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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2009

OR

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

For the transition period from              to    

Commission File No. 000-51995

ETELOS, INC.

(Exact name of registrant as specified in its charter)

(425) 458-4510

Registrant’s telephone number

Securities registered pursuant to Section 12(b) of the Exchange Act:

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, Par Value $0.01

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. .    Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x  Yes    o  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  o  Yes   o   No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

The aggregate market value of the shares of common stock held by non-affiliates of the issuer, based upon the closing price of the common stock as of the last business day of the registrant’s most recently completed second fiscal quarter as reported on the OTC Bulletin Board ($0.36 per share), was approximately $2.16 million.  Shares of common stock held by each executive officer and director and by each person who owned 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates.  This determination of affiliate status is not necessarily a conclusive determination for other purposes.  The determination of who was a 10% stockholder and the number of shares held by such person is based on Schedule 13D, Schedule 13G, and Form 4 filings with the Securities and Exchange Commission as of June 30, 2009.

As of March 16, 2010, there were 23,939,810 shares of the issuer’s common stock outstanding and 743,333 shares of the issuer’s New Series A Preferred stock outstanding.

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EXPLANATORY NOTE

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

On April 23, 2008, Tripath filed a Current Report on Form 8-K announcing, among other things, that Etelos-WA merged with and into Tripath, and that the surviving corporation changed its name to Etelos, Inc. and its fiscal year end to December 31.  The effective date of the merger was April 22, 2008, and Etelos, Inc., as the surviving corporation, will conduct the business and operations previously conducted by Etelos-WA.  In connection with the merger, all outstanding shares of Etelos-WA common stock were converted into shares of Etelos, Inc. common stock on a three for one ratio: one share of Etelos, Inc. common stock for every three shares of common stock of Etelos-WA.  Also in connection with the merger, (i) all outstanding shares of preferred stock of Etelos-WA were converted into shares of common stock of Etelos, Inc., (ii) Etelos, Inc. issued an aggregate of 5,010,000 shares of its common stock to the secured and unsecured creditors of Tripath and (iii) all the shares of Tripath were cancelled.  Prior to the merger, Tripath was a shell corporation and in accordance with the Plan of Reorganization had no assets or liabilities.  While Tripath acquired all the outstanding preferred and common stock of Etelos-WA, for accounting purposes, the acquisition has been treated as a recapitalization of Etelos-WA with Etelos-WA as the acquirer (a reverse acquisition).  The historical financial statements prior to April 22, 2008, are those of Etelos-WA and the description of the business contained in this report as well as the one contained in the financial statements reflect the operations of Etelos-WA for the quarterly and twelve month periods ended December 31, 2008 and 2007.

Also, on April 23, 2008, Etelos, Inc., formerly Tripath, amended its certificate of incorporation with the state of Delaware to change its total authorized shares of stock to 300,000,000 shares, of which 250,000,000 shares are designated “common stock” with a par value of $0.01 per share and 50,000,000 shares are designated “preferred stock” with a par value of $0.01 per share.  The preferred stock may be issued from time to time in one or more series, each of such series to consist of such number of shares and to have such terms, rights, powers and preferences, and the qualifications and limitations with respect thereto, as stated in the resolutions providing for the issue of such series adopted by the board of directors.

Information concerning number of shares outstanding for Etelos, Inc. including the conversion prices and number of shares issuable upon conversion of convertible securities and exercise prices of warrants and stock options and the number of shares issuable upon exercise of such options and warrants, has been adjusted to reflect the three for one conversion ratio effected in connection with the merger as if it had occurred for all periods presented.

In this report, unless the context indicates otherwise, the terms “Etelos,” “Company,” “we,” “us,” and “our” refer to Etelos, Inc., a Delaware corporation.

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Etelos, Inc.

Annual Report on Form 10-K

For the Year Ended December 31, 2009

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FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or the “Securities Act,” and Section 21E of the Securities Exchange Act of 1934 or the “Exchange Act.”  These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under the heading “Risk Factors” and elsewhere in, or incorporated by reference into, this report.

In some cases, you can identify forward looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,” “anticipate,” “estimate,” “predict,” “potential,” or the negative of these terms.  These terms and similar expressions are intended to identify forward-looking statements.  The forward-looking statements in this report are based upon management’s current expectations and belief, which management believes are reasonable.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor or combination of factors, or factors we are aware of, may cause actual results to differ materially from those contained in any forward looking statements.  You are cautioned not to place undue reliance on any forward-looking statements.  These statements represent our estimates and assumptions only as of the date of this report.  Except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including:

·                                          our ability to obtain future financing or funds when needed;

·                                          market acceptance and market demand for our products and services;

·                                          new competitors are likely to emerge and new technologies may further increase competition;

·                                          our operating costs may increase beyond our current expectations and we may be unable to fully implement our current business plan;

·                                          our ability to successfully obtain a diverse customer base;

·                                          our ability to protect our intellectual property through patents, trademarks, copyrights and confidentiality agreements;

·                                          our ability to attract and retain a qualified employee base;

·                                          our ability to respond to new developments in technology and new applications of existing technology before our competitors;

·                                          acquisitions, business combinations, strategic partnerships, divestures, and other significant transactions may involve additional uncertainties; and

·                                          our ability to maintain and execute a successful business strategy.

Other risks and uncertainties include those outlined in risk factors detailed in this report and our other SEC filings.  You should consider carefully the statements under “Item 1A. Risk Factors” in Part I and other sections of this report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition.  All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.

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PART I

ITEM 1.                  BUSINESS

Business

We have a Web Application distribution platform delivering Web Applications for businesses.  We provide a Software-as-a-Service (SaaS) ecosystem for building, distributing, and using Web Applications, including a marketplace to deploy and support them.  Unlike other cloud computing and Platform-as-a-Service (PaaS) solutions, we enable software manufacturers to migrate existing applications or create new applications, then package, distribute, host, bill, market and support their SaaS enabled applications through multiple private label applications marketplaces.

We have developed products for Web Applications, which include open standards-based tools for Web developers, businesses and individual users such as the Etelos Application ServerTM (EASTM) and the Etelos Development EnvironmentTM (EDETM).  EAS and EDE support many common programming languages and also support our English Application Scripting Engine (EASETM), a simple-to-use open standards-based scripting language we developed.  In order to support broader adoption of our products, EASE and other components of the EDE are made available to developers at market appropriate pricing.  This is done to support the development of new Web Applications and the migration of existing Web Applications into the Etelos ecosystem where there are tools and other support mechanisms for the marketing, distribution, and support of these applications.

Our business model focuses on the sales and operation of private-label Web application marketplaces, including provision of the professional services required to develop, deploy and operate such marketplaces, and the launch of offerings of the Etelos Platform SuiteTM.   The Etelos Platform Suite is designed to allow Independent Software Vendors (ISVs) to implement a SaaS delivery version of their existing applications, whether or not those applications are already Web Applications, and to syndicate the offering of those applications through multiple private label marketplaces. In these difficult economic times, we believe that a variety of ISVs will have applications that they need to move to the Web for lower cost implementation, easier, simpler scalability, and broader distribution.  The Etelos Platform Suite also enables Marketplace Partners, including non-technology businesses, to have their own private label marketplaces and tools to offer SaaS Web Applications to better serve their customers in multiple distribution channels.

Although we have long enabled applications to be distributed via the Web, we believe that our shift away from a direct marketing focus to providing professional services and tools to ISVs will have four major benefits for our business.  First, this offering will expose the core platform to more ISVs for greater benefit to their end users and the creation of a larger pool of applications for syndication. Second, the development and operation of third party-branded marketplaces shifts the financial expense and operational burdens of sales and marketing to end users to Marketplace Partners that better know their customers and are better capitalized to support necessary sales and marketing activities.  Third, because this two-pronged go-to-market strategy is offered on a revenue-sharing basis, it fundamentally reduces barriers to acceptance by eliminating up front costs for Syndication Partners to offer their products through multiple Marketplace Partners, and by charging Marketplace Partners only for sales success.   Finally, this shift allows us to focus on our core competency in development and operation of online marketplaces, while better managing limited financial and other resources.

In addition to revenues from consulting services, we receive a transaction fee or subscription fee for transactions that occur within these private-label Web application marketplaces.  Most customers in these marketplaces pay a subscription fee, which we share with Syndication Partners and Marketplace Partners; this revenue share is calculated as a percentage of gross revenues from the sale of subscriptions to Syndication Partner offerings in private-label Web application marketplaces operating on the Etelos Platform Suite.

History

We were originally organized as Etelos, Incorporated, a Washington corporation on May 5, 1999. We have been engaged in the business of web application development and services since our inception.

On February 8, 2007, Tripath Technology Inc., a Delaware corporation (“Tripath”) filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. On February 1, 2008, the bankruptcy court issued an order confirming approval of the Plan of Reorganization, including the merger and the transfer of all of Tripath’s existing assets into a separate bankruptcy estate and the discharge of all of Tripath’s liabilities.  The Plan of Reorganization also contemplated the merger of Etelos, Incorporated with and into Tripath.

On April 22, 2008, we completed the merger with and into Tripath, changed the name of the surviving entity to Etelos, Inc., and changed our fiscal year end to December 31.

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Recent Developments

On June 30, 2009, we restructured our January 2008 and April 2008 Convertible 6% Secured Debentures in the principal amount of $5.5 million. Under the terms of the agreement, the terms of the debentures are extended to December 31, 2012, interest accrues at 0% from the date of the agreement until October 1, 2010, and at 6% thereafter. All accrued but unpaid interest as of June 30, 2009, and interest due to be earned to September 30, 2010 under the original terms of the January 2008 and April 2008 Debentures was added to the principal amount and will be payable on the date of maturity.  Our obligation to make monthly amortizing redemption payments has been terminated; we will make semi-annual interest payments only. We also agreed to terminate the registration rights agreement entered into in conjunction with the debentures and to exchange the warrants issued in conjunction with the debentures for Etelos common stock on a 1:1 basis.

On September 29, 2009, we entered into a securities purchase agreement with three accredited investors for the sale of 10% senior secured convertible debentures in the principal amount of $2.0 million. We refer to these debentures as our September 2009 Debentures.  In this transaction, in addition to the debentures, we issued to the investors warrants to purchase 3,000,000 shares of our common stock with an exercise price of $0.60 per share, or the “September 2009 warrants,” a warrant to purchase 2,250,000 shares of our common stock with an exercise price of $0.01 per share, or the “ September 2009 par value warrant,” and 750,000 shares of our restricted common stock, or the “closing shares.”  One of the investors paid part of its subscription amount through the cancellation of approximately $1.2 million worth of short-term indebtedness we owed to such investor.  The securities purchase agreement further provided that we had the right, subject to certain conditions, to require the investors to purchase an aggregate of $1.0 million in additional principal amount of debentures.  We exercised that right on December 15, 2009, and issued an additional $1.0 million of debentures to the investors on that date.

Subsequently, on January 25, 2010, we entered into a securities purchase agreement with an entity affiliated with Donald W. Morissette, who, together with his affiliates, beneficially owns more than 10% of our outstanding common stock, for the sale of 10% senior secured convertible debentures, identical to the September 2009 Debentures, in the principal amount of $250,000. In this transaction, in addition to the debentures, we issued a warrant to purchase 375,000 shares of our common stock with an exercise price of $0.60 per share and 375,000 shares of our restricted common stock, or the “closing shares.”  We refer to this financing as our January 2010 financing in this report. The securities purchase agreement further provided that we had the right, subject to certain conditions, to require the investor to purchase an aggregate of $125,000 in additional principal amount of debentures between March 15 and 31, 2010. We exercised that right on March 15, 2010, and issued $125 thousand in additional debentures to an entity affiliated with Mr. Morissette.  See “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Liquidity and Capital Resources” below for a description of the terms of all of our outstanding debentures.

In the quarter ended December 31, 2009, and subsequently, we resolved a number of significant litigation items in a manner that we believe was generally favorable to the Company.  These matters asserted claims against the Company in the aggregate amount of approximately $2.5 million, and were settled for cash and note payments in the aggregate amount of approximately $400 thousand, payable over the next 6-12 months, and the issuance of 346,667 shares of common stock of the Company, valued at approximately $218 thousand.  In one of these matters, we repurchased and retired 2.4 million shares of our common stock - approximately 10% of the issued and outstanding shares for $175,000.  See “LEGAL PROCEEDINGS” below.

In addition, payment schedules for approximately $300 thousand in long overdue accounts payable have been negotiated for payment over the next 6-12 months.

On December 22, 2009, the board of directors, with Mr. Kolke and Mr. Rudy abstaining in the matters affecting them or their affiliates, authorized the issuance of (a) 434,754 shares of Common Stock to Selma and Daniel Kolke, for payment of 45% of the principal and 100% of the accrued interest on the promissory note dated December 30, 2007, which has been in default since September 2008; (b) 28,939 shares of Common Stock to Paul Stuit, for payment in full of principal and accrued interest on the promissory note dated February 24, 2009, which was in default; and (c) 143,379 shares of Common Stock to Ronald Rudy, for payment in full of principal and accrued interest on the promissory note dated March 31 2009, which also was in default.  The transactions were effective on December 31, 2009, and the Common Stock was issued at an effective price of $0.75 per share and the amount of notes payable to related parties converted to common stock by these issuances was $455,304.

In partial settlement of approximately $292 thousand of an aggregate $575 thousand in unpaid salaries due and owing to current employees of the Company as of December 31, 2009, the board of directors has authorized the registration of 500,000 shares of Common Stock previously reserved under the Company’s 2009 Equity Incentive Plan as partial payment of up to 50% of the amount of unpaid salary due and owing to each current employee.  369,078 of those shares are to be issued upon completion of the registration process at an effective price of $0.79 per share.

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Industry Background

The 1990s saw the widespread adoption among large enterprises of packaged business management applications that automated a variety of departmental functions, such as accounting, finance, order and inventory management, human resources, sales, and customer support. These sophisticated applications required significant cash outlays for the initial purchase and for ongoing maintenance and support. In addition, these applications were internally managed and maintained by enterprise customers, requiring increasingly large staffs to support complex information technology infrastructures. Most importantly, the applications generally were provided by multiple vendors, with each application providing only a departmental view of the enterprise. To gain an enterprise-wide view, organizations attempted to tie together their various incompatible packaged applications through long, complex, and costly integration efforts. Many of these attempts failed, in whole or in part, often after significant delay and expense. As a consequence, many large enterprises have transitioned from multiple point products to comprehensive, integrated business management suites, such as those offered by Oracle and SAP, as their core business management platforms.

Small-to-Medium sized Businesses (SMBs), which we define as businesses with up to 1,000 employees, have application software requirements that are similar, in many respects, to large enterprises because their core business processes are substantially the same. These requirements include the integration of back-office activities, such as managing payroll and tracking inventory; front-office activities, including order management and customer support; and, increasingly, sophisticated e-commerce capabilities. According to a 2006 forecast for the CRM market and 2007 forecasts for the ERP and supply chain management, or SCM, markets from Gartner, Inc., companies in North America spent approximately $13.7 billion on ERP, CRM, and SCM software applications in 2006, of which SMBs accounted for $4.4 billion, or 32 percent. Gartner projects that SMB spending on these applications will grow 8.7 percent annually from 2006 to 2010, compared to 5.7 percent for large businesses.

SMBs are generally less capable than large enterprises of performing the costly, complex, and time-consuming integration of multiple point products from one or more vendors. As a result, a comprehensive business suite may provide comparatively greater benefits and value for the SMB customer. Suites designed for, and broadly adopted by, large enterprises to provide a comprehensive, integrated platform for managing these core business processes generally are not well suited to SMBs due to the complexity and cost of such applications.

Recently, SMBs have begun to benefit from the development of the on-demand SaaS model. SaaS uses the Internet to provide users with access to software applications from a centrally hosted computing facility through a web browser. SaaS eliminates the costs associated with installing and maintaining applications within the customer’s information technology infrastructure. On-demand applications are generally licensed for a monthly, quarterly or annual subscription fee, as opposed to on-premise enterprise applications that typically require the payment of a much larger, upfront license fee. As a result, on-demand applications require substantially less initial and ongoing investment in software, hardware and implementation services and lower ongoing support and maintenance, making them more affordable for SMBs.

To date, the on-demand software model has been applied to a variety of types of business software applications, including CRM, security, accounting, human resources management, messaging, and others, and it has been broadly adopted by a wide variety of businesses. IDC estimates worldwide on-demand enterprise software vendor revenues were approximately $3.7 billion in 2006 and that they will grow 32 percent annually through 2011 to $14.8 billion.

While SaaS applications have enabled SMBs to benefit from enterprise-class capabilities, most are still products that require extensive, costly, and time-consuming integration to work with other applications. SMBs generally have been unable to implement a comprehensive set of business management products at an affordable level of cost that will enable them to run their businesses using a single system of records, provide real-time views of their operations, and be readily customizable and rapidly deployed and implemented, especially in a geographically dispersed organization.

Etelos™ Products and Services

We have developed and offer a range of products and services for developers and for consumers of Web Applications.  Our product offerings are grouped into two basic programs: the Etelos Ecosystem™ and the Etelos Platform Suite™.

The Etelos Ecosystem. The Etelos Ecosystem is a dynamic development, distribution, and consumption environment for scaling applications and providing business solutions to common business problems.  Our ecosystem is constantly being improved and expanded to contain the tools and support programs that help foster continued development of a network of added value development and distribution partners.

Our products for Web Applications include open standards-based tools for Web developers, business and individual users such as the Etelos Application Server™ (EAS™) and the Etelos Development Environment™ (EDE™).  EAS and EDE support many common application languages and also support the English Application Scripting Engine (EASE™), our simple-to-use open standards scripting language.  In order to support broader adoption of our products, EASE and other components of our platform are provided to developers and users at market appropriate pricing.  This is done to support the development of new Web Applications and the migration of existing Web Applications into the Etelos ecosystem where there are tools and other support mechanisms for the marketing, distribution, sales and support of these applications.  We generally receive a transaction fee, a revenue-share based subscription fee or a license fee for transactions that occur within the Etelos Ecosystem via an Etelos Marketplace.

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Web Applications built with or brought to the Etelos Ecosystem are made available for distribution in an Etelos Marketplace as a subscription service using the Software-as-a-Service (SaaS) or software-on-demand business model. The Etelos Ecosystem gives developers of Web Applications, including us, an easy place to distribute and support Web Applications.  Web Applications delivered through the Etelos Marketplace or through third-party branded Marketplaces operated by us can be easily and conveniently billed, distributed and configured to provide updates and support to users exactly in accordance with the developer’s desires, without requiring the developer to perform development unrelated to the underlying Web Application or to operate a robust licensing and delivery infrastructure.  An Etelos Marketplace relieves the burdens to developers of delivery and support to the users of their Web Applications.  We also provide additional paid professional services and support on behalf of our Syndication and Marketplace Partners.

An Etelos Marketplace enables rapid adoption of Web Applications by giving customers freedom of choice to select from a wide array of fully customizable, on-demand business applications.  These applications may be deployed in the hosting environment of the customer’s choice, including hosting services provided through us. Web Applications built on our platform may be integrated with other Web Applications through the use of Etelos App Sync™, hosted anywhere, and customized to create highly flexible business solutions.  Not only can businesses easily choose from a range of Web Applications, but they can instantly “try or buy” them. The flexibility of the Etelos Ecosystem enables businesses to assemble a Web Applications suite.  The Build-a-Suite™ concept is ideally tailored for particular business needs and building scalable solutions.

Etelos Platform Suite

The Etelos Platform Suite allows third parties to use our software platforms and our services to develop and operate private label applications and marketplaces.  We began working with third parties on private label solutions in November 2008 and our first customers launched their private label marketplaces in mid-fiscal 2009.

There are four components to the Etelos Platform Suite:

·                                          The SaaS Application Platform enables technology providers to move their non-Web Application or service to web-based SaaS distribution;

·                                          The SaaS Marketplace Platform enables third parties to offer a variety of syndicated Web Applications and services in a third party-branded SaaS marketplace;

·                                          The SaaS Distribution Platform allows technology companies and service providers to distribute additional Web Applications and services to customers on a SaaS platform; and

·                                          The SaaS Syndication Platform lets SaaS providers distribute their Web Applications and services through a network of third party-branded marketplaces.

The Etelos Platform Suite allows our customers to take advantage of our tools and experience in the SaaS market to move their existing applications to the Web for lower cost implementation, easier, simpler scalability, and broader distribution.  Our Etelos Platform Suite enables Marketplace Partners, including non-technology businesses, to have their own private label marketplaces and tools to offer SaaS Web Applications to better serve their customers in multiple distribution channels.

Etelos Web Application Hosting. By using almost any programming language a developer chooses, including our own EASE language, and by hosting Web Applications wherever users want, utilizing our Etelos Application Server, the Etelos Development Environment allows our partners to extend solutions using our platform.  Our customers rely on our products and the products of our Syndication Partners to run their businesses, and, as a result, it is our responsibility to ensure the availability of our service. We continue to improve our infrastructure with the goal of maximizing the availability of our Web Applications and those of our developers, distributors and users.  We host on a highly-scalable network located in secure third-party facilities.  We have facility space, power, and Internet connectivity provided by Network OS, a third party co-location and hosting provider, located in the Seattle, WA area. In anticipation of future growth, we may engage additional providers and/or expand the number of data centers utilized with existing vendors. Our hosting operations incorporate industry-standard hardware and our EAS operating system and databases and application servers provide a flexible, scalable architecture. Elements of our products’ infrastructure can be replaced or added with no interruption in service, helping to ensure that the failure of any single device will not cause a broad service outage.

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Professional Services.

We are developing repeatable, cost-effective consulting and implementation services to assist our customers with integrating Web Applications, using them on and off-line and importing data from other systems. We provide support services to aid in changing their business processes to take advantage of the enhanced flexibility enabled by our Build-a-Suite concept. Build-a-Suite enables our customers to implement cost reducing, scalable business processes within their organization and identifying, configuring, and customizing our products and those of our partners for each unique business process and requirement, with a goal of entering data once and using it across the organization and across the applications used by the business.

Our consulting and implementation methodology leverages the nature of our on-demand Web Application software architecture, the industry-specific expertise of our professional services employees, and the design of the Etelos Ecosystem and private-label Web application marketplaces operating on the Etelos Platform Suite. They are used to simplify, reduce costs and expedite the implementation of scalable Web Applications to aid in better business operations. We generally employ a joint staffing model for implementation projects in which we involve the customer more actively in the implementation process than traditional software companies. We believe this better prepares our customers to support their own application set.  In addition, because our Web Applications are on-demand, our Professional Services employees can remotely configure many applications for most situations. Our consulting and implementation services are generally offered on a fixed price basis. Our network of partners also provides professional services to our customers.

Customer Support and Management.

Our technical support organization, with personnel in the United States, offers support via the Web 24 hours a day, seven days a week. Our system allows for skills-based and time zone-based routing to address general and technical inquiries across all aspects of our services. For our direct customers and development partners, we offer tiered customer support programs depending upon the service needs of both our and their customers’ Web Applications. Support contracts typically have a one-year term. For customers who purchase Web Applications through distribution partners, we attempt to assure a quality customer experience by providing primary product support, instead of permitting the distribution partner to provide that support.

Etelos Benefits

The advantages of our products and services are:

Open Standards.  Products distributed in an Etelos Marketplace are developed on open standards.  This foundation makes the products easy to develop, easy to adopt and integrate with other Web Applications, and easy to swap or modify to meet specific customer needs.  The use of open standards for business applications distinguishes the products in an Etelos Marketplace not only from comprehensive product suites from such vendors of proprietary software as Microsoft, Oracle, and SAP, but also from products offered by other SaaS vendors such as salesforce.com or NetSuite, that require developers of Web Applications to adopt a high-cost proprietary foundation for their products, resulting in higher costs to both developers and their customers.

On-Demand Delivery Model. We deliver our products over the Internet as a license-based or subscription based service using a SaaS model, making adoption easy and scalability simple.  The SaaS delivery model also eliminates the need for customers to buy and maintain on-premise hardware and software. Our products are designed to be reliable, scalable and secure. Our architecture enables businesses to maintain very high levels of availability, scale easily as their business and customers grow while providing a safe and secure environment for business-critical data and applications.

Low Total Cost of Ownership. Our SaaS delivery model and each different Web Application’s ease of use and configurability aids in helping to significantly reduce implementation and maintenance costs of hardware, software and services. The Etelos ecosystem virtually eliminates the need for dedicated software development or information technology support personnel. Customers subscribe to products through an Etelos Marketplace for a monthly fee based on the number of users and the products they select.  Subscription fees paid to us periodically, typically monthly, tend to be significantly less than typical upfront costs paid by businesses to purchase product licenses from other providers. Our on-demand delivery model virtually eliminates ongoing maintenance and upgrade costs associated with a typical distributed infrastructure. Because Web Applications distributed in an Etelos Marketplace are developed on open standards and delivered over the Internet, any desired customization can be highly targeted, and therefore usually performed at lower cost to the business customer.

Rapid Implementation. The Internet-based on-demand delivery model implemented by an Etelos Marketplace enables remote deployment and eliminates many of the steps and costs typically associated with on-premise installations. Syndication Partners and their customers can implement our offerings themselves, or work with our development partners or our professional services organization to meet their specific needs.

Security, Control and Choice.  The combination of open standards and Internet-based on-demand delivery and support enabled using an Etelos Marketplace provides customers with security for their important business data, control over the use and portability of that data, and flexibility and freedom of choice in Web Applications that provide built-in quality and scalability as solutions to specific business needs.

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Sales and Marketing

We generate sales through both indirect and direct approaches. Most selling of subscriptions for Web Applications and Hosting is done over the Internet.  Sales of custom products and Professional Services tend to be direct. Our direct sales team consists of professionals in various locations in the United States, including resellers, with additional development, distribution, and business relationships being developed in North America, South America, Europe, and the Asia-Pacific region.

Our Web Applications and Hosting sales activities generally are the result of word of mouth, marketing programs, or user referrals.  Our sales and support personnel provide web based seminars, forums, and direct support services to ensure continued subscription sales.  The sales cycle typically ranges from days to months, and can vary based on the Web Application, the scope of any customization desired, and the scope of any professional services required to meet specific customer requirements.

Our sales process for Custom Products and Professional Services typically begins with the generation of a sales lead from a marketing program or customer referral. After the lead is qualified, our sales personnel conduct focused web-based demonstrations along with initial price discussions. Members of our professional services team are engaged, as needed, to offer insight around aspects of the implementation. Our sales cycle typically ranges from days to months, but can vary based on the specific application, the size and complexity of the potential customer’s information technology environment, and many other factors.

We tailor our marketing efforts around relevant application categories, customer sizes, and customer industries. As part of our marketing strategy, we have established a number of key programs and initiatives, including online and search engine advertising, email campaigns, web based seminars, product launch events, trade show and industry event sponsorship and participation, and marketing support for development and distribution partners.

Customers

As of December 31, 2009, we had limited revenues, primarily from consulting projects for a very limited number of customers in projects of varying sizes and duration.  During 2009, three customers comprised 77% of our total revenues and each of these customers accounted for more than 10 percent of our revenue during the year ended December 31, 2009.  There were no accounts receivable from those three customers as of December 31, 2009; one other customer accounts for 100% of the Company’s accounts receivables as of December 31, 2009.

Competition

We compete with a broad array of Enterprise Software, On-line Advertising and SaaS companies. These markets are highly competitive, fragmented, and subject to rapid changes in technology. Many of our potential customers are seeking their first business Web Application and, as such, evaluate a wide range of alternatives during their purchase process. We face significant competition within each of our markets from companies with broad product suites and greater name recognition and resources than us.  We also face competition from smaller companies focused on specialized solutions. To a lesser extent, we compete with internally developed and maintained solutions.  Current competitors include NetSuite,Inc., Epicor Software Corporation, Jamcracker, Intuit Inc., Microsoft Corporation, SAP, The Sage Group plc, Amazon, salesforce.com, inc., and others not listed here, both public and private.

We believe that the principal competitive factors in our markets include:

·                                          freedom of choice in Web Applications;

·                                          service breadth and functionality;

·                                          performance, security, and reliability;

·                                          “Try and Buy”: the ability to tailor and customize services for a specific company, vertical or industry;

·                                          ease of use and replacement;

·                                          speed and ease of deployment, integration and configuration;

·                                          total cost of ownership, including subscription, implementation and support costs;

·                                          sales and marketing approach; and

·                                          financial resources and reputation.

We believe that we compete favorably with most of our competitors on the basis of each of the factors listed above.  We further note, however, that certain of our competitors have greater sales, marketing, and financial resources, more extensive geographic presence, and greater name recognition than us. In addition, although we have extended the number of applications we have introduced for specific vertical markets, we may be at a disadvantage in certain other vertical markets compared to certain of our competitors. We may face future competition in our markets from other large, established companies, as well as from emerging companies. In addition, we expect that there is likely to be continued consolidation in the industry that could lead to increased technology, price, and other forms of competition.

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Intellectual Property

Our success depends in part upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including trade secrets, patents, copyrights and trademarks, as well as customary contractual protections. We view our patents, trade secrets, and know-how as a significant component of our intellectual property assets, as we have spent years designing and developing our products, which we believe differentiates us from our competitors.

As of December 31, 2009, we had multiple U.S. and foreign patent applications pending. We may file additional patent applications in the U.S. and elsewhere.  We do not know whether our pending or future patent applications will result in the issuance of patents in the U.S. or elsewhere, or whether the examination process will require us to narrow our claims. Even if granted, there can be no assurance that the pending patent applications will provide us with significant competitive protection.

We use a number of unregistered trademarks.  We have not registered any trademarks or service marks.

We maintain a policy requiring our employees, consultants and other third parties to enter into confidentiality and proprietary rights agreements and to control access to software, documentation and other proprietary information.

We do not analyze the software that we distribute from our ISV Syndication Partners to determine the adequacy of their intellectual property rights.  We have not maintained operating controls or logs, or initiated or conducted any forensic, code history, ‘genealogy’ or other form of audit, analysis, processes, training, or code review of software code incorporated into any of our products or in other products offered by our ISV Syndication Partners in any Etelos Marketplace.  These products may include code subject to various forms of ‘open source’, ‘copyleft’ or similar licenses that require as a condition of modification or distribution of software subject to such license(s) that [a] such software or other software combined or distributed with such software be disclosed or distributed in source code form, or [b] such software or other software combined or distributed with such software, and any related intellectual property, be licensed on a royalty-free basis, including for the purposes of making additional copies or derivative works of such software.  This may adversely affect our ability to patent certain inventions or to license or distribute certain products — whether by open source license or other form of license or right — and may result in liability to unknown parties for infringement of their patents or other intellectual property rights.

The steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our proprietary rights. Competitors may also independently develop technologies that are substantially equivalent or superior to the technologies we employ in our services. Failure to protect our proprietary rights adequately could significantly harm our competitive position and operating results.

In addition, we license third-party technologies that are incorporated into some elements of our service offerings. Licenses of third-party technologies may not continue to be available to us at a reasonable cost, or at all.

The software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks, and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us grows. Many of our commercial agreements require us to indemnify our customers for third-party intellectual property infringement claims, which would increase our costs as a result of defending those claims and might require that we pay damages if there were an adverse ruling in any such claims.

With respect to any intellectual property rights claim against us or our customers, we may have to pay damages or stop using technology found to be in violation of a third party’s rights. We may have to seek a license for the technology, which may not be available on reasonable terms, may significantly increase our operating expenses, or may require us to restrict our business activities in one or more respects. The technology also may not be available for license to us at all. As a result, we may be required to develop alternative non-infringing technology, which could require significant effort and expense.

Research and Development

During the years ended December 31, 2009, and 2008, research and development expenses were $1.3 million and $2.6 million, respectively, and consisted primarily of employee and employee-related expenses.  To date, we have expensed all of our product development costs as incurred; we do not capitalize software development costs.

Employees

As of December 31, 2009, we had 12 full-time employees and one part-time employee.  From time to time, we also engage temporary employees and consultants. None of our employees are represented by a labor union with respect to his or her employment with us.  We consider our relationships with our employees to be satisfactory.  However, we have experienced significant operating issues which have caused us to reduce employment and reduce compensation paid to our employees.  See “RISK FACTORS - We have reduced our employment force and have challenges meeting our operating demands” below.

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Additional Information

Our annual and quarterly reports, along with all other reports and amendments filed with or furnished to the SEC are publicly available free of charge on the Investor section of our website at www.etelos.com as soon as reasonably practicable after these materials are filed with or furnished to the SEC. Our corporate governance policies, ethics code and board of directors’ committee charters are also posted within this section of the website. The information on our website is not part of this or any other report we file with, or furnish to, the SEC. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is www.sec.gov.

ITEM 1A.                                            RISK FACTORS

Investment in our common stock involves a high degree of risk. You should carefully consider the risks described below together with all of the other information included in this report before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could suffer. In that case, the market price of our common stock could decline, and you may lose all or part of your investment.

Our current cash will fund our business as currently planned only through early-mid 2010. We need additional funding or we will be forced to curtail or cease operations.

We need immediate and substantial cash to continue our operations. Management has projected that cash on hand will be sufficient only to allow us to continue our operations through early-mid 2010.  We are presently engaged in active discussions for additional investments by existing and prospective investors but we currently have no funding commitments.  We have not made required payments under our outstanding debt securities and the holders of our outstanding debt securities have the right to demand payment of the amounts currently due under such securities or exercise their other remedies, such as foreclosing on our assets.  We also need to make payments and negotiate payment plans for certain notes payable and other payables and there is a risk that trade creditors will not accept deferred payment and may exercise other remedies to collect balances due and owing. We therefore will need additional funding, either through equity or debt financings, or we will be forced to curtail or cease operations or consider other strategic alternatives such as bankruptcy.

We have a substantially reduced employment force and have challenges meeting our operating demands.

We have decreased our number of full-time employees from 46 at June 30, 2008, to 12 as of December 31, 2009.  All except the three lowest paid current employees are being paid less than full salary, ranging from 97% to 74% of net salary, and there is no assurance that any of these personnel will be able to continue to work on this payment arrangement. Our operating plan has placed, and our anticipated growth plan is expected to continue to place, a significant strain on our very limited managerial, administrative, operational, financial, and other resources, compounded by these recent reductions in headcount. Although we will be required to continue to improve our operational, financial, and management controls and our reporting procedures it is clear that we may not be able to do so effectively and may not be able to recruit or retain adequate, qualified personnel to meet our operating demands. As such, we may be unable to manage our expenses effectively in the future, which may negatively impact our gross margins or operating expenses in any particular quarter.

We have a history of losses and are currently carrying a net loss.  If our business model is not successful, or if we are unable to generate sufficient revenue to offset our expenditures, then we may not become profitable and you may lose your entire investment in our company.

We have not been profitable on an annual or quarterly basis since our formation.  We incurred net losses of $6.8 million and $19.3 million for the years ended December 31, 2009, and 2008, respectively, and have an accumulated deficit of $36.6 million at December 31, 2009.  Although our revenue has slightly increased and our costs of sales and expenses have decreased, our growth has been insignificant and future revenue growth may not be sustainable and we may not achieve sufficient revenue to achieve or maintain profitability.  We have incurred and may continue to incur significant losses in the future, for a number of reasons including the other risks described in this report, and we may encounter unforeseen expenses, difficulties, complications, delays, and other unknown factors.  Accordingly we may not be able to achieve or maintain profitability and we may continue to incur significant losses in the foreseeable future. These losses may require us to scale back our business, sell or license some or all of our technology or assets, or curtail or cease operations.

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

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

·                                          maintain and improve our technology;

·                                          expand our product and service offerings and maintain the high quality of products and services offered;

·                                          sell our products and services to sufficient, quality customers to produce revenues adequate to meet our operating needs;

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

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

·                                          maintain adequate control of our expenses;

·                                          implement our product development, marketing, sales, and acquisition strategies and adapt and modify them as needed; and/or

·                                          anticipate and adapt to changing conditions in the markets in which we operate as well as the impact of any changes in government regulation, mergers and acquisitions involving our competitors, technological developments, and other significant competitive and market dynamics.

If we are not successful in addressing any or all of these risks, then our business may be materially and adversely affected.

We may encounter substantial competition in our business and our failure to compete effectively may adversely affect our ability to generate revenue.

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

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

Our major competitors may be better able than us to successfully endure downturns in our markets. In periods of reduced demand for our products, we can either choose to maintain market share by reducing our subscription prices to meet competition or maintain subscription prices, which likely would result in sacrifice of our market share. Sales and overall profitability would be reduced and sustained losses may continue in either case. In addition, we cannot be assured that additional competitors will not enter our existing markets, or that we will be able to compete successfully against existing or new competition.

The market for on-demand Web Applications may develop more slowly than we expect.

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

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

·                                          minimize the time and resources required to implement products distributed through an Etelos Marketplace;

·                                          maintain high levels of customer satisfaction;

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

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

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

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

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

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

·                                          the price, performance, and availability of competing products and services.

Our inability to fund our capital to meet our expenditure requirements may adversely affect our growth and profitability.

Our continued growth is dependent upon our ability to raise capital from outside sources. Our ability to obtain financing will depend upon a number of factors, including our financial condition and results of operations, the condition of the economy, and conditions in relevant financial markets.  If we are unable to obtain financing, as needed, on a timely basis and on acceptable terms, our financial position, competitive position, growth, and profitability may be adversely affected.  The current state of the US and global economy raises substantial doubts, especially about our ability to raise the additional capital that we will need to sustain our business operations.

Our customers are individuals, small and medium-sized businesses, and divisions of large companies, which may increase our costs to reach, acquire and retain customers.

We market and distribute our products and services and other offerings in Private-label Web application marketplaces operating on the Etelos Platform Suite to individuals, SMBs, and divisions of large companies. To grow our revenue quickly, we must add new customers, sell additional services to existing customers, and encourage existing customers to renew their subscriptions. However, selling to and retaining individuals and SMBs can be more difficult than selling to and retaining large enterprises because SMB customers tend to be more price sensitive and more difficult to reach with broad marketing campaigns.  In addition, individuals and SMBs have high churn rates in part because of the nature of their businesses and often lack the staffing to benefit fully from our products.  Further, individuals and SMBs often require higher sales, marketing, and support expenditures by vendors that sell to them per revenue dollar generated for those vendors.

Many of our customers are price sensitive, and if the prices that we or our Syndication Partners charge for subscriptions to products or services offered in an Etelos Marketplace are unacceptable to our customers, then our operating results will be harmed.

Many of our customers are price sensitive, and we have limited experience with respect to determining the appropriate prices for our products or services. In addition, we have no control over prices charged by our Syndication Partners for their products or services offered in an Etelos Marketplace. As the market for our products or services matures, or as new competitors introduce new products or services that compete with ours, we may be unable to renew agreements with existing customers or attract new customers at the same price or based on the same pricing model as previously used. As a result, it is possible that competitive dynamics in our market may require us to change pricing models or reduce prices, which could harm our revenue, gross margin, and operating results.

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

Our success depends, in part, on our ability to protect our proprietary technologies. We rely on a combination of patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our intellectual property rights on a global basis, all of which provide only limited protection.

We own multiple filed United States and foreign patent applications covering our technology and we expect to file more U.S. and foreign patent applications in the future. We have filed to protect most of those patents in many foreign countries. But the process of seeking patent protection can be lengthy and expensive.  We cannot assure you that any patent will issue from our currently pending patent applications in a manner that gives us the protection that we seek, if at all, or that any future patents issued to us will not be challenged, invalidated, or circumvented. Since the filing of some of these patent applications may have been, or will be, made after the date of first sale or disclosure of the subject inventions, patent protection may not be available for these inventions outside the United States.  Any patents that may issue in the future may not provide sufficiently broad protection or they may not prove to be enforceable in actions against alleged infringers. Also, we cannot assure you that any future service mark or trademark registrations will be issued for pending or future applications or that any registered service marks or trademarks will be enforceable or provide adequate protection of our domestic and foreign proprietary rights.

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We do not analyze the software that we distribute from our ISV Syndication Partners to determine the adequacy of their intellectual property rights.  We have not maintained operating controls or logs, or initiated or conducted any forensic, code history, ‘genealogy’ or other forms of audit, analysis, processes, training, or code review of software code incorporated into any Etelos product or in other products offered by our ISV Syndication Partners in any Etelos Marketplace. These products may include code subject to various forms of ‘open source’, ‘copyleft’, or similar licenses that require as a condition of modification or distribution of software subject to such license(s) that (i) such software or other software combined or distributed with such software be disclosed or distributed in source code form, or (ii) such software or other software combined or distributed with such software, and any related intellectual property, be licensed on a royalty-free basis, including for the purposes of making additional copies or derivative works of such software.  This may adversely affect our ability to patent certain inventions or to license or distribute certain products - whether by open source license or other form of license or right - and may result in liability to unknown parties for infringement of their patents or other intellectual property rights.

We require our Syndication Partners to indemnify us for intellectual property claims but we cannot assure that these agreements will be enforceable.

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

Assertions by third parties that we infringe their intellectual property, whether successful or not, could subject us to costly and time-consuming litigation or expensive licenses.

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

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

For any intellectual property rights claim against us or against our Marketplace Partners or customers, we may have substantial direct and indirect costs.  Direct costs can include a requirement to pay damages or stop using technology found to be in violation of a third party’s rights. We may have to purchase a license for the technology, which may not be available on reasonable terms, if at all, may significantly increase our operating expenses, or may require us to restrict our business activities in one or more respects. As a result, we may also be required to develop alternative non-infringing technology, which could require significant effort and expense.  Substantial indirect costs also may be expected in the form of diversion of development and management resources in strategic planning for legal, technology, and business defenses to such claims.

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

Our success and future growth depends to a significant degree on the skills and continued services of our management team, especially Daniel J.A. Kolke, our interim Chief Executive Officer, Acting Chief Financial Officer, and Chairman of the Board. The loss of the services of any member of our management team for any reason may have a material adverse effect on our business and prospects.  We do not maintain key man insurance on any members of our management team, including Mr. Kolke.

We significantly and materially reduced our management team and have not hired replacements for the management team in the positions of Vice President and Chief Financial Officer, Vice President — Marketing, Vice President Corporate Development, and Vice President — Human Resources, as well as several other Director-level positions, primarily in non-technical positions throughout the Company.  We did not fill these positions in the period ending December 31, 2009, and we have not filled any of these positions to the date of this report.

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Our future success also depends on our ability to attract, retain and motivate highly skilled technical, managerial, sales, marketing and service and support personnel, including members of our management team. Competition for sales, marketing, and technology development personnel is particularly intense in the software and technology industries. As a result, we may be unable to successfully attract or retain qualified personnel. Our inability to attract and retain the necessary personnel could harm our business.

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

We plan to expand our sales force and our services and support teams to increase our customer base and revenue. We believe that there is significant competition for sales, service, and support personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in part, on our success in recruiting, training, and retaining sufficient numbers of personnel to support our growth. New hires require significant training and, in most cases, take significant time before they achieve full productivity. Our recent hires and planned hires may not become as productive as we expect and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business. If these expansion efforts are not successful or do not generate a corresponding increase in revenue, then our business will be harmed.

We do not have a dedicated sales team and our revenues and operating results are substantially dependent on third-party resellers.

We do not have a dedicated sales team.  Our chief executive officer and other employees attempt to identify sales opportunities and, when such opportunities materialize, attempt to market and sell our products.  We are substantially dependent upon third-party resellers to market and sell our products and to generate end-user customers.  We have one agreement in place at this time with a third-party reseller to market and sell our products, and that reseller has several additional reseller agreements in place.  We have no control over the amount of time and resources these third-party resellers dedicate to marketing and selling our products.  The loss of any third-party reseller may significantly reduce our revenues.  There is no assurance that we can add additional resellers or replace our current reseller with other resellers or an in-house sales team in the event we lose our reseller or the reseller devotes inadequate time and resources to selling our products.  To the extent we distribute or license our products or services directly to end-user customers, we may be in competition with our resellers. In response to future direct sales strategies or for other business reasons, our resellers may from time to time choose to resell our competitors’ products in addition to, or in place of, our products. Our revenues and financial condition may be adversely affected if our reseller stops marketing and selling our products or if the reseller is not able to generate end-user customers to purchase our products.

Our operating results may be subject to fluctuations that could increase the volatility of the price of our Common Stock. .

Our operating results may fluctuate in the future. As a result, we may fail to meet or exceed the expectations of research analysts or investors, which could cause our stock price to decline. Also period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance.

Fluctuations in our quarterly operating results may be due to a number of factors, including the risks and uncertainties discussed elsewhere in this report. Fluctuations in our quarterly operating results could cause our stock price to decline rapidly, may lead analysts to change their long-term model for valuing our common stock, could cause us to face short-term liquidity issues, may impact our ability to retain or attract key personnel, or cause other unanticipated issues. If our quarterly operating results fall below the expectations of research analysts or investors, then the price of our common stock could decline substantially.

We use third-party data centers to support our services. Any disruption of service at these facilities could interrupt or delay our ability to deliver our service to our customers.

We host many of our services and serve a significant number of our customers from third-party data center facilities with Network OS, located in the greater Seattle Washington area. We do not control the operation of these facilities. These facilities may be vulnerable to damage or interruption from earthquakes, hurricanes, floods, fires, terrorist attacks, power losses, telecommunications failures, and similar events. These facilities also could be subject to break-ins, computer viruses, sabotage, intentional acts of vandalism and other misconduct. The occurrence of a natural disaster or an act of terrorism, a decision to close the facilities without adequate notice, or other unanticipated problems could result in lengthy interruptions in our services.

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

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

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

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

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

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

Because we deliver products as a service through an Etelos Marketplace, errors or defects in the Web Applications underlying the service, or a failure of our hosting infrastructure may make the service unavailable to our customers. Because our customers use the products to manage critical aspects of their business, any errors, defects, disruptions in service, or other performance problems with the products, whether in connection with the day-to-day operation of the products, upgrades or otherwise, could damage our customers’ businesses. If we have any errors, defects, disruptions in service, or other performance problems with the products, then customers could elect not to renew their subscriptions or delay or withhold payment to us. As a result, we could lose future sales or customers may make warranty claims against us or our Syndication Partners, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable, or costly litigation.

Material defects or errors in the software we use to deliver our products and services and the offerings by our Marketplace and Syndication Partners could harm our reputation, result in significant costs to us, and impair our ability to distribute our services.

The Web Applications offered in an Etelos Marketplace are inherently complex and may contain material defects or errors, particularly when first introduced or when new versions or enhancements are released. We have, from time to time, found defects in our products and services, and new errors in our existing software and services may be detected in the future. We have no actual knowledge, but we reasonably expect that the products and services offered by our Syndication Partners may have similar errors and/or defects. Any errors or defects that cause interruptions to the availability of our services and the services for our Marketplace Partners could result in:

·                  a reduction in sales or delay in market acceptance of services from us or our Marketplace Partners;

·                  sales credits or refunds to our customers and customers of our Marketplace Partners;

·                  loss of existing customers and difficulty in attracting new customers;

·                  diversion of development resources;

·                  harm to our reputation, or the reputation of our Marketplace Partners; and/or

·                  increased warranty and insurance costs.

After the release of our services, defects or errors may also be identified from time to time by our internal team, our Marketplace and Syndication Partners, and by our customers. The costs incurred in correcting any material defects or errors in such products or services may be substantial and could harm our operating results.

If our security measures are breached and unauthorized access is obtained to a customer’s data, then we may incur significant liabilities, our service may be perceived as not being secure, and customers may curtail or stop using our products.

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

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If we are unable to develop new products or services, distribute our products or services into new markets, or add Syndication Partners to offer their products or services for distribution in an Etelos Marketplace, then our revenue growth will be harmed and we may not be able to achieve profitability.

Our ability to attract new customers and to increase revenue from existing customers will depend in large part on our ability to enhance and improve our existing products and to add new Marketplace Partners and new Syndication Partners to offer their products and services and distribute into new markets. The success of any enhancement or new Syndication Partner offering depends on several factors, including the timely completion, introduction, and market acceptance of the enhancement, product or service. Any new product or service offered by a Syndication Partner or that we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate significant revenue. Any new markets into which we attempt to distribute our products or services may not be receptive. If we are unable to successfully develop or acquire new products or services, enhance our existing products and services to meet customer requirements, or distribute our products and services into new markets, then our revenue will not grow as expected and we may not be able to achieve profitability.

If we fail to maintain proper and effective internal controls or are unable to remediate the material weakness in our internal controls, then our ability to produce accurate and timely financial statements could be impaired and investors’ views of us could be harmed.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles.

During our audit for the year ended December 31, 2008, we identified material weaknesses in our internal controls. The material weaknesses relate to the absence of specific policies and procedures for some accounting functions and the need for accounting personnel who possess the skill sets necessary to operate and report as a public company, and specifically the skills necessary to ensure that adequate review of critical account reconciliations is performed and that supporting documentation is complete, accurate, and in accordance with generally accepted accounting principles. Our financial position and limited resources make it difficult for us to address these weaknesses and we continue to have these material weaknesses as of December 31, 2009.  If we fail to address these material weaknesses or if additional material weaknesses in our internal controls are discovered in the future, then we may fail to meet our future reporting obligations, our financial statements may contain material misstatements and the price of our common stock may decline.

Implementing any appropriate changes to our internal controls may distract our officers and employees, entail substantial costs to modify our existing processes, and add personnel and take significant time to complete. These changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and harm our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements on a timely basis may harm our stock price and make it more difficult for us to effectively market and distribute our products and services to new and existing customers.

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

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

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

Our customers can use the products and services offered in an Etelos Marketplace to store personal or identifying information regarding their customers and contacts. Super-national, federal, state and other government bodies and agencies have adopted or are considering adoption of laws and regulations regarding the collection, use, and disclosure of personal information obtained from consumers and other individuals. The costs of compliance with, and other burdens imposed by, such laws and regulations that are applicable to the businesses of our customers may limit the use and adoption of our products and services and reduce overall demand.

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In addition to government activity, privacy advocacy groups and the technology and other industries are considering various new, additional, or different self-regulatory standards that may place additional burdens on us and our Marketplace and Syndication Partners. If the gathering of personal information were to be curtailed, then Web-based applications would be less effective, which may reduce demand for the products and services offered in an Etelos Marketplace and harm our business.

Our operating results may be harmed if we are required to collect taxes for our subscription services in jurisdictions where we have not historically done so.

We have not collected any sales or other taxes from our customers or remitted any such taxes to any taxing jurisdiction where we may be required to do so. We have begun an analysis of this issue but to date have not made any accrual for any potential liability.  In addition, additional taxing jurisdictions at various local, national and super-national levels may seek to impose sales or other tax collection obligations on us.  We have not recorded sales or other tax liabilities for the years ended December 31, 2009 or 2008, in respect of sales or other tax liabilities in any jurisdiction. Any determination that we should be collecting sales or other taxes on our service could result in substantial tax liabilities for past sales, discourage customers from purchasing our products, or otherwise harm our business and operating results.

Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations, and harm our operating results.

A change in accounting standards or practices could harm our operating results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may harm our operating results or the way we conduct our business.

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

Although we have no ongoing negotiations or current agreements or commitments for any acquisitions, our business strategy may include acquiring complementary products, services, technologies, or businesses. We also may enter into relationships with other businesses to expand our product or service offerings or our ability to provide service in foreign jurisdictions, which could involve preferred or exclusive licenses, additional channels of distribution, discount pricing, investments in other companies, or other strategies. Negotiating these transactions can be time-consuming, difficult, and expensive, and our ability to close these transactions may often be subject to approvals that are beyond our control. Consequently, these transactions, even if undertaken and announced, may not close.

An acquisition, investment, or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the businesses, technologies, products, services offerings, personnel, or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, the target’s software is not easily adapted to work with ours, or we are unable to retain the customers of any acquired business due to changes in management or otherwise. Acquisitions may also disrupt our business, divert our resources, and require significant management attention that would otherwise be available for operation and development of our business. Moreover, the anticipated benefits of any acquisition, investment, or business relationship may not be realized or we may be exposed to unknown liabilities. For one or more of those transactions, we may:

·                  issue additional equity securities that would dilute our stockholders;

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

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

·                  incur large charges or substantial liabilities;

·                  encounter difficulties retaining key employees of the acquired company or integrating diverse software codes or business cultures; and/or

·                  become subject to adverse tax consequences, substantial depreciation, or deferred compensation charges.

Any of these risks could harm our business and operating results.

We may be subject to other legal claims.

In the quarter ended December 31, 2009, and subsequently, we resolved a number of significant litigation items in a manner that we believe was generally favorable to the Company.  See “LEGAL PROCEEDINGS” below.   The settlements in several of these matters contained unsecured promissory notes and there is no assurance that we will be able to perform the payment obligations under those notes as and when they become due and payable.  If we default on these payment obligations then other claims may be asserted against us to collect on those promissory notes.

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On December 31, 2009, we settled a judgment in the matter of Kaufman Bros., L.P. v. Etelos, Inc. in the Supreme Court of the State of New York, New York County, in the approximate amount of $186,000, for $93,000 in cash, payable in 5 installments with the final installment due June 1, 2010, and the issuance of 200,000 shares of restricted common stock. The settlement permits Kaufman Bros. to sell up to 180,000 shares from July 1, 2010, through March 2011 to recover the remaining $93,373 of the settlement; the additional 20,000 shares are designated for payment of attorneys’ fees in the event of a default in the note payments.  After payment in full of the note payments, if there is no default giving rise to a claim for attorneys’ fees, those 20,000 shares will be returned to the Company and cancelled.  After Kaufman Bros. recovers the remaining $93,373 from the sale of some or all of the 180,000 shares, any remaining shares will be repurchased by the Company for $0.01 and cancelled; after March 2011, any balance due on the remaining amount of the settlement will be discharged and any unsold shares will be repurchased by the Company at $0.01 per share and cancelled.

On October 31, 2008, the Company closed its offices in San Mateo, California.  The landlord for these premises filed a complaint in the Superior Court of San Mateo County, California (Case No. CIV 479535) and trial was set for February 8, 2010.  The parties went to mediation in January 2010 and subsequently entered into a settlement agreement including, inter alia, a $200,000 promissory note, with 6% interest, payable in 12 monthly payments beginning in July 2010.  The settlement agreement and note were executed and delivered on February 8, 2010.

On October 31, 2008, we relocated our Washington offices and abandoned the sub-leased premises of our former offices in Renton, Washington. The sublease for these premises runs through June 2010.  Subsequently, on March 5, 2010, the prime landlord filed a complaint against us for breach of contract and successor liability.  This matter was just served and we have not yet evaluated the claims made in this case.  We will need to evaluate and defend these claims.

As part of our reduction of monthly cash operating expenses during the quarter ended December 31, 2008, and continuing after the end of the quarter, we placed all employees in Washington and California on partial deferrals of salary, ranging from 10% to 100% of base salary. At the end of that quarter, until the filing date of this report, a major portion of this deferral amount remains unpaid, including amounts due to employees who subsequently were terminated.

Since August 22, 2008, we have terminated 33 employees employed in both our California and Washington offices.  Except as noted, none of these terminated employees have asserted any claims against us at this time but no assurances can be given that such employees will not assert such claims in the future.

On March 19, 2009, the Company issued an unsecured note of $88 thousand for an account payable balance. The note bears interest of 11% and is due on April 1, 2010, with payment terms of $15 thousand on issuance of the note, and monthly payments of $6 thousand beginning May 1, 2009 with a final payment on March 20, 2010.  All payments have been made in accordance with the note to the date of this report.

In connection with our operations, reverse merger, multiple financings, and protection of our intellectual property, we have incurred substantial accounts payable to a small number of vendors that remain unpaid and overdue.  We have been in communication with these vendors and have entered into payment plans with some of these vendors and expect to enter into negotiated payment plans with other vendors, but there is no assurance that we will be successful in these negotiations, or that we will be able to make payments under such plans.  Therefore the assertion of claims by these vendors for these amounts due and owing could become the subject of claims in litigation.

Our officers, directors, and affiliates control us through their positions and stock ownership and their interests may differ from other stockholders.

As of December 31, 2009, our officers, directors, and affiliates beneficially own approximately 70 percent of our common stock and 63 percent of our preferred stock. As a result, if they act together, they are able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions, including business combinations. This concentration could also have the effect of delaying or preventing a change in control that could otherwise be beneficial to our stockholders. The interests of our officers, directors, and affiliates may differ from other stockholders. Furthermore, the current ratios of ownership of our common stock reduce the public float and liquidity of our common stock, which can in turn affect the market price of our common stock.

We are responsible for the indemnification of our officers and directors.

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

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

The purchasers of our outstanding convertible promissory notes, debentures, and related warrants, as well as the holders of our other outstanding convertible notes, may, subject to compliance with Rule 144, rely on the provisions of Rule 144 to resell the shares of our common stock acquired upon the conversion and exercise of such securities.  We have no way of knowing whether or when such shares may be sold.  Depending upon market liquidity at the time, a sale of shares by such investors at any given time could cause the trading price of our common stock to decline.  The sale of substantial number of shares of our common stock, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

In connection with our January 2008 and April 2008 Debentures, in the aggregate, we issued a total of $6.3 million principal amount of convertible debentures, convertible into 4,690,695 shares of our common stock, and warrants to purchase an additional 611,111 shares of our common stock.  In connection with our September 2009 Debentures and our January 2010 Debentures, we issued a total of $3.4 million principal amount of convertible debentures, convertible into 6,500,000 shares of our Common Stock and warrants to purchase an additional 5,625,000 shares of our Common Stock. The conversion or exercise into our common stock could result in a substantial increase in the number of shares in our public float.  Depending upon market liquidity at the time a resale of our common stock is made by the investors in such private placements, such sale could cause the trading price of our common stock to decline.  In addition, the sale of a substantial number of shares of our common stock, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

We have significant indebtedness.

We have incurred $9.7 million in principal amount of indebtedness as a result of the issuance of our September 2009, January 2008 and April 2008 Debentures.  The debentures impose significant requirements on us, including, among others, requirements that we pay interest and other charges on the debentures.  Our ability to comply with these provisions may be affected by changes in our business condition or results of our operations, or other events beyond our control.  We have breached certain of these covenants and are in a default under the debentures, which permits the holders thereof to accelerate the maturity of the debentures and demand repayment in full.  Such actions by such holders could impair our ability to operate or cause us to seek bankruptcy protection.

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

Our September 2009, January 2008 and April 2008 Debentures impose significant covenants on us, including restrictions against incurring additional indebtedness, creating any liens on our property, amending our certificate of incorporation or bylaws, redeeming or paying dividends on shares of our outstanding common stock, and entering into certain related party transactions. These covenants and restrictions may impair our ability to issue additional debt or equity, if necessary.

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

Our September 2009, January 2008 and April 2008 Debentures and the related warrants contain provisions that will require us to reduce the conversion price and exercise price, as the case may be, if we issue additional securities while such debentures or warrants are outstanding which contain purchase prices, conversion prices or exercise prices less than the conversion price of our September 2009, January 2008 or April 2008 Debentures or the exercise price of the warrants.  If this were to occur, current investors, other than the investors in our recent private placements, would sustain material dilution in their ownership interest.

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

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

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

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

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

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

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

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

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These provisions, alone or together, could delay hostile takeovers and changes in control or changes in our management.

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

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

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

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

·                  significantly reduce the equity interest of our current stockholders;

·                  cause a change in control if a substantial number of our shares of common stock or voting preferred stock are issued, which may affect, among other things, our ability to use our net operating loss carry-forwards, if any, and could also result in a change in management; and/or

·                  adversely affect prevailing market prices for our common stock.

If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

·                  develop or enhance our products and services;

·                  continue to expand our development, sales and marketing organizations;

·                  acquire complementary technologies, products or businesses;

·                  expand operations;

·                  hire, train and retain employees; and/or

·                  respond to competitive pressures or unanticipated working capital requirements.

Although we have no commitments as of the date hereof to issue any additional securities, we may issue a substantial number of additional shares of our common stock or preferred stock, or a combination of both, including through convertible debt securities, to finance future operations or complete a business combination.  The issuance of additional shares of our common stock or any number of shares of preferred stock, including upon conversion of any debt securities:

·                  may significantly reduce the equity interest of our current stockholders;

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

·                  may adversely affect prevailing market prices for our common stock.

The 2009 Equity Incentive Plan and the 2007 Stock Incentive Plan and all options currently issued pursuant to these plans and options granted outside such plans provides for accelerated vesting of all unvested options in the event of a change of control.  This may be regarded as both a disincentive to acquisition of the Company as a liquidation strategy and a barrier to retention of key employees following a change-of-control acquisition and therefore make such an acquisition more costly or difficult, and therefore an unattractive strategic option, for a prospective acquirer.

We have never paid dividends on our capital stock and we do not anticipate paying any cash dividends in the foreseeable future.

We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our business.  In addition, the terms of the various Debentures prohibit us from making any dividend payment or distribution to holders of our common stock while any portion of the Debentures remain outstanding.  As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

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

Our common stock is quoted on the Over-the-Counter Bulletin Board. The Over-the-Counter Bulletin Board is an inter-dealer, over-the-counter market that provides significantly less liquidity than the NASDAQ Stock Market or other national or regional exchanges. Securities traded on the Over-the-Counter Bulletin Board are usually thinly traded, highly volatile, have fewer market makers, and are not followed by analysts.

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

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

Even though our common stock is quoted on the Over-the-Counter Bulletin Board, the Over-the-Counter Bulletin Board may not permit our investors to sell securities when and in the manner that they wish. Because there are no automated systems for negotiating trades on the Over-the-Counter Bulletin Board, they are conducted via telephone. In times of heavy market volume, the limitations of this process may result in a significant increase in the time it takes to execute investor orders. Therefore, when investors place market orders to buy or sell a specific number of shares at the current market price it is possible for the price of a stock to go up or down significantly during the lapse of time between placing a market order and its execution.

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

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

Our common stock is likely to be subject to penny stock rules.

Our common stock is subject to Rule 15g-1 through 15g-9 under the Exchange Act, which imposes certain sales practice requirements on broker-dealers which sell our common stock to persons other than established customers and “accredited investors” (generally, individuals with net worth in excess of $1 million or annual incomes exceeding $200 thousand (or $300 thousand together with their spouses).  For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to the sale.  This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of such common stock.  Additionally, our common stock is likely to be subject to the SEC regulations for “penny stock.”  Penny stock includes any equity security that is not listed on a national exchange and has a market price of less than $5.00 per share, subject to certain exceptions.  The regulations require that prior to any non-exempt buy/sell transaction in a penny stock, a disclosure schedule set forth by the SEC relating to the penny stock market must be delivered to the purchaser of such penny stock.  This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for the common stock.  The regulations also require that monthly statements be sent to holders of penny stock which disclose recent price information for the penny stock and information of the limited market for penny stocks.  These requirements adversely affect the market liquidity of our common stock.

ITEM IB.                UNRESOLVED STAFF COMMENTS

None.

ITEM 2.                  PROPERTIES

Our corporate headquarters is located in Maple Valley, Washington, but we do not own or lease any real property and conduct the major portion of our business activities virtually: using the Internet and other telecommunications tools like those distributed in Marketplaces based upon the Etelos Platform Suite for SaaS distribution. In the future we may be required to lease workspaces to enhance productivity and collaboration. Our requirements for property are not unique or specialized; if and when the need arises, we believe that suitable space will be available to us on commercially reasonable terms.

ITEM 3.                  LEGAL PROCEEDINGS

From time to time, we become subject to various legal proceedings and claims, both asserted and unasserted, that arise in the ordinary course of business. Litigation in general, and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict. An unfavorable resolution of one or more of these lawsuits would materially adversely affect our business, results of operations, or financial condition. We accrue legal costs when incurred.  The need to defend any such claims could require payments of legal fees and our limited financial resources could severely impact our ability to defend any such claims.

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During the quarter ended December 31, 2009, the Company entered into a Settlement Agreement with Jeffrey L. Garon, our former CEO; see the Company’s Form 8-K filed with the SEC on December 18, 2009.  Subsequent to the end of the quarter, all payments required by the settlement agreement were made, whereby the Company has repurchased 2,356,655 shares of common stock previously issued to Garon at the original purchase price of approximately $175,000, and all the repurchased shares have been cancelled.

In June 2008, Kaufman Bros. L.P. initiated litigation against us for breach of contract under an advisory services agreement and, effective on December 5, 2008, we entered into a settlement agreement with Kaufman Bros., pursuant to which (i) we agreed to pay to Kaufman Bros. $210,000, in twelve monthly installments of $17,500; (ii) we issued to Kaufman Bros. a warrant to purchase 500,000 shares of our common stock at an exercise price of $0.75 per share exercisable for a period of five years; (iii) we agreed with Kaufman Bros. to immediately terminate all provisions, terms and conditions of the advisory services agreement and exchanged mutual releases; and (iv) Kaufman Bros. agreed to dismiss the pending lawsuit in the Supreme Court of New York, without prejudice.  Subsequent to entering into the settlement agreement, we did not fully comply with our payment obligations under the settlement agreement and we received a notice of default and confession of judgment against us. On December 31, 2009, we settled the judgment in the approximate amount of $186,000, for $93,000 in cash, payable in 5 installments with the final installment due June 1, 2010, and the issuance of 200,000 shares of restricted common stock. The terms of the settlement agreement permit Kaufman Bros. to sell up to 180,000 shares from July 1, 2010, through March 2011 to recover the remaining $93,373 of the settlement; the additional 20,000 shares are designated for payment of attorneys’ fees in the event of a default in the note payments.  After payment in full of the note payments, if there is no default giving rise to a claim for attorneys’ fees, those 20,000 shares will be returned to us and cancelled.  After Kaufman Bros. recovers the remaining $93,373 from the sale of some or all of the 180,000 shares, we have a right to repurchase any remaining shares for $0.01 and cancel such shares, after March 2011, any balance due on the remaining amount of the settlement will be discharged and we will repurchase any unsold shares at $0.01 per share and cancel them.

On October 31, 2008, we closed our offices in San Mateo, California.  On or about December 19, 2008, the landlord for these premises filed a complaint claiming damages of $659 thousand and other amounts against the Company’s predecessor Etelos, Incorporated, a Washington corporation (“Etelos —WA”) in the Superior Court of San Mateo County, California (Case No. CIV 479535).  A default judgment was set aside because the landlord failed to properly serve either the Company or Etelos-WA. The Company was subsequently served properly and trial was set for February 8, 2010.  The parties went to mediation in January 2010 and subsequently entered into a settlement agreement, including a release of claims, in which we agreed: (a) to pay $66,000 in cash within 30 days, (b) to issue a $200,000 promissory note, with 6% interest, payable in 12 monthly payments beginning in July 2010, and (c) to issue shares of Common Stock of the Company equal to $125,000 in value, based upon the closing price of the Company’s stock on January 6, 2010.  The settlement agreement and note were executed and delivered on February 8, 2010, and 166,667 shares were subsequently were delivered on March 1, 2010.

As part of our reduction of monthly cash operating expenses during the quarter ended December 31, 2008, and continuing after the end of the quarter, we placed all employees in Washington and California on partial deferrals of salary, ranging from 10% to 100% of base salary. At the end of that quarter, until the filing date of this report, a major portion of this deferral amount remains unpaid, including amounts due to employees who subsequently were terminated.

ITEM 4.                  REMOVED AND RESERVED

PART II

ITEM 5.                  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market for Registrant’s Common Equity

Effective April 29, 2008, shares of our common stock began being quoted on the OTC Bulletin Board under the symbol “ETLO.”  The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices and volume information in over-the-counter equity securities.  The OTC Bulletin Board securities are traded by a community of market makers that enter quotes and trade reports.

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The following table sets forth the high and low bid prices per share of our common stock by the OTC Bulletin Board for the periods indicated as reported on the OTC Bulletin Board.

The quotes represent inter-dealer prices, without adjustment for retail mark-up, markdown or commission and may not represent actual transactions.  The trading volume of our securities fluctuates and may be limited during certain periods.  As a result of these volume fluctuations, the liquidity of an investment in our securities may be adversely affected.

Holders of Record

As of March 16, 2010, there were 23,939,810 shares of our common stock outstanding held by approximately 62 holders of record.

Transfer Agent

Our transfer agent is BNY Mellon Shareowner Services, P.O. Box 358016, Pittsburgh, PA 15252.

Dividends

We have never declared or paid any cash dividends on our common stock.  For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock.  In addition, we are restricted from paying any dividends on our common stock under the terms of our January debentures and April debentures.  Any future determination to pay dividends will be at the discretion of our board of directors.

Securities Authorized for Issuance under Equity Compensation Plans

The table below sets forth information as of December 31, 2009, with respect to compensation plans under which our common stock is authorized for issuance.  The figures related to securities authorized for issuance under equity compensation plans relate to options granted under the 1999 Stock Option Plan, the 2007 Stock Incentive Plan, and the 2009 Equity Incentive Plan.  The 1999 Stock Option Plan, and the 2007 Stock Incentive Plan were approved by our shareholders.  Our shareholders have not approved the 2009 Equity Incentive Plan.

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Daniel J.A. Kolke received a grant of 3,433,333 options under his employment agreement that was not issued under the terms of these equity compensation plans.

ITEM 6.                  SELECTED FINANCIAL DATA

As a smaller reporting company we are not required to provide the information required by this item.

ITEM 7.                  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 related notes and other financial information appearing elsewhere in this report. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation, the disclosures made under “Item 1A. Risk Factors” included in Part I of this report.

Overview

We are a provider of tools and services for the development and distribution of Web Applications.  We generate revenues from a share of revenues generated by the sales of subscriptions to use Web Applications developed by us and by our Syndication Partners, which are offered through Marketplaces based on the Etelos Platform Suite for SaaS distribution, that we develop and operate.  We also are engaged in negotiations for the licensing of the Etelos Platform Suite for the development and operation of marketplaces by third parties.  Our principal cost of revenue is hardware, software, and network connectivity used in connection with the delivery of our products and services.  Our primary operating expenses are for personnel costs, especially in technology research and development.

During the quarter ended December 31, 2008, we took significant steps intended to improve our operating results, ranging from changing the focus of our business model from an end-user-focused model to a focus on enterprise customer sales to reducing monthly cash operating expenses by aggregate workforce reductions of over 70% and relocating our corporate headquarters to lower cost facilities.  The shift in business focus was a fundamental change, and the reduction of operating expenses was a one-time exercise in survival that has thus far been successful, but this exercise is not completed and has created, and continues to create, a substantial working capital deficit that must be addressed and resolved.

As a major part of our reduction of monthly cash operating expenses during the six quarters ending December 31, 2009, and continuing to the date of this report, we placed all remaining employees on partial payment of salary; all except the three lowest paid employees are receiving payment ranging from 97% to 74% of net pay.   At the end of the quarter, and as of the filing date of this report, the amount of this deferral, which has been accrued, remains substantially unpaid, including amounts due to employees in our California office who subsequently were terminated during the quarter ending December 31, 2008.

Similar to other companies, we have suffered the effects of the current adverse economic conditions.  We restructured a major portion of our debt securities on June 30, 2009, and entered into an additional long-term debt financing on September 30, 2009, which converted a series of bridge loans entered into in the first three quarters of calendar 2009, and provided for additional cash in September 2009 and in December 2009.   That cash was originally intended to carry us to June 2010 but we incurred substantial unexpected expenses in connection with resolving certain litigation matters and other major creditor claims.  See “LEGAL PROCEEDINGS” above.

Our survival plan has continued and we continue to need immediate and substantial cash to continue our operations. Management has projected that the combination of cash on hand will be sufficient to allow us to continue our operations only through early-mid 2010. If cash reserves are not sufficient to sustain operations, then we plan to raise additional capital by selling shares of our capital stock or other securities.  We are presently engaged in active discussions for additional investments by existing and prospective investors but we have no funding commitments in place at this time and we can give no assurance that such capital will be available on favorable terms, or at all.  If we cannot obtain financing, then we may be forced to further curtail our operations, cease voluntarily filing reports with the SEC, or possibly be forced to evaluate a sale or liquidation of our assets, or consider strategic alternatives such as bankruptcy.  Even if we are successful in raising additional funds, there is no assurance regarding the terms of any additional investment and any such investment or other strategic alternative would likely substantially dilute or eliminate the interests of our stockholders.

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Recent Financings

January 2010 Debentures

On January 25, 2010, we entered into a securities purchase agreement with an entity affiliated with Donald W. Morissette for the sale of 10% senior secured convertible debentures, identical to the September 2009 Debentures, in the principal amount of $250,000. In this transaction, in addition to the debentures, we issued a warrant to purchase 375,000 shares of our common stock with an exercise price of $0.60 per share and 375,000 shares of our restricted common stock, or the “closing shares.”  We refer to this financing as our January 2010 financing in this report. The securities purchase agreement further provided that we had the right, subject to certain conditions, to require the investor to purchase an aggregate of $125,000 in additional principal amount of debentures between March 15 and 31, 2010. We exercised that right on March 15, 2010, and issued $125 thousand in additional debentures to the investor.  Mr. Morissette, who, together with his affiliates, beneficially owns more than 10% of our outstanding common stock.

September 2009 Debentures

On September 29, 2009, we entered into a securities purchase agreement with three accredited investors for the sale of 10% senior secured convertible debentures in the principal amount of $2.0 million. One of the investors in our September 2009 financing is an affiliate of Enable Capital Management LLC, who, together with its affiliates, beneficially owns more than 10% of our outstanding common stock and holds $7.7 million in principal amount of our outstanding debentures, excluding the principal amount of the debentures purchased in our September 2009 financing.

The following summarizes the terms of the debentures we agreed to issue:

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We refer to these debentures as our September 2009 Debentures. The summary of the financing transaction, and of the terms of the securities and agreements related to such transaction, is qualified in its entirety by reference to the form of securities purchase agreement, debenture, warrant, and security agreement, each of which is filed as an exhibit to this report and incorporated herein by this reference.

In this transaction, in addition to the debentures, we issued warrants to purchase 3,000,000 shares of our common stock with an exercise price of $0.60 per share, or the “September 2009 warrants,” a warrant to purchase 2,250,000 shares of our common stock with an exercise price of $0.01 per share, or the “ September 2009 par value warrant,” and 750,000 shares of our restricted common stock, or the “closing shares.”  One of the investors paid part of its subscription amount through the cancellation of approximately $1.2 million worth of indebtedness we owed to such investor in principal amount and accrued interest of various short-term promissory notes previously issued throughout 2009.  The securities purchase agreement further provided that we had the right, subject to certain conditions, to require the investors to purchase an aggregate of $1.0 million in additional principal amount of debentures.  We exercised that right on December 15, 2009, and issued $1.0 million of additional debentures at that time.

For a more detailed discussion of our September 2009 Debentures, please see the discussion under the caption “September 2009 Debentures” under “Note 6. Convertible Notes and Debentures and embedded Derivative and Warrant Liability” to our financial statements contained in this report.

June 2009 Amendment Agreement

On June 30, 2009, we entered into an amendment agreement with the holder of our outstanding 6% secured convertible debentures in an aggregate principal amount of $5.5 million issued in January 2008 and April 2008 and our outstanding warrants to purchase up to 666,666 shares of our common stock issued in January 2008 and April 2008.

With respect to the debentures, under the terms of the amendment agreement, the parties agreed to:

·                                          extend the date of maturity to December 31, 2012 (with respect to the debentures issued in January 2008, the maturity date was previously January 31, 2010 and with respect to the debentures issued in April 2008, the maturity date was April 30, 2010);

·                                          eliminate the monthly redemption requirement;

·                                          require that all future interest payments be made in cash (previously, we could make payments in shares of our common stock);

·                                          reduce the interest rate to 0% per annum until September 30, 2010;

·                                          defer interest payments until January 1, 2011;

·                                          require all accrued but unpaid interest as of June 30, 2009 and interest that would have been earned under the original terms to September 30, 2010 be added to the principal amount and be payable on the date of maturity;

·                                          waive any event of default arising out of the nonpayment of any accrued interest as of the date of the amendment agreement; and

·                                          modify the anti-dilution protection provisions such that the conversion price will not be reduced to less than $0.10 as a result of any subsequent equity sales.

The reduction in interest rate, deferment of interest payments, and elimination of the right to make interest payments in shares of common stock significantly reduce the short term cash requirements for our company and the potential for future dilution to our stockholders that could have occurred as a result of the issuance of shares of our common stock to meet interest and monthly redemption payment obligations.

In addition, under the terms of the amendment agreement, the holder of the warrants was granted the right to exchange such outstanding warrants for shares of our common stock at the rate of one share of common stock underlying such warrants for one share of common stock.  In exchange, the anti-dilution protection under the warrants was eliminated.  Previously the exercise price of the warrants would decrease, and the number of shares issuable upon exercise would increase, generally, each time we issued common stock or common stock equivalents at a price less than the exercise price of the warrants.  The amendment agreement eliminates the potential for future dilution from the warrants.

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Under the terms of the amendment agreement, the parties also agreed to terminate the registration rights agreement dated January 31, 2008, as amended on April 22, 2008, and each agreed to waive any and all defaults that may have occurred under such agreement. We further agreed to provide an additional remedy to the holder if we fail to satisfy, for any reason, the current public information requirement under Rule 144(c).

For a more detailed discussion of our April 2008 Debentures, please see the discussion under the caption “April 2008 Debentures” under “Note 6. Convertible Notes and Debentures and Embedded Derivative and Warrant Liability” to our financial statements contained in this report.

For a more detailed discussion of our January 2008 Debentures, please see the discussion under the caption “January 2008 Debentures” under “Note 6. Convertible Notes and Debentures and Embedded Derivative and Warrant Liability” to our financial statements contained in this report.

Series A Preferred Financing

In December 2008 and February 2009, we closed a round of financing for the sale of 843,333 shares of our Series A Preferred Stock at $0.75 per share, for an aggregate purchase price of $632.5 thousand, and warrants to purchase 843,333 shares of common stock of the Company, at an exercise price of $0.75 per share, and a three year term.  This financing was led by Daniel J.A. Kolke, our founder, chairman, chief executive officer, acting chief financial officer, and chief technology officer, with participation from two of our directors and other prior investors. The holders of the January 2008 Debentures and the April 2008 Debentures consented to this financing, but did not participate.

During the quarter ended December 31, 2009, holders of 100,000 shares of our Series A Preferred Stock converted the shares into common stock at the conversion price of $0.75 per share.  At December 31, 2009 we had 743,333 shares of Series A Preferred Stock issued and outstanding.

Critical Accounting Policies Involving Management Estimates and Assumptions

Our discussion and analysis of our financial condition and results of operations is based on our financial statements.  In preparing our financial statements in conformity with accounting principles generally accepted in the United States, we must make a variety of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses.  We have identified the following accounting policies that we believe require application of management’s most subjective judgments, often requiring the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

Allowance for Doubtful Accounts

We provide, when appropriate, an allowance for doubtful accounts to ensure that our trade receivables are not overstated due to un-collectability. The collectability of our accounts receivables is evaluated based on a variety of factors, including the length of time receivables are past due, indication of the customer’s willingness to pay, significant one-time events and historical experience.  We have not recorded an allowance for doubtful accounts at this time as we believe all our accounts receivable will be collected.

Revenue Recognition

We provide Web Applications as a subscription service using the Software-as-a-Service (SaaS) or software-on-demand business model and allow third parties to offer their products and services through Storefronts in an Etelos Marketplace, and to advertise on our web site or in our annual magazine for a fee.  We also license our software under perpetual and term licenses.  Revenues are recognized on these service and licensing transactions using the criteria in ASC 605-10, “Revenue Recognition” (ASC 605-10) and ASC 985-605, “Software Revenue Recognition”, (ASC 985-605) respectively, which both provide that revenue may be recognized when all of the following criteria are met:

·                  Persuasive evidence of an arrangement exists,

·                  The product or service has been delivered,

·                  The fee is fixed or determinable, and

·                  Collection of the resulting receivable is reasonably assured or probable.

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We must first determine whether ASC 605-10 or ASC 985-605 applies to our revenue transactions.  We than determine if the criteria above have been met by assessing the ASC 605-10 and ASC 985-605 and their various interpretations in view of the agreements and other documentation related to the revenue transactions.  The interpretation of the agreements often requires considerable judgment as well as determining what accounting literature is appropriate and how that literature should be applied.  If our standard agreements are used to establish evidence of the arrangement, then our revenue is generally recognized as follows:

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

For software licensed under term or perpetual agreements, persuasive evidence of the arrangement is evidenced by a binding agreement signed by the customer and delivery generally occurs upon delivery of the software to a common carrier. If a significant portion of a fee is due after our normal payment terms of typically 30 days, we recognize revenue as the fees become due. If we determine that collection of a fee is not reasonably assured, we defer the fees and recognize revenue upon cash receipt, provided that all other revenue recognition criteria are met.

However, if the terms and conditions of an agreement are nonstandard, then significant contract interpretation is sometimes required to determine the appropriate accounting for these transactions including: (1) whether an arrangement exists; (2) how the arrangement consideration should be allocated among potential multiple elements; (3) when to recognize revenue on the deliverables; (4) whether all elements of the arrangement have been delivered; (5) whether the arrangement should be reported gross as a principal versus net as an agent; (6) whether we receive a separately identifiable benefit from the purchase arrangements with our customer for which we can reasonably estimate fair value; and (7) whether the arrangement should be characterized as revenue or a reimbursement of costs incurred. In addition, our revenue recognition policy requires an assessment as to whether collection is reasonably assured, which inherently requires us to evaluate the creditworthiness of our customers. Changes in judgments on these assumptions and estimates could materially impact the timing or amount of revenue recognition.

Internal Use Software

Under ASC 985-20 “Costs of Software to be Sold, Leased, or Marketed” (ASC 985-20), costs incurred in the research and development of new software products are expensed as incurred until technological feasibility is established.  Alternatively, ASC 350-40 “Internal Use Software” (ASC 350-40), applies to software development costs that are not related to software to be sold, licensed, leased or otherwise marketed as a separate product or as part of a product or process and are within the scope of ASC 985-20.  Under ASC 350-40, software development costs incurred for software that is only used internally, including costs incurred to purchase third party software, are capitalized beginning when the Company has determined certain factors are present, including among others, that technology exists to achieve the performance requirements, buy versus internal development decisions have been made, and the Company’s management has authorized the funding for the project.  We must determine whether ASC 985-20 or ASC 350-40 is applicable to our software development costs.  We then must determine when software capitalization should begin and cease and what costs under the applicable standard can be capitalized.  Both of these tasks involves considerable judgment and can result in material different amounts of software being capitalized and have a significant impact on our reported results of operations.  To date, because we plan to license all our software products, we have determined that the provisions of ASC 985-20 should be applied to the cost of our product development.  As products and enhancements have generally reached technological feasibility and have been released for sale at substantially the same time, all research and development costs have been expensed.

Stock-Based Compensation Expense

We have adopted ASC 718-10 using the modified prospective method and therefore have not restated prior periods’ results. Under the fair value recognition provisions of ASC 718-10, we recognize stock-based compensation expense net of an estimated forfeiture rate and therefore only recognize compensation cost for those shares expected to vest over the service period of the award.  Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility, and the pre-vesting option forfeiture rate. We estimate the expected life of options granted based on historical exercise patterns, which we believe are representative of future behavior. We estimate the volatility of our common stock on the date of grant based on the historical volatility of other publicly traded companies in our industry. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate, as well as the probability that performance conditions that affect the vesting of certain awards will be achieved, and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted, exercised, and cancelled. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. Beginning in the quarter ended December 31, 2008, and continuing in the year ended December 31, 2009, the global economy has been highly volatile and, during this period, the Company found it necessary to take drastic measures to reduce operating expenses, but the likelihood of success of these efforts cannot be predicted.  Therefore the forfeiture rate in the quarter ended December 31, 2008, was very high.  The forfeiture rate declined substantially during the year ended December 31, 2009, but it is not known whether this forfeiture rate will be maintained in the future; management will continue to monitor its estimates.

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Accounting for Convertible Notes and Debentures, Embedded Derivatives and Warrants

We evaluate the embedded derivatives included in the debt instruments we issue under the guidance in ASC 815-10 “Derivatives and Hedging” (ASC 815-10) on the issuance date of the debt and on each subsequent reporting date to determine whether such embedded derivatives are clearly and closely related to the debt host.  The purpose of the evaluation is to determine whether the embedded derivatives, which are not clearly and closely related to the debt host, need to be bifurcated from the debt host and accounted for as a derivative at their estimated fair value as a liability or asset at the date of issuance and thereafter, adjusted to estimated fair value with a charge or credit to our statement of operations. ASC 815-10 generally indicates that if the conversion features are (i) indexed to the Company’s capital stock under the guidance in ASC 815-40-15 “Derivatives and Hedging — Contracts in Entity’s Own Equity — Scope and Scope Exceptions” (ASC 815-40-15) and (ii) would be classified as equity if a freestanding derivative under the guidance in ASC 815-40-25 “Derivatives and Hedging — Contracts in Entity’s Own Equity — Recognition” (ASC 815-40-25), then the embedded derivatives need not be bifurcated from the debt host.  We also evaluate the warrants issued with the debt under ASC 815-40-25 to determine whether the proceeds allocated to the warrants or the fair value of the warrants should be recorded as equity or a liability, respectively, and if a liability adjusted to fair value with a charge or credit to our statement of operations. ASC 815-40-25 generally requires, among other factors, that (i) the Company can settle the derivative in cash or its own stock, at its option, (ii) settlement can be made in unregistered shares, and (iii) the Company has sufficient authorized shares to issue shares of its common stock for all equity instruments convertible to or which can be exercised for its capital stock. ASC 815-10 also provides guidance on when put and call features included in a debt host agreement are not clearly and closely related to the debt host and must be bifurcated and recorded as liability.  The guidance in ASC 815-10 is complex and it has many interpretations.  Accordingly, we must use judgment to apply and interpret this guidance as well as ensure we have applied the correct guidance.

If the embedded derivatives or warrants must be recorded as a liability, then we must make certain assumptions to value the embedded derivative.  This includes computing the discounted net present value of the debt and making assumptions about interest rates, probabilities of outcomes, volatility, fair value of the Company’s stock prior to its merger with Tripath, and discount rates.  The discount factor is the Company’s estimate of the appropriate rate of return that an investor would expect from a similar debenture not taking into consideration the conversion feature or warrants.  All of these assumptions have a material impact on the value attributed to the derivative or warrant.

Our analysis and judgment may vary from quarter to quarter and changes in estimates may result in significant increases or decreases in expenses.  Moreover, because of the relative size of our operations and the number of stock options and derivative instruments we have issued, income and expenses associated with changes in the value of outstanding derivative securities historically have had an overshadowing impact on our financial results.  Consequently, our net income or loss for any particular period may not be indicative of the Company’s performance for that period as a result of the application of such accounting rules, and therefore should not be relied upon by any person as an accurate depiction of the true financial condition of the Company.

Results of Operations

Year Ended December 31, 2009, Compared with Year Ended December 31, 2008

Revenues

Revenues were $150 thousand and $123 thousand for the years ended December 31, 2009 and 2008, respectively. Revenues increased by $27 thousand, or 22 percent, in the year ended December 31, 2009, compared to the same period in 2008.   The increase was due to a few additional ad hoc projects undertaken concurrently with the transition in our business model.

Cost of Revenue

Cost of revenue includes our costs of network hardware, software and other resources used in delivery of our products and services. Cost of revenue was $268 thousand and $542 thousand for the years ended December 31, 2009 and 2008, respectively. Cost of revenue for the year of 2009 decreased by $274 thousand, or by 51 percent.  The decrease in cost of revenue from 2008 to 2009 was primarily attributable to the decreased costs of hosting and Internet bandwidth associated with the transition in our business model. Stated as a percentage of revenues, cost of revenue for the year ending December 31, 2009, was 179 percent and for the corresponding period of 2008 was 440 percent.

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Operating Expenses

General and Administrative.  General and administrative expenses include payroll and related employee benefits, and other headcount-related costs associated with finance, facilities, legal and other administrative expenses. General and administrative expenses were $3.1 million and $3.2 million for the years ended December 31, 2009 and 2008, respectively. The $102 thousand, or 3 percent, decrease in general and administrative expense was primarily attributable to due to decreased salary and benefits expense of all administrative personnel, offset by increased use of consultants to support being a public company.

Sales and Marketing Expenses.  Sales and marketing expenses include payroll, employee benefits, and other headcount-related costs associated with sales and marketing personnel and travel, advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses were $0.8 million and $1.7 million for the years ended December 31, 2009 and 2008, respectively. The $831 thousand, or 50 percent, decrease in sales and marketing expense was due to decreased activities in direct sales and marketing.

Research and Development.  Research and development expenses include primarily employee and employee related expenses. Research and development expenses were $1.3 million and $2.6 million for the years ended December 31, 2009 and 2008, respectively. Research and development expenses decreased by $1,325 thousand or by 50 percent, in the year ending December 31, 2009, compared to the same period in 2008.  This decrease was primarily due to decreased salary and benefits expenses for engineers engaged in research and development.

Restructuring

Restructuring costs of $92 thousand for the year ended December 31, 2009, consisted primarily of an increase in the estimated closing costs of the San Mateo office rent obligations of $244 thousand based on the settlement reached with the landlord in January 2010, offset by a decrease in the estimated employee related costs of $175 thousand based on the settlement reached with our former CEO in December 2009.  There were costs of $632 thousand in 2008, consisting primarily of employee related costs and office rent obligations.

Other Income (Expense)

Net other expense for the year ended December 31, 2009, is $572 thousand, consisting of loss on extinguishment of debt in connection with the amendment of the January 2008 and April 2008 Debentures, and conversion of outstanding promissory notes into part of the September 2009 Debentures.

Interest Expense

Net interest expense was $1.1 million for the year ended December 31, 2009, compared to interest income of $2.6 million for the comparable period of 2008. The increase in interest expense from 2008 to 2009 of $3,689 thousand was due to the reduction in the marked-to-market valuation of liabilities relating to embedded derivatives and warrants because of the stability in the Company’s share price between December 31, 2009 and 2008 and due to the reclassification of warrants from liabilities to equity upon the restructuring of the January 2008 and April 2008 Debentures, offset by a reduction in the amortization of debt discount on the January 2008 and April 2008 Debentures due to the acceleration in 2008 of the unamortized debt discount because of the default events related to those Debentures.

Net Loss

Our net loss was $6.8 million and $19.3 million for the years ended December 31, 2009 and 2008, respectively, a decrease of $12.5 million, or 65 percent.  The decrease in net loss from 2008 to 2009 was due primarily to the Merger costs in 2008 of $13.4 million, decreased salaries and general and administrative expenses and other operating expenses of $3.0 million, offset by the increase in interest expense, discussed above.

Liquidity and Capital Resources

On December 31, 2009, we had $445 thousand in cash and cash equivalents, and net accounts receivable of $10 thousand, and prepaid expenses and other current assets of $16 thousand. Our working capital deficit at December 31, 2009, was $5 million, which included $315 thousand of warrant and derivative liability, compared to a deficit of $10.4 million, including $108 thousand in warrant and derivative liability at December 31, 2008.  The decrease in working capital deficit is mainly attributable to the reclassification of the January 2008 and April 2008 Debentures to long-term liabilities upon the amendment of those instruments on June 30, 2009.

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Net cash used by operating activities during the year ended December 31, 2009, was $2.4 million, compared to $7 million during the year ended December 31, 2008. The reduction in the primary use of cash from operating activities from 2008 to 2009 was due mainly to a reduction in payment of salaries and general and administrative expenses and other operating expenses of $3.0 million, and a delay in payment of accounts payable, accrued payroll, and accrued expenses of approximately $1.3 million.

Net cash provided by financing activities for year ended December 31, 2009, was $2.8 million, primarily from the issuance of our September 2009 Debentures, further discussed in “Note 6 — Convertible Notes and Debentures and Embedded Derivative and Warrant Liability” in our financial statements included in this report.

Net cash provided by financing activities for the year ended December 31, 2008, was $6.2 million, primarily from the issuance of our January 2008 Debentures and our April 2008 Debentures and the sale of the New Series A Preferred shares, further discussed in “Note 6 — Convertible Notes and Debentures and Embedded Derivative and Warrant Liability” in our financial statements included in this report.

Similar to other companies, we have suffered the effects of the current adverse economic conditions. We are in default of our September 2007 notes for failure to make payments when due.  The aggregate principal and accrued interest currently due under these debt securities as of the year ended December 31, 2009, is $2 million.  We restructured a major portion of our debt securities on June 30, 2009, and entered into an additional long-term debt financing on September 30, 2009, which converted a series of bridge loans entered into in the first three quarters of calendar 2009, and provided for additional cash in September 2009 and in December 2009.   That cash was originally intended to carry us to June 2010 but we incurred substantial unexpected expenses in connection with resolving certain litigation matters and other major creditor claims.

Our survival plan has continued and we continue to need immediate and substantial cash to continue our operations. Management has projected that the combination of cash on hand will be sufficient to allow us to continue our operations only through early-mid 2010. If cash reserves are not sufficient to sustain operations, then we plan to raise additional capital by selling shares of our capital stock or other securities.  We are presently engaged in active discussions for additional investments by existing and prospective investors but we have no funding commitments in place at this time and we can give no assurance that such capital will be available on favorable terms, or at all.  If we cannot obtain financing, then we may be forced to further curtail our operations, cease voluntarily filing reports with the SEC, or possibly be forced to evaluate a sale or liquidation of our assets, or consider strategic alternatives such as bankruptcy.  Even if we are successful in raising additional funds, there is no assurance regarding the terms of any additional investment and any such investment or other strategic alternative would likely substantially dilute or eliminate the interests of our stockholders.

Subsequent Events

Subsequently, on January 25, 2010, we entered into a securities purchase agreement with an entity affiliated with Donald W. Morissette for the sale of 10% senior secured convertible debentures, identical to the September 2009 Debentures, in the principal amount of $250,000. In this transaction, in addition to the debentures, we issued a warrant to purchase 375,000 shares of our common stock with an exercise price of $0.60 per share and 375,000 shares of our restricted common stock, or the “closing shares.”  We refer to this financing as our January 2010 financing in this report. The securities purchase agreement further provided that we had the right, subject to certain conditions, to require the investor to purchase an aggregate of $125,000 in additional principal amount of debentures between March 15 and 31, 2010.  We exercised that right on March 15, 2010, and issued $125 thousand in additional debentures to an entity affiliated with Mr. Morissette.  Mr. Morissette, who, together with his affiliates, beneficially owns more than 10% of our outstanding common stock.

During the quarter ended December 31, 2009, we entered into a Settlement Agreement with our former CEO Jeffrey L. Garon; see the Company’s Form 8-K filed with the SEC on December 18, 2009.  Subsequent to the end of the quarter, all payments required by the settlement agreement were made, whereby we repurchased 2,356,655 shares of common stock previously issued to Garon at the original purchase price of approximately $175,000, and those shares were cancelled.

On October 31, 2008, we closed our offices in San Mateo, California.  On or about December 19, 2008, the landlord for these premises filed a complaint claiming damages of $659 thousand and other amounts against the Company’s predecessor Etelos, Incorporated, a Washington corporation (“Etelos —WA”) in the Superior Court of San Mateo County, California (Case No. CIV 479535).  A default judgment was set aside because the landlord failed to properly serve either the Company or Etelos-WA. The Company was subsequently served properly and trial was set for February 8, 2010.  The parties went to mediation in January 2010 and subsequently entered into a settlement agreement, including a release of claims, in which we agreed: (a) to pay $66,000 in cash within 30 days, (b) to issue a $200,000 promissory note, with 6% interest, payable in 12 monthly payments beginning in July, 2010, and (c) to issue shares of Common Stock of the Company equal to $125,000 in value, based upon the closing price of the Company’s stock on January 6, 2010.  The settlement agreement and note were executed and delivered on February 8, 2010, and 166,667 shares subsequently were delivered on March 1, 2010.

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In partial settlement of approximately $292 thousand of an aggregate $575 thousand in unpaid salaries due and owing to current employees of the Company as of December 31, 2009, the board of directors has authorized the registration of 500,000 shares of Common Stock previously reserved under the Company’s 2009 Equity Incentive Plan as partial payment of up to 50% of the amount of unpaid salary due and owing to each current employee.  369,078 of those shares are to be issued upon completion of the registration process at an effective price of $0.79 per share.

Commitments and Contingencies

At December 31, 2009, we had the following financing obligations:

September 2007 Notes

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

Under the terms of the remaining $1.8 million of the notes that were not converted, principal payments began being payable on September 1, 2008, and continued to be payable on the last day of each calendar quarter, and interest payments began being payable beginning February 1, 2008.

All principal and interest payments under the September 2007 notes is due and payable at December 31, 2009, in the approximate aggregate amount of $2 million.

January 2008 and April 2008 Debentures

In January 2008, we issued our January 2008 Debentures with an aggregate principal amount of $2.0 million. In April 2008, we issued our April 2008 Debentures in the aggregate principal amount of $3.5 million. On June 30, 2009, we entered into an amendment agreement that modified the terms of these debentures.  As modified, the debentures mature on December 31, 2012.  No interest accrues under the debentures until September 30, 2010, at which time interest will accrue at 6% per annum.  Semi-annual payments of interest only, in the approximate amount of $95 thousand, begin January 1, 2011, and continue until maturity.

September 2009 Debentures

On September 29, 2009, we entered into a securities purchase agreement with three accredited investors for the sale of 10% senior secured convertible debentures in the principal amount of $2.0 million. We refer to these debentures as our September 2009 Debentures.  In this transaction, in addition to the debentures, we issued to the investors warrants to purchase 3,000,000 shares of our common stock with an exercise price of $0.60 per share, or the “September 2009 warrants,” a warrant to purchase 2,250,000 shares of our common stock with an exercise price of $0.01 per share, or the “September 2009 par value warrant,” and 750,000 shares of our restricted common stock, or the “closing shares.”  One of the investors paid part of its subscription amount through the cancellation of approximately $1.2 million worth of short-term indebtedness we owed to such investor.  The securities purchase agreement further provided that we had the right, subject to certain conditions, to require the investors to purchase an aggregate of $1.0 million in additional principal amount of debentures.  We exercised that right on December 15, 2009, and issued an additional $1.0 million of debentures to the investors on that date.

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The following is a summary of our convertible notes and debentures obligations as of December 31, 2009:

Operating and Capital Leases

Rent expense under leases totaled ($13) thousand and $254 thousand for the periods ended December 31, 2009 and 2008, respectively.  We have no future minimum rental payments required under non-cancelable leases as these have been recorded as restructuring costs and are included in other accrued expenses as at December 31, 2009. All capital leases were paid off in full during the year ended December 31, 2009.

On October 31, 2008, we relocated our Washington offices and abandoned the sub-leased premises of our former offices in Renton, Washington. The sublease for these premises runs through June 2010.  Subsequently, on March 5, 2010, the prime landlord filed a complaint against us for breach of contract and successor liability.  This matter was just served and we have not yet evaluated the claims made in this case.  We will need to evaluate and defend these claims.

On or about December 19, 2008, the landlord for the San Mateo premises filed a complaint claiming damages of $659 thousand and other amounts against the Company’s predecessor Etelos, Incorporated, a Washington corporation (“Etelos —WA”) in the Superior Court of San Mateo County, California (Case No. CIV 479535).  A default judgment was set aside because the landlord failed to properly serve either the Company or Etelos-WA. The Company was subsequently served properly and trial was set for February 8, 2010.  The parties went to mediation in January 2010 and subsequently entered into a settlement agreement, including a release of claims, in which we agreed: (a) to pay $66,000 in cash within 30 days, (b) to issue a $200,000 promissory note, with 6% interest, payable in 12 monthly payments beginning in July, 2010, and (c) to issue shares of Common Stock of the Company equal to $125,000 in value, based upon the closing price of the Company’s stock on January 6, 2010.  The settlement agreement and note were executed and delivered on February 8, 2010, and 166,667 shares subsequently were delivered on March 1, 2010.

Off Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of the period ended December 31, 2009.

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Going Concern Issue

During the year ended December 31, 2009, we have been unable to generate cash flows sufficient to support our operations and have been dependent on debt raised from qualified investors.  We remain dependent on outside sources of funding until our results of operations provide positive cash flows.  Our independent auditors issued a going concern explanatory paragraph in their report dated March 17, 2010. With our current level of funding, substantial doubt exists about our ability to continue as a going concern.

The financial statements contained in this report do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should we be unable to continue in existence.  Our ability to continue as a going concern is dependent upon our ability to generate sufficient cash flows to meet our obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitable operations.  However, there is no assurance that profitable operations or sufficient cash flows will occur in the future.

We have supported current operations by raising additional operating cash through bridge loans and the private sale of our convertible debentures and preferred stock.  This has provided us with the cash inflows to continue our business plan, but has not resulted in significant improvement in our financial position. We are considering alternatives to address our cash flow situation that include raising capital through additional sale of our common stock and/or debentures.

This could result in substantial dilution of existing stockholders. There can be no assurance that our current financial position can be improved, that we can raise additional working capital, or that we can achieve positive cash flows from operations. Our long-term viability as a going concern is dependent upon our ability to (i) locate sources of debt or equity funding to meet current commitments and near-term future requirements and (ii) achieve profitability and ultimately generate sufficient cash flow from operations to sustain our continuing operations.

Recent Accounting Pronouncements

During the third quarter of 2009, the Company adopted the new Accounting Standards Codification (“ASC”) as issued by the Financial Accounting Standards Board (FASB).  The ASC has become the authoritative source of US GAAP recognized by FASB to be applied by non-governmental entities.  The ASC is not intended to amend or change US GAAP.  The adoption of the ASC did not have a material impact on the Company’s financial statements.

In June 2009, the FASB issued new standards for the accounting for transfers of financial assets. These new standards eliminate the concept of a qualifying special-purpose entity; remove the scope exception from applying the accounting standards that address the consolidation of variable interest entities to qualifying special-purpose entities; change the standards for de-recognizing financial assets; and require enhanced disclosure. These new standards are effective beginning in the first quarter of 2010, and are not expected to have a significant impact on the financial statements.

In June 2009, the FASB issued amended standards for determining whether to consolidate a variable interest entity. These amended standards eliminate a mandatory quantitative approach to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity in favor of a qualitatively focused analysis, and require an ongoing reassessment of whether an entity is the primary beneficiary. These amended standards are effective beginning in the first quarter of 2010 and are not expected to have a significant impact on the financial statements.

In October 2009, the FASB issued new standards for revenue recognition with multiple deliverables. These new standards impact the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. These new standards are required to be adopted in the first quarter of 2011; however, early adoption is permitted. The Company does not expect these new standards to significantly impact the financial statements.

In October 2009, the FASB issued new standards for the accounting for certain revenue arrangements that include software elements. These new standards amend the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. These new standards are required to be adopted in the first quarter of 2011; however, early adoption is permitted. The Company does not expect these new standards to significantly impact the financial statements.

In January 2010, the FASB issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers, beginning in the first quarter of 2010. Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3), beginning in the first quarter of 2011. The Company does not expect these new standards to significantly impact the financial statements.

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ITEM 7A.                 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 8.                    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements are included beginning on page F-1 of this report:

ITEM 9.                    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.                 CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our disclosure controls and procedures are designed to provide reasonable assurances that material information related to our company is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer evaluated our disclosure controls as of December 31, 2009.

Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of December 31, 2009, at the reasonable assurance level for the reasons discussed below related to material weaknesses in our internal control over financial reporting.

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.  Our internal controls are intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Our internal controls include policies and procedures that:

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting.  Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  Based on our evaluation under that framework, our management concluded that our internal control over financial reporting was not effective as of December 31, 2009 as a result of several material weaknesses in our internal controls.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.  We had previously concluded that our internal control over financial reporting as of December 31, 2008, was not effective because of a lack of resources to obtain sufficient in-house personnel, as described below. Therefore, we have identified the following material weaknesses:

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It is possible that we may have additional material weaknesses that we have not yet identified. We are in the process of attempting to remediate the above noted material weaknesses, but that remediation was not complete as of December 31, 2009, or the filing date of this report.

Our plans to remediate the identified material weaknesses include: developing action plans to complete the implementation of internal controls necessary to correct each such weakness; assessing the need to take additional actions including, but not limited, to the following: evaluate accounting and control systems to identify opportunities for enhanced controls; recruit and hire additional staff to provide greater segregation of duties; evaluate the need for other employee changes; and evaluate such other actions as our advisors may recommend.  During 2009, we engaged outside consultants with technical accounting knowledge and expertise to advise and ensure the preparation of our financial statements in accordance with GAAP, with particular emphasis on certain complex or non-routine transactions.  Nevertheless, our ability to remediate all weaknesses is substantially impaired by our limited financial resources.

Management does not believe that any of the Company’s annual or interim financial statements issued to date contain a material misstatement as a result of the aforementioned weaknesses in our internal control over financial reporting.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit the company to provide only management’s report in this annual report.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or internal controls over financial reporting will prevent all errors or all instances of fraud.  A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls.  The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions.  Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.  Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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Changes In Internal Controls over Financial Reporting.

We did not make any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during our most recent fiscal quarter that has materially affected, or is likely to materially affect, our internal control over financial reporting.

ITEM 9B.                 OTHER INFORMATION

None.

PART III

ITEM 10.                  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Our directors are elected by our stockholders to a term of one year and to serve until his or her successor is duly elected and qualified, or until his death, resignation or removal.  Each of our officers is appointed by our board of directors to a term of one year and serves until his successor is duly elected and qualified, or until his death, resignation or removal from office.

Our bylaws provide that the number of directors that shall constitute our whole board of directors shall not be less than one or more than nine.  The number of directors is determined by resolution of our board of directors or by our stockholders at our annual meeting.  Our current board of directors consists of four directors.

The following table sets forth certain information regarding our executive officers and directors as of December 31, 2009:

Daniel J. A. Kolke

Danny Kolke founded Etelos, Incorporated in May 1999.  It is his vision and energy as the key architect that has driven development of the Etelos Ecosystem.  Mr. Kolke has served as a member of our board of directors and as various executive officers since our inception in 1999.  He has served as chairman of our board of directors since April 4, 2000. Mr. Kolke is widely respected as an industry-leading pioneer in SaaS and cloud computing and makes significant contributions to the Company and our board of directors as the key architect of the Etelos Ecosystem and as a lecturer and evangelist for SaaS and cloud computing.  He was appointed our chief executive officer in September 2008 and as our acting chief financial officer in December 2008.  He attended the Stanford Law School Directors College in 2008.

Ronald A. Rudy

Ronald A. Rudy has served as a director since March 1, 2006.  He has been an independent investor and consultant to the mortgage industry since September 2005. He founded Portland Mortgage Company in 1983 and served as its president and chief executive officer until it was acquired in 2004, until September 2005. Portland Mortgage Company was the largest independent Mortgage Banking Company in Oregon and Southwest Washington with over $1 billion in loan volume.  Mr. Rudy was responsible for managing all financial and regulatory reporting, and the management of a $39 million warehouse line of credit and the hedging operations in connection with $100-$150 million of loans in process.  His expertise in financial matters and experience in management of financial and regulatory matters make a major contribution to our board of directors.  Mr. Rudy served as president of the Oregon Mortgage Bankers Association in 1989 and as president of Oregon Executives in 2003.  Mr. Rudy served on the Board of Governors for The Mortgage Bankers Association from 1996-2003 and on the National Board of Directors of The Mortgage Bankers Association in 2003-2004. He also was president of the Portland Guadalajara Sisters Association in 2000 and a member of its board of directors from 1996-2001. Mr. Rudy is a graduate of the University of Portland and attended the Stanford Law School Directors College in 2008.

Andy Liu

Andy Liu has served as a director since his appointment by the Board on August 8, 2008.  He is CEO of BuddyTV, the largest independently held TV site on the Internet. Prior to BuddyTV, Mr. Liu served as President and CEO of NetConversions from 1999-2004 prior to its sale to aQuantive and served as VP and GM of its Site Optimization unit from 2004-2005. He is also a founder of a non-profit that is focused on technology in developing countries and is very passionate about entrepreneurship. Mr. Liu brings deep experience in building companies, site optimization, viral marketing, SEO, community building and product development. In 2003, he was named to Puget Sound Business Journal’s “40 Under 40.” Mr. Liu earned his MBA from Wharton.

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Robert L. Thordarson

Bob Thordarson has served as a director since his appointment by the Board on October 20, 2008.  He brings 15 years of direct entrepreneurial experience to Etelos, most in the ideation, funding, launch and growth of startups within the Telecommunications and Web Services marketplace. He is founder and CEO of BluCapp, a Web services startup, and co-founder of Cequint, Inc., a software company revolutionizing mobile Caller ID services. He was formerly President of TechFaith America, a mobile handset ODM headquartered in Beijing (CNTF), and formerly CEO and Co-Founder of Consumerware, a telecommunications device design and manufacturing company focused on developing consumer products for North America’s largest telecommunications carriers. Mr. Thordarson brings hands-on operational and development experience to building companies, business and partner development, managing diverse and distributed teams and channel marketing. Mr. Thordarson studied Economics at the University of Washington.

There are no family relationships among our directors or executive officers.  There are no arrangements between any of our directors and any other person pursuant to which they have been appointed to the Board.

Audit Committee

We have a separately designated audit committee of our board of directors, established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Our audit committee is comprised of Messrs. Rudy and Thordarson.  The audit committee is responsible for the appointment, compensation, retention and oversight of our independent registered public accounting firm.  In addition, the committee reviews with our management and its independent auditors financial information that will be provided to stockholders and others, the systems of internal controls which management and our board have established and our audit and financial reporting processes. The committee operates under a written Audit Committee Charter adopted by our board, a copy of which can be found under the “Investor Information — Corporate Governance — Board Committee Charters” section of our website at www.etelos.com. Our audit committee met in April 2009 in connection with the audit of our 2008 financial statements, and met three times in 2009.   Our board of directors has chosen to use the independence standards of the Nasdaq Stock Market to evaluate the independence of its audit committee members.  Our board of directors has determined that all current members of the audit committee are “independent” as that term is defined in the current applicable rules of the Nasdaq Stock Market and also meet the additional criteria for independence of audit committee members under the applicable rules of the Exchange Act.  In addition, our board of directors believes that Mr. Rudy is an “audit committee financial expert” as defined in Item 407(d) of Regulation S-B.   Mr. Rudy has served as President & Chief Executive Officer of a major regional mortgage company, where he was responsible for managing all financial and regulatory reporting, and the management of $1 billion in loan volume, a $39 million warehouse line of credit, and the hedging operations in connection with over $100-$150 million of loans in process.  As a result of the successful management of these responsibilities, Mr. Rudy has extensive experience analyzing and evaluating financial statements, an understanding of generally accepted accounting principles, an understanding of internal control over financial reporting and an understanding of audit committee functions. Mr. Rudy is a graduate of the University of Portland and attended the Stanford Law School Directors College in 2008.

Code of Ethics

Our board of directors adopted a “Code of Conduct and Policy for Reporting Possible Violations” that applies to our directors and all employees, including our executive officers. Our code of ethics can be viewed by visiting our website at www.etelos.com and clicking on “Investors.” In the event we make any amendments to, or grant any waivers of, a provision of our code of ethics that applies to our principal executive officer, principal financial officer, or principal accounting officer that requires disclosure under applicable SEC rules, we intend to disclose such amendment or waiver and the reasons therefore on a Form 8-K or on our next periodic report in accordance with SEC rules.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than ten percent of a registered class of our securities, to file with the SEC reports of ownership of our securities and changes in reported ownership. Officers, directors and greater than ten percent stockholders are required by SEC rules to furnish us with copies of all Section 16(a) reports they file.

Based solely on a review of the reports furnished to us, or written representations from reporting persons that all reportable transaction were reported, we believe that during the fiscal year ended December 31, 2009, our officers, directors and greater than ten percent stockholders timely filed all reports they were required to file under Section 16(a).

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ITEM 11.                  EXECUTIVE COMPENSATION

Summary Compensation

The Summary Compensation Table below summarizes the total compensation paid or earned by each of our named executive officers during the years ended December 31, 2009 and 2008.  Throughout this prospectus, the individuals included in the Summary Compensation Table set forth below are referred to as the “named executive officers.”

Summary Compensation Table

(1) Mr. Kolke was appointed Chief Executive Officer in September 2008 and Chief Financial Officer in November 2008; prior to that time he served as our Chief Technology Officer.

(2)  Represents the amount recognized for financial statement reporting purposes in respect of outstanding option awards in accordance with ASC 718. The assumptions made in valuing option awards reported in this column are discussed in Note 3, “Summary of Significant Accounting Policies” under “Stock-Based Compensation” and Note 12, “Accounting for Share-Based Compensation” to our financial statements included in this report.

Employment Agreement

Under the terms of the agreement between us and Mr. Kolke regarding his employment, Mr. Kolke is entitled to receive base salary in the amount of $175,000 payable in accordance with our payroll policies. In addition, in connection with his employment, on August 11, 2007, we granted Mr. Kolke an option to purchase up to 3,433,333 shares of common stock at an exercise price of $0.051 per share, of which 858,833 vested on the date of grant, 858,833 vested on the one year anniversary of August 11, 2008, and the balance vest ratably during the 24 months following August 11, 2008. If not exercised, the option expires on August 11, 2017.  On October 2, 2009, Mr. Kolke was granted an additional option to purchase 1,700,000 shares of common stock at an exercise price of $0.51 per share, of which  425,000 vested upon grant, 425,000 will vest on October 2, 2010, and the balance will vest ratably during the 24 months following October 2, 2010.  If not exercised, then these options expire on October 2, 2019.

Outstanding Equity Awards at Fiscal Year End

The following table sets forth information concerning unexercised options, stock that has not vested and equity incentive plan awards for each named executive officer outstanding as of December 31, 2009:

Outstanding Equity Awards at Fiscal Year-End

(1) Consists of the vested portion of options granted to Mr. Kolke pursuant to his August 2007 and October 2009 stock option grants.

(2) Consists of the unvested portion of options granted to Mr. Kolke, pursuant to his August 2007 or October 2009 stock option grants.  The unvested options granted in August 2007 vest monthly at the rate of 71,528 options per month, until August 2010.  The unvested options granted in October 2009 vest (a) 425,000 options on October 2, 2010, and (b) thereafter at 35,417 shares per month until October 2012.

Director Compensation

On March 5, 2008, our board of directors adopted a board compensation plan providing for (a) existing non-executive board members to receive options to acquire up to 10,000 shares of our common stock at an exercise price of $1.20 per share, which vest as to 50 percent on the 12 month anniversary of the date of grant and the remaining 50 percent on the 24 month anniversary of the date of grant; (b) new non-executive board members to receive options to acquire up to 10,000 shares of our common stock at an exercise price equal to the fair market value of our common stock on the date of grant, which vest as to 50 percent on the 12 month anniversary of the date of grant and the remaining 50 percent on the 24 month anniversary of the date of grant; (c) all re-elected board members to receive, upon their re-election, options to acquire up to 10,000 shares of our common stock at an exercise price equal to the fair market value of our common stock on the date of grant, which vest as to 100 percent on the 12 month anniversary of the date of grant; and (d) a quarterly payment of $1.5 thousand to each non-executive member of the board for their expenses in connection with attendance at quarterly board meetings and periodic board committee meetings.  In September 2009, our board of directors increased the annual grant size for non-executive directors to 100,000 options.

The table below sets forth the compensation the member of our board of directors received during the fiscal year ended December 31, 2009.

Director Compensation

(1)           Represents the amount recognized for financial statement reporting purposes in respect of outstanding option awards in accordance with ASC 718. The assumptions made in valuing option awards reported in this column are discussed in Note 3, “Summary of Significant Accounting Policies” under “Stock-Based Compensation” and Note 12, “Accounting for Share-Based Compensation” to our financial statements included in this report. At December 31, 2009, the following option awards were outstanding: (a) Ronald Rudy 120,000 options, of which 10,000 have vested as of the date of this report; (b) Andy Liu 110,000 options, 5,000 of which have vested; and (c) Robert L. Thordarson 110,000 options, 5,000 of which have vested.

10,000 of the options issued to Mr. Liu were amended by action of the board of directors, Mr. Liu abstaining, on October 2, 2009, which amended all unexpired or forfeited options previously granted on August 8, 2008, to revise the exercise price from $5.93 to $0.51, the closing price of the Company’s common stock on October 2, 2009.

We plan to enter into indemnification agreements with each of our directors (and our executive officers) on terms that we believe are reasonable, customary, and comparable to those entered into by other publicly traded companies in the United States.

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ITEM 12.                  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth certain information with respect to the beneficial ownership of our common stock as of March 16, 2010, by (i) any person or group owning more than 5 percent of our common stock, (ii) each director, (iii) each of our named executive officers, and (iv) all named executive officers and directors as a group.  As of March 16, 2010, we had 23,939,810 shares of common stock issued and outstanding and 743,333 shares of Series A Preferred stock issued and outstanding.   Beneficial ownership is determined in accordance with Rule 13d-3(d) promulgated by the SEC under the Exchange Act and includes shares that can be acquired within 60 days through exercise or conversion of a security.  Unless otherwise stated, each beneficial owner has sole power to vote and dispose of the shares and the address of such person is c/o Etelos, Inc., 26828 Maple Valley Highway #297, Maple Valley, Washington 93038.

(1)               Consists of (i) 260,629 shares of common stock, (ii) 5,133,333 shares of common stock issuable upon exercise of options, (iii) 333,333 shares of common stock issuable upon conversion of Series A Preferred Stock, (iv) 333,333 shares of common stock issuable upon exercise of warrants, and (v) 73,585 shares of common stock held by Mr. Kolke’s spouse.

(2)               Consists of (i) 980,273 shares of common stock, (ii) 110,000 shares of common stock issuable upon exercise of options, (iii) 133,333 shares of common stock issuable upon conversion of Series A Preferred Stock, and (iv) 166,666 shares of common stock issuable upon exercise of warrants.

(3)               Consists of 110,000 shares of common stock issuable upon exercise of options.

(4)               Consists of (i) 33,334 shares of common stock, (ii) 110,000 shares of common stock issuable upon exercise of options, and (iii) 33,333 shares of common stock issuable upon exercise of warrants.

(5)               Consists of (i) 1,373,603 shares of common stock, (ii) 6,495,999 shares of common stock issuable upon exercise of options, (iii) 466,666 shares of common stock issuable upon conversion of Series A Preferred Stock, and (iv) 533,332 shares of common stock issuable upon conversion of warrants.

(6)               Don Morissette and Don Morissette, LLC collectively hold (i) 9,728,650 shares of common stock, (ii) 375,000 shares of common stock issuable upon exercise of warrants and (iii) 750,000 shares of common stock issuable upon conversion of a debenture.  Mr. Morissette may be contacted at 4230 Galewood, Suite 100, Lake Oswego, Oregon 97035.

(7)               Based solely upon information filed by this stockholder in a Form 4 filed with the SEC on January 12, 2010.  Enable Growth Partners, L.P., a Delaware limited partnership (“EGP”), Enable Opportunity Partners, L.P., a Delaware limited partnership (“EOP”), and Pierce Diversified Strategy Master Fund, LLC, a Delaware limited liability company (“Pierce”, and together with EOP and EGP, the “Investors”), collectively hold (i) 3,707,084 shares of our common stock, (ii) warrants to purchase 444,444 shares of our common stock at an exercise price of $0.75 per share, subject to certain adjustments (the “Enable Warrants”), (iii) a 6% convertible note (“Note 1”) in the aggregate principal amount of $924,000, which is convertible into shares of our common stock at a conversion rate of $0.75 per share, (iv) a 6% convertible note (“Note 2”) in the aggregate principal amount of $440,000, which is convertible into shares of our common stock at a conversion rate of $0.75 per share, (v) a 6% convertible note (“Note 3”) in the principal amount of $1,000,000, which is convertible into shares of our common stock at a conversion rate of $0.75 per share, and (vi) a 6% convertible note (“Note 4”, and together with Note 1, Note 2, and Note 3, the “Notes”) in the principal amount of $3,000,000, which is convertible into shares of our common stock at a conversion rate of $0.75 per share. Note 3, Note 4, and the Enable Warrants each contain an issuance limitation prohibiting the Investors from exercising or converting those securities to the extent that such exercise would result in beneficial ownership by the Investors of more than 4.99% of the Shares then issued and outstanding.  Enable Capital Management, LLC (“ECM”) is the investment manager and general partner of EOP and EGP. ECM also serves as the investment manager of Pierce. Mitchell S. Levine is the Managing Member of ECM and has voting and investment power over the securities held by the Investors. Thus, for the purposes of Reg. Section 240.13d-3, EGP, EOP, Pierce, ECM and/or Mr. Levine may be deemed to be beneficial owners of more than 10% of the shares. Mr. Levine holds 73,333 shares in his individual capacity. Accordingly, this table reflects the aggregate holdings of EGP, EOP, Pierce and Mr. Levine. Other than the shares held by Mr. Levine in his individual capacity, ECM and Mr. Levine do not hold directly any of the securities or derivative securities with respect thereto, and disclaim any beneficial ownership of any of the securities or derivative securities reported or excluded herein for purposes of Rule 16a-1(a) under the Exchange Act, except for their pecuniary interest therein.  ECM may be contacted at One Ferry Building Ste. 225, San Francisco, California 94111.

(8)              Consists of (i) 1,000,000 shares of common stock and (ii) 2,000,000 shares of common stock issuable upon exercise of options.

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ITEM 13.                  CERTAIN RELATIONSHIPS AND RELATED TRANSACTION, AND DIRECTOR INDEPENDENCE

Related Transactions.

We previously entered into a series of loan transactions with the parents and two brothers of our chairman and chief executive officer, Mr. Daniel J.A. Kolke.  In connection with the settlement of these loans on December 30, 2007, we issued three unsecured promissory notes in the aggregate principal amount of $815.8 thousand which will become secured by certain of our presently unidentified assets if and when Mr. Kolke is no longer neither an employee nor a member of our board of directors. The unsecured promissory notes bear interest at 7.5 percent.  On December 22, 2009, our board of directors, with Daniel J.A. Kolke abstaining, approved the issuance of 434,754 shares of common stock of the company to Daniel & Selma Kolke, as payment of 45% of principal and 100% of accrued interest due on their note, as of December 31, 2009, at a value of $0.75 per share, or approximately $326 thousand.  The balance due on the note to Daniel & Selma Kolke as of December 31, 2009, was $324 thousand, and the principal amount outstanding under the other two promissory notes, in the aggregate, as of December 31, 2009, was $30 thousand.

In March 2009, we entered into a promissory note with Ronald A. Rudy, a member of our Board of Directors, in the principal amount of $100 thousand, bearing interest of 10% per annum.  On December 22, 2009, our board of directors, with Mr. Rudy abstaining, approved the issuance of 143,379 shares of our common stock to Mr. Rudy as payment in full of all principal and accrued interest due on the promissory note as of December 31, 2009, at a value of $0.75 per share.

On December 18, 2009, we entered into a promissory note with Daniel J.A. Kolke, our chairman, in the principal amount of $40 thousand, bearing interest at 6% per annum.  All principal on the note was paid in full on January 4, 2010.

Parent Companies.

We do not have a parent company.

Director Independence.

Our board of directors currently consists of four members, Daniel J. A. Kolke, Ronald A. Rudy, Andy Liu and Robert L. Thordarson.  Messrs. Rudy, Liu, and Thordarson are considered independent under the definition of independence established by The Nasdaq Stock Market.

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ITEM 14.                  PRINCIPAL ACCOUNTANT FEES AND SERVICES

We have selected Stonefield Josephson, Inc. as our independent registered public accounting firm for 2009. The audit committee of our board of directors intends to meet with the auditor in June 2010 to discuss the terms of the audit engagement for fiscal 2010. Stonefield Josephson was our principal accountant for the fiscal year ended December 31, 2008. Representatives from Stonefield Josephson have been invited to attend the annual meeting. If they attend, they will be provided the opportunity to make a statement if they desire to do so, and are expected to be available to answer appropriate questions.

For purposes of the tables below:

The following table sets forth the aggregate fees billed for services from January 1, 2009, to December 31, 2009, by Stonefield Josephson:

The following table sets forth the aggregate fees billed for services from January 1, 2008, to December 31, 2008, by Stonefield Josephson:

Audit Committee Pre-Approval Policies and Procedures

The policy of the audit committee of our board of directors is to pre-approve all audit and permissible non-audit services provided by our independent auditors. These services may include audit services, audit-related services, tax services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services. The independent auditor and management are required to periodically report to the audit committee regarding the extent of services provided by the independent auditor in accordance with this pre-approval.  All of our audit expenses incurred in 2008 were pre-approved by our Audit Committee.

PART IV

ITEM 15.                  EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)    Documents filed as part of this Report:

(1) Financial Statements—all financial statements of the Company as set forth under Item 8, on page F-1 of this Report.

(2) Financial Statement Schedules—as a smaller reporting company we are not required to provide the information required by this item.

(3) Exhibits

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EXHIBIT INDEX

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*     Filed with this report

#     Management contract or compensatory plan or arrangement

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being a director or officer of Etelos, Inc., a Delaware corporation, hereby constitutes and appoints Daniel J.A. Kolke and Kennedy Brooks, or each of them individually, as his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his name, place and stead in any and all capacities, to sign any and all amendments to this annual report on Form 10-K and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done that such annual report and its amendments shall comply with the Securities Act, and the applicable rules and regulations adopted or issued pursuant thereto, as fully and to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them or their substitute or re-substitute, may lawfully do or cause to be done by virtue hereof.

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

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ETELOS, INC.

FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Etelos, Inc.:

We have audited the accompanying balance sheets of Etelos, Inc. as of December 31, 2009 and 2008, and the related statements of operations, stockholders’ deficit, and cash flows for each of the years in the two-year period ended December 31, 2009. Etelos, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Etelos, Inc. as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.

As described in Note 4 to the financial statements, the accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company’s recurring net losses and accumulated deficit raise substantial doubt about its ability to continue as a going concern. Management’s plans to address these matters are discussed in Note 4 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Stonefield Josephson, Inc.

San Francisco, California

March 17, 2010

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ETELOS, INC.
BALANCE SHEETS

(in thousands, except share data)