We are to provide a monthly budget to GRM for media placement. GRM will purchase the media and invoice us for the cost plus 2.5% in overhead expenses incurred in connection with providing the media placement services. As security for the payment of the media costs and overhead, we have agreed to grant to GRM a security interest and lien in any proceeds held in a merchant services account we have established with Litle Merchant Services. The purpose of the merchant services account is to collect the proceeds from sales made as a result of the media campaigns. These sales will be made through websites we will establish that will be exclusively used to receive and process orders of our products from customers who respond to the media campaign (“direct response websites”).

As compensation for GRM’s services under the Media and Marketing Services Agreement, we have issued an amended and restated fully vested five year warrant to purchase 1,000,000 shares of our common stock at an exercise price of $1.25 per share. This warrant has both cash and cashless exercise provisions. This warrant supersedes and replaces a warrant issued to GRM in November 2008. We also issued to GRM a second fully vested five year warrant to purchase 1,000,000 shares of our common stock at an exercise price of $1.25 per share. This warrant may be exercised for cash only. Finally, we issued GRM a five year warrant to purchase 8,000,000 shares of our common stock at an exercise price of $1.25 per share, exercisable for cash only. This warrant was issued to compensate GRM for providing media placement costs on 45 days terms with us and is subject to vesting as follows: for each $2 of media placement costs advanced by GRM on our behalf, the right to purchase one share of our common stock will vest. As of August 31, 2009, the right to purchase 386,221 of the 8,000,000 warrant shares has vested. If GRM terminates the agreement due to a breach by us in our performance or as a result of our discontinuance, dissolution, liquidation, winding up or insolvency, or if we terminate the agreement for any reason other than a breach by GRM or our discontinuance, dissolution, liquidation, winding up or insolvency, any unexpired and unvested rights of GRM to purchase shares of our common stock pursuant to this third warrant will immediately vest.

 
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If the average closing price of our common stock as reported by Bloomberg LP for the 20 trading days preceding January 1, 2010 is not at least $3.00 per share or if our common stock is not publicly traded on any stock exchange or over-the-counter market as of December 31, 2009, then we will be required to pay a monthly royalty to GRM. The royalty will be equal to 20% of gross renewal revenue, which is defined as the aggregate gross revenue, net of refunds and chargebacks, earned by us as a result of renewals and/or re-orders of our products by our customers who both (i) became customers during the period commencing on March 1, 2009 and ending upon the earlier of (A) the termination date of the Media and Marketing Services Agreement or (B) the date following January 1, 2010 when the average closing price of our common stock as reported by Bloomberg LP for the 20 trading days preceding that date was at least $5.00 per share and (ii) initially purchased any of our products from any direct response websites. Our obligation to pay these royalties will survive the expiration or termination of the agreement.

The agreement may be terminated by either us or GRM in the following events:

 
·
if there is a breach or default in performance of any obligation, unless the breach or default is cured with 15 business days following receipt of written notice from the non-breaching party;

 
·
upon the discontinuance, dissolution, liquidation or winding up of the other party’s business or the insolvency of the other party; or

 
·
by either party for any reason by giving the other party written notice of the termination at least 30 days prior to the effective date of termination.

After May 30, 2009, GRM may terminate the agreement upon 5 days written notice to us in the event that the average media placement costs for any 3 consecutive months during the term are less than $250,000 per month.

If we breach our payment obligations under the agreement and fail to cure the breach within 15 days after receiving notice from GRM, then the number of warrant shares which would otherwise vest during the month of the delinquent payment will automatically double and GRM will have the right to enforce its security interest in the merchant services account. If we breach our payment obligation more than 3 times, we will not be entitled to cure the breach and GRM will be entitled to enforce its rights and remedies under the agreement.

If the agreement is terminated by GRM prior to the expiration of the term because of our breach, our discontinuance, dissolution, liquidation, winding up or insolvency or because our average media placement costs for any 3 consecutive months during the term are less than $250,000, or if we terminate the agreement upon notice, then, if we propose to procure media purchasing services from a third party which are similar to the services provided by GRM under the agreement, we will notify GRM of the terms of such engagement. GRM will have a period of 15 days to elect to provide the services on the same terms.

Revenue Model

We earn revenues from the sale of our products. We license CyberDefender Early Detection Center software for $12.99 to $49.99 for one year of service. This price includes technical support related to the basic software installation, software updates and definition updates. After one year of service, customers have the option to renew the service. Users are notified when a subscription is due to expire and what the cost will be to continue the subscription. In September 2007, we launched CyberDefenderULTIMATE and CyberDefenderCOMPLETE (although we no longer offer CyberDefenderCOMPLETE) which we sell or sold for $99.99 to $299.99 per year. By promoting our newer products and increasing the amount of money spent on advertising, the number of licenses sold, gross sales and the average dollar per sale from January 2008 through June 2009 increased significantly. In addition, we are also offering CyberDefender Registry Cleaner and CyberDefender Identity Protection Service to all of the customers who purchase CyberDefender Early Detection Center. The total number of licenses sold for all products during the period increased from 1,043 in January 2008 to 31,033 in June 2009, gross sales receipts increased from $38,791 in January 2008 to $1,706,008 in June 2009 and the average dollars per sale increased from $37.19 in January 2008 to $54.97 in June 2009. We expect this trend to continue, although we cannot guarantee that it will do so.

We also generate advertising revenue from CyberDefenderFREE 2.0 and MyIdentityDefender V1.0. Since November 2006, we began generating revenue from advertising by showing users of our CyberDefender FREE V2.0 software small banners inside the user interface, showing text links to third party products and/or getting paid by search engine companies whenever individuals use our MyIdentityDefender security toolbar. Our goal is to maximize our advertising revenue by increasing the number of CyberDefender FREE 2.0 and MyIdentityDefender toolbar users.  Individuals who use these free products also contribute to the earlyNETWORK since they create additional “nodes” or peers, which allow for faster threat updates.

 
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On occasion, we also offer to our software users, both paying and non-paying, other subscription services such as identity theft protection and consumer credit management.

Retail Sales

In September 2008, we signed an agreement with a marketing partner, Allianex Corporation, which will give us an opportunity to sell our products through over 200,000 retail locations worldwide. We anticipate delivering our products via this retail channel during the fourth quarter of 2009.

Customers

Our primary customers are consumers who use home computers that use the Windows operating systems. Our customers reside primarily in the United States. The number of our customers fluctuates due to the fact that, while we gain new customers on a daily basis, existing customers can cancel or may not renew their subscriptions.

Marketing and Sales

We market our products to computer users through the use of Internet marketing and our e-commerce website, retailers, distributors, direct marketers, Internet-based resellers, original equipment manufacturers (OEMs), and Internet service providers. In October 2008, we signed a contract with Maxtek Distributing Inc. which is currently marketing our products through an online retailer, NEWEGG.com. In addition, we have an ongoing contract with DDNI Corporation which is currently in the process of launching our product through Lenovo Computers. In March 2009, we entered into a Media and Marketing Services Agreement with GRM. Pursuant to the agreement, GRM will provide direct response media campaigns, including radio and television direct response commercials, to promote the Company’s products and services and will purchase media time on the Company’s behalf. Current and future marketing opportunities include search engine optimization, international marketing, co-marketing with distributors and resellers, marketing through the use of a CyberDefender web browser security toolbar and participation in trade and computer shows and user group conferences.

Competition

Internet security markets are competitive and subject to continuous technological innovation. Our competitiveness depends on our ability to offer products that meet customers’ needs on a timely basis. The principal competitive factors of our products are time to market, quality, price, reputation, terms of sales, customer support and breadth of product line.

Some of our competitors include WebRoot Software, Sunbelt Software and Kaspersky Labs. In addition, we may face potential competition from operating system providers and network equipment and computer hardware manufacturers. These competitors may provide various security solutions in their current and future products and may limit our ability to penetrate these markets. These competitors have significant advantages due to their ability to influence and control computing platforms and security layers in which our products operate. At this time, we do not represent a competitive presence in the SCM industry.

Intellectual Property

Our software is proprietary and we make every attempt to protect our software technology by relying on a combination of copyright, patent, trade secret and trademark laws and restrictions on disclosure.

On September 22, 2005 we filed two patent applications with the U.S. Patent and Trademark Office.  The application titles and serial numbers are “Threat Protection Network” – Application No. 11/234,531 and “System for Distributing Information Using a Secure Peer to Peer Network” – Application No. 11/234,868. On June 29, 2009, we filed a provisional patent application. The title and serial number of the provisional application is "System and Method for Operating an Anti-Malware Network on a Cloud Computing Platform" - Application No. 61/221,477.

 
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On September 21, 2005 we submitted an application to the US Patent and Trademark Office for the registration of our name, CyberDefender, on the principal register. The mark was registered on the principal register on March 13, 2007 as number 3217137. On November 19, 2008 we filed an application with the US Patent and Trademark Office for registration of the mark CyberDefender Registry Cleaner, but we have decided to abandon this application. We also own a registered mark consisting of the @ symbol inside a star.

We may also license intellectual property from third parties for use in our products and, in the future, we may license our technology to third parties. We face a number of risks relating to intellectual property, including unauthorized use and copying of our software solutions. Litigation may be necessary to enforce our intellectual property rights or to protect trade secrets.

Employees

We currently employ 61 full time employees and 14 independent contractors. Our employees are segmented by the following functions: executive management, research and development, information technology, marketing and sales, customer service and call center, and finance and administration.

Government Regulation and Probability of Affecting Business

The development of our products is generally not subject to government regulation. However, laws and regulations that apply to Internet communications, commerce and advertising are becoming more prevalent. These regulations could affect the costs of communicating on the Internet and adversely affect the demand for our products or otherwise harm our business, results of operations and financial condition. The United States Congress has enacted Internet legislation regarding children’s privacy, sending of unsolicited commercial email and spyware. Other laws and regulations may be adopted in the future. This legislation could hinder growth in the use of the Internet generally and decrease the acceptance of the Internet as a communications, commercial and advertising medium.

In addition, the growth and development of the market for Internet commerce may prompt calls for more stringent consumer protection laws, such as laws against identity theft, which may impose additional burdens on companies conducting business over the Internet. While none of the current laws governing Internet commerce has imposed significant burdens on us to date, in the future our business, results of operations and financial condition could be materially and adversely affected by the adoption or modification of laws or regulations relating to the Internet, or the application of existing laws to the Internet or Internet-based advertising.

Description of Property

Our corporate office is located at 617 West 7th Street, Suite 401, Los Angeles, California. The monthly rent is $10,669.50, and increases by 3% per year. Aside from the monthly rent, we are required to pay our share of the “Common Operating Expenses”, which are all costs and expenses (including property taxes) incurred by the landlord with respect to the operation, maintenance, protection, repair and replacement of the building in which the premises are located and the parcel of land on which the building is located. We occupy approximately 4,742 square feet of office space, or approximately 2.47% of the building. On June 19, 2009, the Company entered into a non-binding Letter of Intent with its current landlord to relocate and to occupy approximately 16,000 square feet in the building to accommodate growth and the landlord has agreed to abate the rent for all current office space beginning July 1, 2009 while the parties complete a formal amendment to the current office lease. It is anticipated that the new lease will be completed in October 2009 and that the Company will relocate to its new office space under the terms of this amended lease during the first quarter of 2010.

Legal Proceedings

We are not currently a party to any legal proceedings. Occasionally we are named as a party in claims and legal proceedings arising out of the normal course of our business. These claims and legal proceedings may relate to contractual rights and obligations, employment matters, or to other matters relating to our business and operations.

 
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DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

The following table identifies our current executive officers and directors.
 
Name
 
Age
 
Position Held
Gary Guseinov
 
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Chief Executive Officer and Chairman of the Board of Directors
Kevin Harris
 
40
 
Chief Financial Officer and Director
Igor Barash
 
38
 
Chief Information Officer, Secretary and Director
Bennet Van De Bunt
  
47
  
Director

There are no family relationships between any of our directors or executive officers. Our directors serve until the next annual meeting of shareholders and until their successors are elected by our shareholders, or until the earlier of their death, retirement, resignation or removal. Our executive officers are appointed by our board of directors and serve at the board’s discretion. Except as described below, there is no arrangement or understanding between any of our directors or executive officers and any other person pursuant to which any director or officer was or is to be selected as a director or officer. Mr. Van De Bunt was appointed to our board of directors pursuant to our obligation under section 1.5 of the Media and Marketing Services Agreement dated March 24, 2009 between our company and GRM.

None of our directors or executive officers has, during the past five years,
 
·
had any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer, either at the time of the bankruptcy or within two years prior to that time,

·
been convicted in a criminal proceeding and none of our directors or executive officers is subject to a pending criminal proceeding,

·
been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities, futures, commodities or banking activities, or

·
been found by a court of competent jurisdiction (in a civil action), the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated.
 
Business Experience

Gary Guseinov is one of our co-founders and has served as our Chief Executive Officer and as a director since our inception in August of 2003. Mr. Guseinov has over 12 years of start-up business experience in the e-commerce sector in addition to direct marketing expertise. In 1994, Mr. Guseinov rapidly grew Digital Media Concepts, a web development firm, by establishing business relationships with AT&T and Pacific Bell. While at Digital Media Concepts, Mr. Guseinov built a client base of over 475 clients in less than two years. In 1998, Digital Media Concepts merged with Synergy Ventures Inc., a direct marketing firm focusing on online marketing and customer acquisition. By 1999, Mr. Guseinov developed the first Automated Media Planning System (SynergyMPS), allowing media buyers and media sellers to communicate on a single platform and issue insertion orders. While building SynergyMPS, Mr. Guseinov developed business relationships with over 2,500 media companies in the U.S., U.K., and Japan. In 2002, Mr. Guseinov developed one of the largest enterprise email transmission systems capable of handling over 1 billion email messages per month. While at Synergy, Mr. Guseinov was responsible for acquiring such clients as Lucent Technologies, Wells Fargo Bank, Citibank, Chase, New Century Financial, JD Powers and Associates, Sears, GoToMyPC and many other Fortune 1000 clients. Under Mr. Guseinov’s management, DirectSynergy was able to generate over $2 billion in revenues for its clients. Mr. Guseinov earned his B.A. from the California State University at Northridge, School of Social and Behavioral Sciences.

 
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Kevin Harris joined us as a consultant on October 1, 2008, became interim Chief Financial Officer on December 1, 2008 and became our Chief Financial Officer on January 1, 2009. Prior to that date, Mr. Harris was the Chief Operating Officer of Statmon Technologies Corp., a publicly traded company, from April 2004 through November 2008 and was a financial consultant to the same company from December 2002 until April 2004 Prior to his employment with Statmon Technologies Corp., from February 2001 to April 2004, Mr. Harris served as the Senior Vice President of Finance and Controller for RKO Pictures, LLC, where he oversaw all aspects of accounting, finance, technology and administration for the company, its subsidiaries and its not-for-profit ventures. He continued to provide services as a financial consultant to RKO Pictures, LLC from April 2004 through December 2006. Prior to working for RKO Pictures, LLC, Mr. Harris served as Controller and Vice President of Finance for POP.com and as the Director of Corporate Financial Planning for Metro Goldwyn Mayer Studios, Inc. From 1993 to 1995, Mr. Harris was a senior auditor at KPMG Peat Marwick. Mr. Harris is a licensed CPA. He graduated with honors from the California State University at San Bernardino earning his B.S. degree in business administration.

Igor Barash is one of our co-founders and has served as our Chief Information Officer (and currently serves as our Chief Product Officer) and as a director since our inception in August of 2003. Mr. Barash has over 10 years of senior level management experience with tier one Internet service providers. In 1997, Mr. Barash became the first employee of Hostpro, a Los Angeles based ISP. With his extensive knowledge of the Internet-based systems, servers, administration and development, Hostpro grew to become one of the largest hosting service providers in the world. After Hostpro’s purchase by Micron PC, Mr. Barash took a key roll in Micron’s Internet services business, including developing value added features on enterprise level service models, restructuring its data center, and participating as Micron’s representative to Microsoft. Later, Mr. Barash became the technical due diligence leader during Micron’s procurement of other ISPs, and Mr. Barash delivered assessments of all companies in contention to be purchased and incorporated under the Micron umbrella. In 1999, Mr. Barash was given the task of restructuring and incorporating into Micron’s business WorldWide Hosting in Boca Raton, an acquisition he led. Since January 2000, Mr. Barash has been operating his own consulting firm, supplying high level IT solutions and management services. Mr. Barash earned his B.S. from the California State University at Northridge, School of Computer Science.

Bennet Van De Bunt has served as a director since July 21, 2009. Mr. Van De Bunt is a principal of Guthy-Renker and is Co-President of Guthy-Renker LLC, where he is responsible for business affairs and new business development. Mr. Van De Bunt joined Guthy-Renker in 1993. Prior to joining Guthy-Renker, Mr. Van De Bunt was an attorney at Allen, Matkins. A graduate of Harvard Law School and a member of the California Bar Association, he also holds a degree in history from UCLA where he graduated with honors. Mr. Van De Bunt was also on the Board of Directors of the Electronic Retailing Association (ERA).

Significant Employees

In addition to our executive officers and directors, we value and rely upon the services of the following significant employee in the support of our business and operations.

Steve Okun, 45
Senior Vice President, Marketing

Mr. Okun, joined CyberDefender in June 2009 from LeadPoint, Inc., where he was in charge of the company's customer acquisition efforts as their Vice President of Sales and Business Development from April 2005 to May 2009. As a founding member of their senior management team, he was instrumental in delivering record level year-over-year revenue growth during the last four years of his service. From March 2000 to July 2002, Mr. Okun also held the position of Vice President of Global Sales at Commission Junction, the largest pay-for-performance affiliate network, where he was responsible for leading the growth of the company's U.S. and international sales and account management teams. He served as a member of the Executive Committee before Commission Junction was sold to ValueClick. Earlier in his career, Mr. Okun served in senior management roles at several Internet-related B2C software technology companies including Success Learning Systems, a Web-based training and educational products company that he founded and led as President.

 
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Executive Compensation

Compensation Discussion and Analysis
 
This section explains how our executive compensation programs are designed and operate with respect to our named executive officers listed in the Summary Compensation Table below. Our executive officers in 2008 and 2007 were Gary Guseinov, President and Chief Executive Officer; Michael Barrett, Chief Financial Officer (February 2008 through December 15, 2008); Ivan Ivanovich, Chief Financial Officer (January 2007 through January 2008); Igor Barash, Chief Information Officer; and Bing Liu, Chief Software Architect. Our current Chief Financial Officer is Kevin Harris, who joined us on January 1, 2009.

Executive Summary
 
Our compensation strategy focuses on providing a total compensation package that will not only attract and retain high-caliber executive officers and employees, but will also be utilized as a tool to communicate and align employee contributions with our objectives and shareholder interests.

Compensation for our named executive officers consists of the elements identified in the following table.
 
Compensation Element
 
Objective
     
Base salary
 
To recognize ongoing performance of job responsibilities and as a necessary tool in attracting and retaining employees.
Annual performance-based cash compensation
 
To re-emphasize corporate objectives and provide additional reward opportunities for our executive officers (and employees generally) when key business objectives are met.
Long-term equity incentive compensation
 
To reward increases in shareholder value and to emphasize and reinforce our focus on team success.
Severance and change of control benefits
 
To provide income protection in the event of involuntary loss of employment and to focus executive officers on shareholder interests when considering strategic alternatives.
    Health and welfare benefits
 
To provide a basic level of protection from health, dental, life, and disability risks.
 
Each of the elements of our executive compensation program is discussed in more detail below. Our compensation programs are designed to be flexible and complementary and to collectively serve the compensation objectives described above. We have not adopted any formal or informal policies or guidelines for allocating compensation between long-term and short-term compensation, between cash and non-cash compensation or among different forms of cash and non-cash compensation.
 
Determining Executive Compensation

In setting compensation for our officers our board of directors, which is currently comprised of Mr. Gary Guseinov, Mr. Igor Barash, Mr. Kevin Harris and Mr. Ben Van De Bunt, look primarily at the person’s responsibilities, at salaries paid to others in businesses comparable to ours, at the person’s experience and at our ability to replace the individual.

 
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Elements of Compensation

Base salaries. In general, base salaries for our executive officers were initially established at the time the individual was hired, taking into account comparable industry compensation and internal pay equity considerations, as well as the individual’s qualifications and experience. Base salaries of our executive officers are reviewed annually by our board of directors. In making decisions regarding salary adjustments, we review performance, comparable industry compensation and internal pay equity consideration. We also draw upon the experience that members of our board of directors may have within our industry. We do not assign a specific weight to any single factor in making decisions regarding base salary adjustments.

Bonuses. Bonuses are used to reward exceptional performance, either by the individual or by the company. Bonuses are both discretionary and performance based. There is no single method of computing bonuses. The board of directors may use any criteria to determine the amount of a bonus.

Long-term equity incentive compensation. Our executive officers are eligible to receive long-term equity-based incentive awards, which are intended to align the interests of our executive officers with the interests of our shareholders and to emphasize and reinforce our focus on team success. Historically, our long-term equity-based incentive compensation awards have been made solely in the form of stock options subject to vesting based on continued employment or the achievement of performance goals. We believe that stock options are an effective tool for meeting our compensation goal of increasing long-term shareholder value by tying the value of the stock options to our future performance. Because employees are able to profit from stock options only if our stock price increases relative to the stock option’s exercise price, we believe stock options provide meaningful incentives to employees to achieve increases in the value of our stock over time.
 
All stock option awards are approved by the board of directors. In determining the size of a stock option grant, the board of directors takes into account individual performance, internal pay equity considerations and the value of existing long-term incentive awards. Employees may receive an initial grant of stock options in connection with the commencement of their employment. Our board of directors retains discretion to make stock option awards to employees at any time.
 
The exercise price of each stock option grant is generally the fair value of our common stock on the grant date or a slight discount of the fair value of our common stock on the grant date.
 
Stock option awards to our current executive officers typically vest over a two- or four-year period. We believe this vesting schedule appropriately encourages long-term employment with our company, while allowing our executives to realize compensation in line with the value they have created for our shareholders. In the past we have granted options with shorter vesting periods to executive officers that were employed as consultants due to the short term nature of their consulting agreements.
 
Based on these factors, in 2007 and 2008 the board of directors granted stock options to the executive officers as set forth below in “Grants of Plan-Based Awards.”

Severance and change of control arrangements. Pursuant to their employment agreements, some of our executive officers are eligible for severance benefits consisting of base salary continuation (ranging from 6 to 12 months) and paid COBRA coverage for 6 months if the officer’s employment is terminated by us without cause or as a result of a constructive termination. We provide these benefits to promote retention and ease the consequences to the executive of an unexpected termination of employment.
 
The employment agreements with our Chief Executive Officer and our Chief Financial Officer also provide for accelerated vesting of the executive’s then outstanding stock options in the event the executive is terminated by us without cause, is constructively terminated, or following a change of control. These arrangements are intended to preserve morale and productivity and encourage retention in the face of the disruptive impact of a change of control and to allow them to focus on the value of strategic alternatives to shareholders without concern for the impact on their continued employment, as each of their offices is at heightened risk of turnover in the event of a change of control.

 
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Employee benefits. Our executive officers receive the same benefits available to our employees generally. These include participation, sometimes at the employee’s expense, in health, dental, group life and disability insurance plans. The type and extent of benefits offered are intended to be competitive within our industry.

Tabular Disclosure Regarding Executive Compensation

The following table reflects all compensation awarded to or earned by our Chief Executive Officer, our two most highly compensated officers other than the Chief Executive Officer and any other individuals who are no longer serving, but who did serve, as an officer during the last two completed fiscal years.

SUMMARY COMPENSATION TABLE
 
Name and Principal
Position
 
Year
 
Salary
   
Bonus
   
Option
Awards(1)
   
All Other
Compensation (8)
   
Total
 
Gary Guseinov, Chief
Executive Officer and
President
 
2008
 
$
225,000
(2)
 
$
112,500
     
0
   
$
14,024
   
$
351,524
 
   
2007
 
$
225,000
(2)
 
$
0
     
0
   
$
13,757
   
$
238,757
 
                                             
Ivan Ivankovich, former
Chief Financial Officer