Fonon Corp - FORM 10-Q - October 13, 2011

Attached files

file	filename
EX-31.1 - Fonon Corp	v236755_ex31-1.htm
EX-31.2 - Fonon Corp	v236755_ex31-2.htm
EX-32.2 - Fonon Corp	v236755_ex32-2.htm
EX-32.1 - Fonon Corp	v236755_ex32-1.htm

U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO ___________

Commission File Number: 000-51443

RAPTOR NETWORKS TECHNOLOGY, INC.

(Exact name of registrant as specified in its charter)

Colorado		84-1573852
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1588 South Coast Drive

Costa Mesa, California 92626

(Address of Principal Executive Offices)

(657) 859-2888

(registrant’s telephone number)

Not applicable

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

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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerate filer ¨	Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company	Smaller reporting company x

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

As of October 13, 2011, there were 88,080,979 shares of the issuer’s common stock, $0.001 par value, outstanding.

	Page

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets as of June 30, 2011 (unaudited) and December 31, 2010 (audited)	F-1

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2011 and 2010 (unaudited)	F-2

Consolidated Statement of Stockholders’ Deficit for the Six Months Ended June 30, 2011 (unaudited)	F-3

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010 (unaudited)	F-4

Notes to Consolidated Financial Statements (unaudited)	F-5

Item 2. Management’s Discussion and Analysis or Plan of Operation	1

Item 4T. Controls and Procedures	11

PART II - OTHER INFORMATION

Item 1. Legal Proceedings	12

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	12

Item 3. Defaults Upon Senior Securities	12

Item 4. Submission of Matters to a Vote of Security Holders	12

Item 5. Other Information	12

Item 6. Exhibits	13

Signatures	14

Exhibits Filed with this Report on Form 10-Q	15

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED BALANCE SHEETS

	June 30, 2011			December 31, 2010
	(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	923		$	82,777
Accounts receivable, net of allowance for doubtful accounts of $0		-			143,568
Inventories, net		510,332			515,662
Prepaid interest		2,206			15,441
License fees		-			32,850
Other current assets		863			30,226
Total current assets		514,324			820,524
PROPERTY AND EQUIPMENT, NET		20,951			40,527
DEPOSITS		1,560			1,560
TOTAL ASSETS	$	536,835		$	862,611

LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable	$	61,231		$	95,615
Accrued interest payable		516,554			253,106
Current portion of legal settlement payable		75,245			100,955
Deferred revenue		-			11,108
Accrued liabilities		81,851			579,249
Detachable warrant liabilities		219,600			993,852
Conversion option liabilities		10,428,166			5,808,201
Senior convertible notes payable, net of debt discount of $8,165 and $57,151 at June 30, 2011 and December 31, 2010, respectively		11,104,689			10,803,195
Total current liabilities		22,487,336			18,645,281
LEGAL SETTLEMENT PAYABLE, NET OF CURRENT PORTION		-			14,931
TOTAL LIABILITIES		22,487,336			18,660,212
COMMITMENTS AND CONTINGENCIES		-			-
STOCKHOLDERS' DEFICIT
Preferred stock, no par value; 5,000,000 shares authorized; no shares issued and outstanding		-			-
Common stock, $0.001 par; 200,000,000 shares authorized; 88,080,979 shares issued and outstanding at June 30, 2011 and December 31, 2010		88,081			88,081
Additional paid-in capital		66,506,366			66,506,366
Accumulated deficit		(88,544,948	)		(84,392,048	)
Total stockholders' deficit		(21,950,501	)		(17,797,601	)
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT	$	536,835		$	862,611

The accompanying notes are an integral part of these consolidated financial statements.

F-1

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months Ended						For the Six Months Ended
	June 30, 2011			June 30, 2010			June 30, 2011			June 30, 2010
REVENUE, NET	$	171		$	392,449		$	353,281		$	819,688
COST OF SALES		27,008			243,065			218,489			459,250
GROSS (LOSS) PROFIT		(26,837	)		149,384			134,792			360,438
OPERATING EXPENSES
Salary expense and salary related costs		108,707			153,067			221,447			372,245
Research and development		108			479			5,537			17,142
Selling, general and administrative		64,378			87,483			154,878			227,010
Total operating expenses		173,193			241,029			381,862			616,397
Loss from operations		(200,030	)		(91,645	)		(247,070	)		(255,959	)
OTHER INCOME (EXPENSE)
Interest income		4			2			5			4
Change in fair value of conversion option and warrant liabilities		(1,869,994	)		(2,786,132	)		(3,710,618	)		(1,157,088	)
Amortization of discount on convertible debt		(24,494	)		(590,473	)		(184,082	)		(1,638,372	)
Interest expense		(266,913	)		(251,911	)		(534,503	)		(502,102	)
Loss on sale of property and equipment		-			-			(1,697	)		-
Miscellaneous income		525,065			86,619			525,065			86,619
Total other expense		(1,636,332	)		(3,541,895	)		(3,905,830	)		(3,210,939	)
Loss before income taxes		(1,836,362	)		(3,633,540	)		(4,152,900	)		(3,466,898	)
Income tax benefit		-			-			-			-
NET LOSS	$	(1,836,362	)	$	(3,633,540	)	$	(4,152,900	)	$	(3,466,898	)
Loss per share - basic and diluted	$	(0.02	)	$	(0.04	)	$	(0.05	)	$	(0.04	)
Weighted average number of shares outstanding - basic and diluted		88,080,979			85,922,744			88,080,979			85,922,744

The accompanying notes are an integral part of these consolidated financial statements.

F-2

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

For the Six Months Ended June 30, 2011

(Unaudited)

					Additional					Total
	Common Stock				Paid-in		Accumulated			Stockholders'
	Shares		Amount		Capital		Deficit			Deficit
Balance, January 1, 2011		88,080,979	$	88,081	$	66,506,366	$	(84,392,048	)	$	(17,797,601	)
Net loss		-		-		-		(4,152,900	)		(4,152,900	)
Balance, June 30, 2011		88,080,979	$	88,081	$	66,506,366	$	(88,544,948	)	$	(21,950,501	)

The accompanying notes are an integral part of these consolidated financial statements.

F-3

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

For the Six Months Ended June 30,

	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(4,152,900	)	$	(3,466,898	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		6,728			5,939
Amortization of discount on convertible debt and debt issuance costs		184,082			1,638,373
Loss on sale of property and equipment		1,547			72,939
Change in fair value of conversion option and warrant liabilities		3,710,618			1,157,088
Change in inventory reserve		(90,367	)		18,917
Changes in operating assets and liabilities:
Accounts receivable		143,568			(101,962	)
Inventories		106,498			30,437
Prepaid expenses and other assets		75,448			116,296
Accounts payable and accrued liabilities		(56,468	)		399,775
Deferred revenue		(11,108	)		42,718
Net cash used in operating activities		(82,354	)		(86,378	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment		500			-
Net cash provided by investing activities		500			-
Net decrease in cash and cash equivalents		(81,854	)		(86,378	)
CASH AT BEGINNING OF PERIOD		82,777			162,242
CASH AT END OF PERIOD	$	923		$	75,864
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$	18,547		$	8,854
Cash paid for income taxes	$	1,600		$	1,651
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:
Accrued interest payable added to principal balance	$	252,508		$	336,283
Increase in debt discount for conversion option liabilities resulting from accrued interest added to principal balance	$	135,096		$	138,956

The accompanying notes are an integral part of these consolidated financial statements.

F-4

General

Basis of Presentation

The accompanying consolidated financial statements have been prepared by Raptor Networks Technology, Inc. (the “Company”) without audit (unless otherwise indicated) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as allowed by such rules and regulations, and management believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements include all of the adjustments which, in the opinion of management, are necessary for a fair presentation of financial position and results of operations. All such adjustments are of a normal and recurring nature. The December 31, 2010 consolidated balance sheet was derived from audited financial statements as of December 31, 2010. These financial statements should be read in conjunction with the audited financial statements at December 31, 2010 included in the Company’s most recent annual report on Form 10-K. Results of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results of operations expected for the full year or for any other period.

Going Concern

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. The Company has incurred a net loss of $4,152,900 for the six months ended June 30, 2011. Additionally, the Company also has an accumulated deficit of $88,544,948 and a working capital deficit of $21,973,012 as of June 30, 2011, of which $10,647,766 relates to the fair value of derivative financial instruments. In September 2008, the Company shifted its principal operating model from product sales to licensing enabling a reduction in headcount, footprint and infrastructure that reduced operating expense run rates substantially. This shift in business model has not been successful as the Company has not generated any revenues from licensing agreements until July 5, 2011, at which time the Company entered into an agreement with California Capital Equity, LLC (“CCE”) granting CCE an exclusive license (even as to the Company) leaving the Company without any continuing rights in or to its intellectual property. For further details on this transaction, see the disclosures made under the heading “Subsequent Events” in this quarterly report and to the Form 8-K filed by the Company on July 11, 2011. In addition, on August 1, 2011 all of the Company’s remaining assets were sold during a public foreclosure sale.

The Company’s service contract with a Government prime contractor was depleted as of March 31, 2011 and consequently, revenues for the quarter under review amounted to close to zero. Taking into account the current status of the U.S. Government budget, we believe it is unlikely that we will find a replacement for the expired contract revenue prior to January 2012.

The items discussed above raise substantial doubts about the Company's ability to continue as a going concern.

During 2010, the 2007 Notes, April 2008 Notes and July 2008 Notes (see Note 4) matured. The Company did not pay the principal balances and accrued interest at maturity or thereafter. As mentioned hereafter under the heading “Subsequent Events,” the note holders exercised their right as a secured lender against the Company’s assets and held a public foreclosure sale of substantially all of the Company’s assets and acquired all of these assets at a price of $100,000 which price was credited against the outstanding notes on August 1, 2011. As a result of the public sale on August 1, 2011, the Company retains no material assets with which to continue its operations. The Company is seeking companies or businesses with an interest in utilizing the Company as a public shell vehicle and in August 2011 has signed a non binding “Letter of Intent” with an interested party for a possible merger. There can be no assurance, however, that such a transaction will ultimately be consummated.

F-5

In light of these factors, management believes that a comprehensive financial restructuring with the utilization of the public shell entity as a reverse merger vehicle for a new entity is the only way to preserve any value for the public shareholders. Should such a transaction be consummated, the resultant debt for equity exchange will most likely result in a near total loss of shareholder value. Should a restructuring be unachievable, Raptor will permanently cease operations resulting in a total loss of shareholder value.

The financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Summary of Significant Accounting Policies

For a complete discussion of the Company’s significant accounting policies, please refer to the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2010.

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three and six months ended June 30, 2011, as compared to the recent accounting pronouncements described in the Annual Report on Form 10-K that are of material significance, or have potential material significance, to the Company.

2.	Inventories

Inventories consist of the following as of:

	June 30,			December 31,
	2011			2010
Raw materials	$	402,940		$	503,459
Finished goods		262,531			257,709
		665,471			761,168
Allowance for obsolescence		(155,139	)		(245,506	)
Inventories, net	$	510,332		$	515,662

3.	Stock-Based Compensation

2005 Stock Plan

The Company has one stock-based compensation plan, the 2005 Stock Plan (the “2005 Plan"). Under the 2005 Plan, 3,000,000 shares of stock are reserved for issuance to eligible employees, non-employee directors and certain consultants. The 2005 Plan is administered by the board of directors or committee of the board of directors, who have sole discretion to set vesting, expiration and other terms of awards under the 2005 Plan. As of June 30, 2011, the 2005 Plan had a total of 340,000 options outstanding and 2,560,000 shares available for future grants.

Non-Plan Options

Prior to approval of the 2005 Plan, the Company granted stock options out-of-plan. These non-plan options provided for the periodic issuance of stock options to employees and non-employee members of the board of directors. The vesting period for the non-plan stock options was over a three-year term, commencing on the first anniversary of the date of grant. The maximum contractual term of stock options granted under these out-of-plan options was eight years. As of June 30, 2011, there were 850,000 non-plan options outstanding.

F-6

Stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period. The fair value is determined using the Black-Scholes Option pricing model.

No options were granted during the three or six months ended June 30, 2011 or 2010.

For the three months ended June 30, 2011 and 2010, the Company recognized $0 and $18,720, respectively, of stock-based compensation costs. During the six months ended June 30, 2011 and 2010, the Company recognized $0 and $72,939, respectively, of stock-based compensation costs. The 2010 compensation cost includes a one-time charge of $28,812 for the true-up of stock options that became fully vested during the first quarter of 2010 quarter. These costs are reflected in operating expenses.

Stock option activity was as follows for the six months ended June 30, 2011:

	Number of Options			Weighted- Average Exercise Price		Weighted-Average Remaining Contract Term (Years)		Aggregate Intrinsic Value

Outstanding, January 1, 2011		1,462,000		$	1.21		2.79
Granted		-			-
Forfeited / Expired		(272,000	)	$	0.88
Exercised		-			-

Outstanding, June 30, 2011		1,190,000		$	0.91		1.92	$	-
Exercisable, June 30, 2011		1,190,000		$	0.91		1.92	$	-

As of January 1, 2011, all stock options had vested and, accordingly, all stock-based compensation cost was recognized.

4.	Securities Purchase Agreements

The Company entered into four separate securities purchase agreements (the “2006 SPA,” the “2007 SPA,” the “April 2008 SPA” and the “July 2008 SPA,” collectively the “SPAs”) with three institutional investors in connection with private placement transactions that provided for, among other things, the issuance of senior convertible notes (the “2006 Notes,” the “2007 Notes,” the “April 2008 Notes” and the “July 2008 Notes”), warrants to purchase shares of common stock (the “2006 Warrants,” the “2007 Warrants,” “the April 2008 Warrants,” the “July 2008 Warrants” and the “Replacement Warrants,” collectively the “Warrants”) and the issuance of common stock (the “April 2008 Stock” and the “July 2008 Stock”). Following is a summary of the securities issued pursuant to the terms of the SPAs.

F-7

Transaction	Date of Financing	Initial Principal Amount of Notes		Series of Warrants Issued	Initial Number of Warrants Issued to the Investors			Shares of Common Stock Issued

2006 SPA	July 30, 2006(1)	$	8,804,909	L and M		39,797,031			-
2007 SPA	July 31, 2007		3,500,000	N, O and P		6,047,886			-
April 2008 SPA	April 1, 2008		3,125,000	Q		6,250,000			3,125,000
July 2008 SPA	July 28, 2008		1,250,000	R		8,750,000	(2)		1,250,000
		$	16,679,909			60,844,917			4,375,000

(1) The information presented reflects the January 22, 2007 amendment.

(2) Includes 2,500,000 Series R warrants and 6,250,000 Replacement Warrants.

On July 27, 2010, the Company issued an unsecured convertible note payable (the “July 2010 Note”) to one of the investors from the previous financings in the principal amount of $176,471. All outstanding notes payable are collectively referred to as (the “Notes”).

The Company allocated the proceeds of the April 2008, July 2008 and July 2010 Notes to the individual financial instruments included in the transactions based on their relative estimated fair values as follows:

	April 2008 Notes			July 2008 Notes			July 2010 Notes
Total proceeds	$	3,125,000		$	1,250,000		$	176,471
Allocated to:
Common stock		2,531,250			675,000			-
Warrants		2,993,750			856,750			-
Conversion option		1,002,813			142,500			97,973
		6,527,813			1,674,250			97,973
Debt discount		(3,125,000	)		(1,250,000	)		(97,973	)
Cost of financing convertible notes	$	3,402,813		$	424,250		$	-

The fair value of the common stock was based on the closing market price of the Company’s common stock on the date of the transaction. The fair values of the warrants and conversion options were based on the Black-Scholes Option pricing model.

All of the SPAs contain registration rights agreements which require the Company to file registration statements with the SEC for the resale of the shares of common stock underlying all of the Notes, Warrants and common stock issued. The Company is required to maintain the effectiveness of the registration statements through the latest date at which the Notes can be converted or the Warrants can be exercised. Notwithstanding other remedies available under the SPAs, the Company will be required to pay liquidated damages equal to 2% of the principal amount of the Notes on the date of failure and 2% of the principal amount of the Notes every 30th day thereafter (or for a pro rated period if less than 30 days) for failure to timely file the registration statements or have them declared effective by the SEC and failure to maintain the effectiveness of the registration statements, subject to certain grace periods. Any liquidated damages not paid timely will accrue interest at the rate of 2% per month. Registration penalties under SPAs are capped at 12.5% of the principal amount of the respective Notes. The maximum registration penalties under the Notes are as follows:

F-8

Transaction	Maximum Registration Penalty
2006 SPA	$	1,100,614
2007 SPA		437,500
April 2008 SPA		390,625
July 2008 SPA		156,250
	$	2,084,989

The Company is required to assess its potential liability with respect to registration rights agreements. On May 29, 2008, the investors agreed to delay payments in connection with the registration rights agreement contained in the April 2008 SPA and the registration of the shares underlying the L-1 and L-2 warrants. The deadline has been indefinitely extended by the investors. As such, no liability related to the registration rights agreements has been recorded in the accompanying consolidated financial statements.

Significant events of default under the SPAs include:

The failure of any registration statement to be declared effective by the SEC within 60 days after the date required by the applicable registration rights agreement or the lapse or unavailability of such registration statement for more than 10 consecutive days or more than an aggregate of 30 days in any 365-day period (other than certain allowable grace periods).

The failure to issue unlegended certificates within 3 trading days after the Company receives documents necessary for the removal of the legend.

In January 2007, the Company amended the 2006 SPA (the “2006 Amended SPA”). The amendments included, but were not limited to, a waiver of all fees, penalties and defaults as of January 19, 2007 which related to registration statement filing failures and/or effectiveness failures, as described in the 2006 SPA, an increase in the principal amount of the 2006 Notes from an aggregate of $5 million to an aggregate of $7.2 million, issuance of an additional 5,688,540 2006 Warrants which increased the aggregate number of shares of common stock issuable upon exercise of the Series L-1 Warrants from an aggregate of 17,065,623 shares to an aggregate of 22,754,163 shares and a reduction in the exercise price of the Series L-1 Warrants and the Series M-1 Warrants from $0.5054 per share to $0.43948 per share. The Company did not receive any additional cash consideration for these amendments.

Additionally, pursuant to the terms of the 2006 Amended SPA, the Company entered into a securities purchase agreement with one of the existing institutional investors in a private placement transaction providing for, among other things, the issuance of senior convertible notes (the “2006 Amended Notes”) in the principal amount of $1.6 million, Series L-2 Warrants to purchase up to 7,281,332 shares of common stock and Series M-2 Warrants to purchase up to 2,366,433 shares of common stock. The Series L-2 Warrants were immediately exercisable. The Series M-2 warrants will become exercisable only upon a mandatory conversion of the 2006 Notes, as defined in the 2006 Notes. Both the Series L-2 Warrants and Series M-2 Warrants have an exercise price of $0.43948 per share and expire on July 31, 2013.

The April 2008 SPA amended the 2007 Notes and the 2007 Warrants. Pursuant to the 2008 SPA, the conversion prices of the 2007 Notes and the exercise price of the 2007 Warrants were reduced from $1.20 to $0.50. The April 2008 SPA had no effect on the 2006 Notes. The July 2008 SPA amended the exercise price of the Series Q warrants from $1.00 to $0.50.

The April 2008 SPA also amended the terms of the Series M-1 and M-2 Warrants to eliminate the contingency provisions and therefore, the Series M-1 and Series M-2 warrants became immediately exercisable upon the effective date of the April 2008 SPA.

The conversion price of the Notes and the exercise price of the Warrants are subject to customary anti-dilution provisions for stock splits and the like, and are also subject to full-ratchet anti-dilution protection such that if the Company issues or is deemed to have issued certain securities at a price lower than the then applicable conversion or exercise price, then the conversion or exercise price will immediately be reduced to such lower price.

F-9

The Notes and the Warrants contain certain limitations on conversion or exercise, including that a holder of those securities cannot convert or exercise those securities to the extent that upon such conversion or exercise, that holder, together with the holder’s affiliates, would own in excess of 4.99% of the Company’s outstanding shares of common stock (subject to an increase, upon at least 61-days’ notice, by the investor to the Company, of up to 9.99%).

Notes

Information relating to the Notes is as follows:

											As of June 30, 2011
Transaction	Initial Principal Amount		Interest Rate (4), (5), (6)			Maturity Date	Initial Fixed Conversion Price		Current Fixed Conversion Price		Principal Balance		Unamortized Discount			Carrying Value
2006 Notes(1)	$	8,804,909		9.25	%(3)	7/31/2008	$	0.44	$	0.44	$	4,987,137	$	-		$	4,987,137
2007 Notes(2)		3,500,000		9.25	%	8/1/2010	$	1.21	$	0.50		3,084,046		-			3,084,046
April 2008 Notes(7)		3,125,000		10.00	%	3/31/2010	$	1.00	$	1.00		2,288,392		-			2,288,392
July 2008 Notes(7)		1,250,000		10.00	%	7/28/2010	$	1.00	$	1.00		576,808		-			576,808
July 2010 Note(7)		176,471		15.00	%	7/27/2011	$	1.00	$	1.00		176,471		(8,165	)		168,306
	$	16,856,380									$	11,112,854	$	(8,165	)	$	11,104,689

(1) All information presented reflects amendments made in January 2007.

(2) Fixed conversion price reflects the effect of anti-dilution provision as a result of the April 2008 SPA.

(3) The interest rate may be reduced to 7% at the beginning of each quarter if certain conditions are met. No such conditions have been met to date.

(4) The interest rates for the 2006, 2007, April and July 2008 Notes increase to 15% upon the occurrence of an event of default.

(5) The interest rate on the July 2010 Note increases to 21% upon the occurrence of an event of default.

(6) Interest is calculated on the basis of a 360 day year.

(7) Interest for the first two years of the April 2008 Notes and July 2008 Notes was deducted from the proceeds. Interest for the first year of the July 2010 Note was deducted from the proceeds. Prepaid interest is reflected in the accompanying consolidated balance sheets as follows for the period ended:

	June 30,		December 31,
	2011		2010
April 2008 Notes	$	-	$	53,125
July 2008 Notes		-		49,583
July 2010 Notes		2,206		-
	$	2,206	$	102,708

The Company may elect to make monthly installment payments in cash or in shares of the Company’s common stock.

The maturity date of the Notes may be extended at the option of the investors so long as there is not an event of default.

During 2010, the 2007 Notes, April 2008 Notes and July 2008 Notes (see Note 4) matured. The Company did not pay the principal balances and accrued interest at maturity or thereafter. The note holders have demanded repayment of all amounts due under the Notes. The Company was unable to make any payments on the Notes and on August 1, 2011, the note holders foreclosed on substantially all assets of the Company.

F-10

The July 2010 Notes matured on July 31, 2011 and the Company did not repay the principal.

The 2006 and 2007 Notes are convertible into shares of common stock at the option of the holder at the lower of the fixed conversion price or the optional conversion price, defined as 90% of the arithmetic average of the weighted-average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date. However, if the weighted average price for the 20 trading days preceding the date of conversion exceeds $1.00, the conversion price is computed as 92.5% of the weighted average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date. However, the Company may, at its option, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of the Company’s common stock over the prior 20-trading day period on the 2007 Notes.

Subject to certain conditions, the Company may require the investors to convert up to 50% of the 2006 Notes at any time when the shares of the Company’s common stock are trading at or above 150% of the initial conversion price or up to 100% of the 2006 Notes at any time when the shares of the Company’s common stock are trading at or above 175% of the initial conversion price. The 2006 Notes contain certain limitations on optional and mandatory conversion. Under certain conditions, the Company may require investors to convert up to either 50% or 100% of the outstanding balance of the 2007 Notes at any time the Company shares are trading at or above $1.80 or $2.11, respectively.

The April 2008 Notes are convertible into shares of common stock at the lower of the fixed conversion price or the optional conversion price, defined as 85% of the arithmetic average of the weighted-average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date. However, following the disclosure of an SEC event, as defined in the July 2008 Notes, the conversion price will be computed using the lowest of (i) 50% of the arithmetic average of the weighted average price for the 30 trading days preceding the date of conversion; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.

The July 2008 Notes are convertible into shares of common stock at the lower of the fixed conversion price or the optional conversion price, defined as the lesser of (i) 85% of the arithmetic average of the weighted-average price of the common stock for the 30 consecutive trading days immediately preceding the conversion date and (ii) 85% of the arithmetic average of the weighted-average price of the common stock for the 3 lowest trading days during the 30 consecutive trading days immediately preceding the conversion date. However, following the disclosure of an SEC event, as defined in the April 2008 Notes, the conversion price will be computed using the lowest of (i) 50% of the amounts determined as above; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.

The Notes are secured by a first priority perfected security interest in all of the Company's assets and the common stock of the Company’s subsidiary. Additionally, the Notes are guaranteed by the Company’s subsidiary.

Significant events of default under the Notes include:

The suspension from trading or failure of the common stock to be listed for trading on the OTC Bulletin Board or another eligible market for more than 5 consecutive trading days or more than an aggregate of 10 trading days in any 365-day period.

The failure to issue shares upon conversion of the Notes or for more than 10 business days after the relevant conversion date or a notice of the Company’s intention not to comply with a request for conversion.

F-11

The Company’s failure to pay any amount of principal, interest, late charges or other amounts when due.

If there is an event of default, the investors have the right to redeem all or any portion of the Notes, at the greater of (i) up to 125% of the sum of the outstanding principal, interest and late fees, depending on the nature of the default, and (ii) the product of (a) the greater of (1) the closing sale price for the Company’s common stock on the date immediately preceding the event of default, (2) the closing sale price for the Company’s common stock on the date immediately after the event of default and (3) the closing sale price for the Company’s common stock on the date an investor delivers its redemption notice for such event of default, multiplied by (b) 130% of the number of shares into which the Notes (including all principal, interest and late fees) may be converted.

In the event of a default or upon the occurrence of certain fundamental transactions as defined in the 2007 Notes, the investors will have the right to require the Company to redeem the 2007 Notes at a premium. In addition, at any time on or after August 1, 2010, the investors may accelerate the partial payment of the 2007 Notes by requiring that the Company convert at the lower of the then conversion price or a 7.5% or 10.0% discount to the recent volume weighted average price of the Company’s common stock, or at the option of the Company, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of the Company’s common stock over the prior 20-trading day period.

Warrants

In connection with the SPAs, the Company issued detachable warrants as follows:

Series of Warrants	Initial Number of Warrants Issued		Initial Exercise Price		Current Exercise Price		Term(4)	Additional Warrant Grants(6)		Warrants Outstanding at June 30, 2011		Fair Value of Warrant Liability as of June 30, 2011		Fair Value of Warrant Liability as of December 31, 2010
L-1(1)		22,754,163	$	0.505	$	0.439	7 years		-		22,754,163	$	72,813	$	170,656
L-2(1)		7,281,332	$	0.505	$	0.439	7 years		-		7,281,332		23,300		54,610
M-1(1),(3)		7,395,103	$	0.505	$	0.439	7 years		-		7,395,103		23,664		55,463
M-2(1), (3)		2,366,433	$	0.505	$	0.439	7 years		-		2,366,433		7,573		17,748
N(2)		2,909,636	$	1.203	$	0.500	7 years		4,090,364		7,000,000		26,600		130,900
O(2),(5)		1,891,263	$	1.203	$	0.500	7 years		2,658,737		4,550,000		N/A		N/A
P(2)		1,246,987	$	1.203	$	0.500	7 years		1,753,013		3,000,000		11,400		56,100
Q(7),(8)		6,250,000	$	1.000	$	0.500	7 years		-		6,250,000		38,750		363,125
R		2,500,000	$	0.500	$	0.500	7 years		-		2,500,000		15,500		145,250
Replacement (9)		6,250,000	$	1.000	$	1.000	7 years		-		6,250,000		N/A		N/A
		60,844,917							8,502,114		69,347,031	$	219,600	$	993,852

(1)	All information presented reflects amendments made in January 2007.

(2)	Current exercise price reflects the effect of anti-dilution provision as a result of the April 2008 SPA.

(3)	The April 2008 SPA modified the warrants to eliminate the contingency provision.

(4)	The term begins as of the effective date of the registration statement.

(5)	The fair value of the Series O warrants has not yet been recorded since the contingency provisions have not been met.

(6)	Additional warrants were granted due to the anti-dilution provisions in the 2007 SPA.

(7)	Exercise price is the lesser of $0.50 or 75% of the lowest of the following:

(i) The average of the dollar volume-weighted average price of the stock for the 15 consecutive trading days immediately following the public disclosure of an event of default;

(ii) The lowest of the dollar volume-weighted average price of the stock during the 30 consecutive trading days ending on the date of exercise;

(iii) The average of the dollar volume-weighted average price of the stock for the 3 consecutive trading days immediately preceding the date of exercise; or

(iv) The average of the dollar volume-weighted average price of the stock for the 3 consecutive trading days immediately following the date of exercise.

F-12

(8)	Exercise price was amended by July 2008 SPA.

(9)	The Replacement Warrants are exercisable on a one-to-one basis as the Series Q warrants are exercised. The exercise price is the lowest of $0.50 or 75% of the lowest of the following:

(i) The average of the dollar volume-weighted average price of the stock for the 30 consecutive trading days immediately following the public disclosure of an event of default;

(ii) The average of the dollar volume-weighted average price of the stock for the 30 consecutive trading days immediately preceding the public disclosure of an event of default;

(iii) The average of 3 lowest volume-weighted average prices of the stock during either (i) or (ii) above.

The holders’ rights to exercise the 9,761,536 Series M warrants were contingent on a mandatory conversion of the 2006 Notes at the option of the Company. A mandatory conversion for a portion of the 2006 Notes took place on July 30, 2007 entitling investors to exercise up to 7,646,361 M warrant shares. The 2008 SPA contained a provision which removed the contingency on the remaining M warrants such that they became immediately exercisable.

Since conversion of the Series O warrants is contingent on a mandatory conversion of the 2007 Notes and since the exercise of the Replacement Warrants is contingent on the exercise of the Series Q warrants, the total charge was measured as of the date of issuance of the Series O warrants and the Replacement Warrants. This charge will not be recognized until the mandatory conversion contingency has been satisfied. The fair values of the Series O warrants and Replacement Warrants when issued were $1,493,341 and $2,725,625, respectively.

The fair value of the conversion options and the detachable warrant liabilities were calculated using the Black-Scholes Option Pricing Model with the following assumptions for the three months ended:

	June 30, 2011												June 30, 2010
	2006 Notes			2007 Notes			April 2008 & July 2008 Notes			July 2010 Notes			2006 Notes			2007 Notes			April 2008 & July 2008 Notes
Stock price	$	0.01		$	0.01		$	0.01		$	0.01		$	0.28		$	0.28		$	0.28
Exercise price	$	0.009		$	0.009		$	0.009		$	0.009		$	0.25		$	0.50		$	0.24
Expected life (in years)		0.75			1.25			1.00			1.00			0.75			1.50			1.26
Volatility		302	%		247	%		270	%		270	%		108	%		148	%		147	%
Risk-free rate of return		0.14	%		0.26	%		0.19	%		0.19	%		0.27	%		0.47	%		0.40	%
Expected dividend yield		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%

	2006 Warrants			2007 Warrants			April 2008 & July 2008 Warrants						2006 Warrants			2007 Warrants			April 2008 & July 2008 Warrants
Stock price	$	0.01		$	0.01		$	0.01					$	0.28		$	0.28		$	0.28
Exercise price	$	0.44		$	0.50		$	0.50					$	0.44		$	0.50		$	0.50
Expected life (in years)		0.75			1.50			2.76						0.75			1.50			2.76
Volatility		302	%		229	%		207	%					108	%		148	%		144	%
Risk-free rate of return		0.14	%		0.32	%		0.72	%					0.27	%		0.47	%		0.91	%
Expected dividend yield		0.00	%		0.00	%		0.00	%					0.00	%		0.00	%		0.00	%

F-13

Activity in the 2006 Notes and 2006 Warrants was as follows:

	Principal Balance		Discount on Notes Payable			Conversion Option Liability			Detachable Warrant Liability
Balance, January 1, 2010	$	4,448,440	$	-		$	2,584,949		$	2,145,060
Accrued interest added to principal balance		102,871		(64,326	)*		64,326			-
Amortization of debt discount		-		64,326	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			(544,996	)		(1,090,439	)
Balance, March 31, 2010		4,551,311		-			2,104,279			1,054,621
Accrued interest added to principal balance		105,249		(48,562	)*		48,562			-
Amortization of debt discount		-		48,562	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			(110,976	)		1,464,531
Balance, June 30, 2010		4,656,560		-			2,041,865			2,519,152
Accrued interest added to principal balance		107,683		(47,660	)*		47,660			-
Amortization of debt discount		-		47,660	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			105,763			(1,607,800	)
Balance, September 30, 2010		4,764,243		-			2,195,288			911,352
Accrued interest added to principal balance		110,173		(50,694	)*		50,694
Amortization of debt discount		-		50,694	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			120,818			(612,875	)
Balance, December 31, 2010		4,874,416		-			2,366,800			298,477
Accrued interest added to principal balance		112,721		(54,766	)*		54,766			-
Amortization of debt discount		-		54,766	*		-			-
Change in fair value of conversion option and detachable warrant liabilities							1,013,371			35,818
Balance, March 31, 2011		4,987,137		-			3,434,937			334,295
Change in fair value of conversion option and detachable warrant liabilities		-		-			1,108,899			(206,945	)
Balance, June 30, 2011	$	4,987,137	$	-		$	4,543,836		$	127,350

The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was July 31, 2008. Accordingly, all discount is immediately amortized.

F-14

Activity in the 2007 Notes and 2007 Warrants is as follows:

	Principal Balance		Discount on Notes Payable			Conversion Option Liability			Detachable Warrant Liability
Balance, January 1, 2010	$	2,752,309	$	(877,592	)	$	519,085		$	943,000
Accrued interest added to principal balance		63,349		(12,898	)		12,898			-
Amortization of debt discount		-		396,131			-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			1,303			4,000
Balance, March 31, 2010		2,815,658		(494,359	)		533,286			947,000
Accrued interest added to principal balance		64,814		(13,170	)		13,170			-
Amortization of debt discount		-		380,647			-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			298,674			520,000
Balance, June 30, 2010		2,880,472		(126,882	)		845,130			1,467,000
Accrued interest added to principal balance		66,313		(45,130	)		45,130			-
Amortization of debt discount		-		172,012			-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			798,845			(769,000	)
Balance, September 30, 2010		2,946,785		-			1,689,105			698,000
Accrued interest added to principal balance		67,846		(38,890	)*		38,890			-
Amortization of debt discount		-		38,890	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			(2,956	)		(511,000	)
Balance, December 31, 2010		3,014,631		-			1,725,039			187,000
Accrued interest added to principal balance		69,415		(39,686	)*		39,686			-
Amortization of debt discount		-		39,686	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			516,034			(66,000	)
Balance, March 31, 2011		3,084,046		-			2,280,759			121,000
Change in fair value of conversion option and detachable warrant liabilities		-		-			597,684			(83,000	)
Balance, June 30, 2011	$	3,084,046	$	-		$	2,878,443		$	38,000

The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was August 1, 2010. Accordingly, all discount is immediately amortized.

F-15

Activity in the April 2008 Notes and 2008 Warrants is as follows:

	Principal Balance		Discount on Notes Payable			Conversion Option Liability			Detachable Warrant Liability
Balance,January 1, 2010	$	2,125,000	$	(431,192	)	$	1,670,404		$	655,625
Amortization of debt discount		-		431,192			-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			(52,348	)		53,125
Balance, March 31, 2010		2,125,000		-			1,618,056			708,750
Change in fair value of conversion option and detachable warrant liabilities		-		-			(60,913	)		512,500
Balance, June 30, 2010		2,125,000		-			1,557,143			1,221,250
Accrued interest added to principal balance		53,125		(29,974	)*		29,974			-
Amortization of debt discount		-		29,974	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			(358,624	)		(538,750	)
Balance, September 30, 2010		2,178,125		-			1,228,493			682,500
Accrued interest added to principal balance		54,453		(30,712	)*		30,712			-
Amortization of debt discount		-		30,712	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			30,437			(319,375	)
Balance, December 31, 2010		2,232,578		-			1,289,642			363,125
Accrued interest added to principal balance		55,814		(32,235	)*		32,235			-
Amortization of debt discount		-		32,235	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-		-			444,151			(176,250	)
Balance, March 31, 2011		2,288,392		-			1,766,028			186,875
Change in fair value of conversion option and detachable warrant liabilities		-		-			495,442			(148,125	)
Balance, June 30, 2011	$	2,288,392	$	-		$	2,261,470		$	38,750

The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was March 31, 2010. Accordingly, all discount is immediately amortized.

F-16

Activity in the July 2008 Notes and Warrants is as follows:

	Principal Balance			Discount on Notes Payable			Conversion Option Liability			Detachable Warrant Liability
Balance, Januaary 1, 2010	$	850,000		$	(364,583	)	$	668,161		$	262,250
Amortization of debt discount		-			156,250			-			-
Change in fair value of conversion option and detachable warrant liabilities		-			-			(20,939	)		21,250
Balance, March 31, 2010		850,000			(208,333	)		647,222			283,500
Amortization of debt discount		-			156,250			-			-
Change in fair value of conversion option and detachable warrant liabilities		-			-			(42,684	)		205,000
Balance, June 30, 2010		850,000			(52,083	)		604,538			488,500
Conversion of notes to common stock		(150,000	)		-			(113,286	)		-
Amortization of debt discount		-			52,083			-			-
Change in fair value of conversion option and detachable warrant liabilities		-			-			(96,442	)		(215,500	)
Balance, September 30, 2010		700,000			-			394,810			273,000
Conversion of notes to common stock		(150,000	)		-			(90,016	)		-
Accrued interest added to principal balance		12,250			(6,909	)*		6,909			-
Amortization of debt discount		-			6,909	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-			-			13,079			(127,750	)
Balance, December 31, 2010		562,250			-			324,782			145,250
Accrued interest added to principal balance		14,558			(8,408	)*		8,408			-
Amortization of debt discount		-			8,408	*		-			-
Change in fair value of conversion option and detachable warrant liabilities		-			-			112,235			(70,500	)
Balance, March 31, 2011		576,808			-			445,425			74,750
Change in fair value of conversion option and detachable warrant liabilities		-			-			124,597			(59,250	)
Balance, June 30, 2011	$	576,808		$	-		$	570,022		$	15,500

The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was July 28, 2010. Accordingly, all discount is immediately amortized.

F-17

Activity for the July 2010 Notes is as follows:

	Principal Balance		Discount on Notes Payable			Conversion Option Liability
Balance, July 27, 2010 (Inception)	$	176,471	$	(97,973	)	$	97,973
Amortization of debt discount		-		16,329			-
Change in fair value of conversion option liability		-		-			1,559
Balance, September 30, 2010		176,471		(81,644	)		99,532
Amortization of debt discount		-		24,493			-
Change in fair value of conversion option liability		-		-			2,406
Balance, December 31, 2010		176,471		(57,151	)		101,938
Amortization of debt discount		-		24,493			-
Change in fair value of conversion option liability		-		-			31,765
Balance, March 31, 2011		176,471		(32,658	)		133,703
Amortization of debt discount		-		24,493			-
Change in fair value of conversion option liability		-		-			40,692
Balance, June 30, 2011	$	176,471	$	(8,165	)	$	174,395

A summary of the balances as of June 30, 2011 is as follows:

	Principal Balance		Discount on Notes Payable			Conversion Option Liability		Detachable Warrant Liability
2006 Notes	$	4,987,137	$	-		$	4,543,836	$	127,350
2007 Notes		3,084,046		-			2,878,443		38,000
April 2008 Notes		2,288,392		-			2,261,470		38,750
July 2008 Notes		576,808		-			570,022		15,500
July 2010 Notes		176,471		(8,165	)		174,395		-
Balance, June 30, 2011	$	11,112,854	$	(8,165	)	$	10,428,166	$	219,600

F-18

Warrants

Warrants granted to investors, brokers and other service providers are summarized as follows:

	Warrant			Weighted Average
	Shares			Exercise Price
Outstanding at January 1, 2011		70,514,126		$	0.51
Granted		-			-
Cancelled/forfeited		(366,385	)	$	(0.52	)
Exercised		-			-
Outstanding at June 30, 2011		70,147,741		$	0.51

The following tables summarize warrants outstanding at June 30, 2011:

Range		Number		Weighted Average Life	Weighted Average Exercise Price		Number Exercisable

$	0.43-1.20		70,147,741	2.61 years	$	0.51		59,347,741

Series	Issue Date	Outstanding at January 1, 2011		Granted		Exercised / Forfeited			Outstanding at June 30, 2011
L-1	July 2006 & January 2007		22,754,163		-		-			22,754,163
L-2	July 2006 & January 2007		7,281,332		-		-			7,281,332
M-1	July 2006 & January 2007		7,395,103		-		-			7,395,103
M-2	July 2006 & January 2007		2,366,433		-		-			2,366,433
N	July 2007		7,000,000		-		-			7,000,000
O	July 2007		4,550,000		-		-			4,550,000
P	July 2007		3,000,000		-		-			3,000,000
Q	April 2008		6,250,000		-		-			6,250,000
Replacement	July 2008		6,250,000		-		-			6,250,000
R	July 2008		2,500,000		-		-			2,500,000
Miscellaneous	2003 - 2007		1,167,095		-		(366,385	)		800,710
			70,514,126		-		(366,385	)		70,147,741

F-19

Fair Value Disclosures

ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820-10 are described below:

Level 1	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2	Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
Level 3	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

The following table sets forth the Company’s financial assets and liabilities measured at fair value by level within the fair value hierarchy. As required by ASC 820-10, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The table below sets forth a summary of the fair values of the Company’s financial assets and liabilities as of June 30, 2011.

	Total		Level 1		Level 2		Level 3
LIABILITIES:
Conversion option liabilities	$	10,428,166	$	-	$	-	$	10,428,166
Detachable warrant liabilities		219,600		-		-		219,600
	$	10,647,766	$	-	$	-	$	10,647,766

The Company’s detachable warrant and conversion option liabilities are valued using pricing models and the Company generally uses similar models to value similar instruments. Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of such inputs. These financial liabilities do not trade in liquid markets, and as such, model inputs cannot generally be verified and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy. The conversion option and detachable warrant liabilities are included in current liabilities in the accompanying consolidated balance sheets. The change in fair value of the conversion option and detachable warrant liabilities is included as a component of other income (expense) in the consolidated statements of operations.

F-20

Commitments and Contingencies

In October 2008, the Company rendered possession of its prior operating facility to the landlord. In November 2009, the Company settled the matter for $216,000 plus simple interest at 10 percent per annum. The Company paid $7,000 on the date of the agreement. Beginning January 15, 2010 and continuing through January 15, 2012, the Company will make monthly payments of $9,000. A final payment of $6,106 is due on February 15, 2012. On July 25, 2011, the Company entered into another settlement agreement with the landlord for one final payment of $40,000. The balance due on the lease on the settlement date was $75,040. Accordingly, the Company recorded a gain on the settlement of the lease of $35,040 in the third quarter of 2011.

On August 1, 2011, the Company terminated the lease of its existing facility effective August 31, 2011.

Subsequent Events

The following subsequent events have occurred through the filing date of this report, October 13, 2011.

On July 31, 2011, the July 2010 Notes matured and the Company did not repay the principal balance.

Effective July 1, 2011, the Company sold an exclusive, worldwide, perpetual, irrevococable, fully paid, transferable and sublicensable right and license in all of the Company’s registered patent and patent applications for $384,000. The license is exclusive even to the Company, such that the Company no longer has any rights to its intellectual property.

On June 17, 2011, Raptor Acquisition, LLC, a wholly-owned subsidiary of California Capital Equity, LLC (“CCE”) purchased all of the convertible notes payable from the previous note holders in an outside transaction. On July 6, 2011, CCE provided the Company with notice of default on the notes payable and demanded repayment in full. They also informed the Company of their intent to exercise their rights and remedies against the Company’s assets. On August 1, 2011, CCE, in its capacity as a secured lender, held a public foreclosure sale of substantially all of the Company’s assets. CCE was the only bidder and the assets of the Company were acquired for $100,000 which amount was credited against outstanding notes.

On August 1, 2011, the Company terminated the lease of its existing facility effective August 31, 2011.

On August 19 the Company signed a non binding letter of intent for a merger transaction with an interested partner. The merger is contingent on the outcome of due diligence and a definitive Merger Agreement to be agreed upon by all parties, including the current note-holder, in the near future. There can be no guarantee that this transaction will be consummated. Management believes that a comprehensive financial restructuring with the utilization of the public shell entity as a reverse merger vehicle for a new entity is the only way to preserve any value for the public shareholders. Should such a transaction be consummated, the resultant debt for equity exchange will most likely result in a near total loss of shareholder value. Should a restructuring be unachievable, Raptor will permanently cease operations resulting in a total loss of shareholder value.

F-21

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

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

our inability to continue as a going concern,

our inability to raise additional capital,

lower sales and revenues than forecast,

our inability to carry out our marketing and sales plans,

unexpected costs and operating deficits,

our failure to establish relationships with and capitalize upon access to new customers,

litigation and administrative proceedings involving us or our products,

adverse publicity and news coverage,

adverse economic conditions,

entry of new and stronger competitors,

changes in interest rates and inflationary factors, and

other specific risks that may be referred to in this report or in other reports that we have issued.

These forward-looking statements necessarily depend upon assumptions and estimates that may prove to be incorrect. Although we believe that the assumptions and estimates reflected in the forward-looking statements are reasonable, we cannot guarantee that we will achieve our plans, intentions or expectations. The forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ in significant ways from any future results expressed or implied by the forward-looking statements. Except as required by law, we undertake no duty to update any forward-looking statement after the date of this report, either to conform any statement to reflect actual results or to reflect the occurrence of unanticipated events.

Any of the factors described above, elsewhere in this report, or in the “Risk Factors” section of our most recent annual report on Form 10-K could cause our financial results, including our net income (loss) or growth in net income (loss) to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

Current Business Outlook

Since inception, the Company has incurred losses and realized negligible revenues from product sales. Our government design services contract, which funded a major portion of the Company's operating expenses, expired in April 2011 and all funds generated from this contract were depleted as of June 2011.

As disclosed in previous filings, the Company shifted its principal operating model from product sales to licensing, enabling a substantial reduction in headcount, footprint and infrastructure that reduced operating expense run rates substantially. This shift in business model has not been successful as the Company has not generated any revenues from licensing agreements until July 5, 2011, at which time the Company entered into an agreement with California Capital Equity, LLC (“CCE”) granting CCE an exclusive license (even as to the Company) leaving the Company without any continuing rights in or to its intellectual property.

As of July 31, 2011, all of our convertible notes payable have fully matured, representing a total principal amount outstanding of $11,112,854 and accrued interest of $516,554 as of June 30, 2011. The Company did not repay these amounts. Consequently, the note holders exercised their right as a secured lender against substantially all of the Company’s assets and held a public foreclosure sale of substantially all of the Company’s assets and acquired all of these assets at a price of $100,000, which was credited against the outstanding notes on August 1, 2011. As a result of the public sale on August 1, 2011, the Company retains no material assets with which to continue its operations. The Company is seeking companies or businesses with an interest in utilizing the Company as a public shell vehicle and in August 2011 has signed a non-binding “Letter of Intent” with an interested party for a possible merger. There can be no assurance, however, that such a transaction will ultimately be consummated.

For further details on the above, see the language included under “risk factors” starting on page 8 of our annual report on Form 10-K for the year ended December 31, 2010, “conclusion on capital resources and liquidity” on page 11 of this Form 10-Q, “presentation as a going concern” on page F-5 of this form 10-Q, “subsequent events” on page F-21 of the Form 10-Q and the Forms 8-K filed on July 11, 2011 and August 4, 2011.

Overview

We design, produce and sell standards-based, proprietary high-speed network switching and related “virtualized fabric” technologies. Our “distributed hybrid fabric” networking and integrated systems’ technologies allow users to upgrade both their traditional networks as well as their server and storage arrays with our products to allow for more efficient management of high-bandwidth transport, applications and security. The implementation of our products in a user’s network provides architectural solution alternatives, at a systems level, unavailable from existing switching, routing and server technologies.

We have designed and produced a family of virtualized network switching products branded the “Ether-Raptor” line, which consist of core and edge switch products that operate together in a unique and highly efficient manner. In a departure from traditional, centralized chassis-based switch architectures that were originally designed to handle latency (a time delay in the transfer of data) insensitive traffic such as email and block data transfers, we have developed the ability to “bind” physically separated network switches into a common “virtual chassis,” creating the ability for a single network device to exist in multiple locations at the same time. This contiguous transport architecture allows for very fast data transport while removing the limitations of active/passive link states common in legacy networks. This functionality is believed to be essential to new high-bandwidth, latency sensitive applications such as Voice over Internet Protocol (“VoIP”), streaming video, Internet Protocol Television (“IPTV”) and cloud computing and storage, none of which existed when traditional chassis-based network switch designs were originally designed. We believe that our “distributed fabric” architecture and associated products may redefine the manner in which data distribution occurs for service providers offering VOIP, streaming video, IPTV and cloud computing and access. Due to the full, open-standards compatibility of our Ether-Raptor product line, our network switching products have nearly universal applicability on legacy as well as newly installed Ethernet networks where speed, high bandwidth, cyber resiliency and survivability are essential.

From 2009 through 2011, we have advanced our architecture and intellectual property to design a next-generation network appliance that becomes a “hybrid fabric” device; part core network transport product, part embedded applications server, part content caching device and part secure communications appliance. Management’s belief is that the IT world will ultimately adopt “hybrid fabric” architectures, blurring the distinction between a network device, a computing device and a security device, creating the same degree of convergence in the systems arena that has already occurred in the telecom space. We are thus designing our first “hybrid fabric” converged machine comprising a high performance, virtualized fabric core networking device with a multi-core, applications ready processor and accompanying storage embedded in the transport fabric itself.

Going Concern Qualification

We have a limited operating history with minimal sales and have incurred cumulative net losses of $88,544,948 through June 30, 2011. At June 30, 2011, we had a deficit in working capital of $21,973,012 of which $10,647,766 relates to the fair value of derivative financial instruments.

As mentioned before under the heading “Subsequent events” in this quarterly report the Company sold an exclusive right to its registered patents effective July 1, 2011 and on August 1, 2011 all of the Company’s remaining assets were sold during a public foreclosure sale leaving the Company without any rights to its intellectual property and without any assets

These conditions, among others, raise substantial doubt about our ability to continue as a going concern and our independent registered public accounting firm has qualified their opinions with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2003 through December 31, 2010.

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

RISK FACTORS

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

CRITICAL ACCOUNTING POLICIES

Critical Accounting Estimates and Judgments

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

Inventories

We determine our inventory value at the lower of average cost or market. When required, a provision is made to reduce excess and obsolete inventories to estimated net realizable value. Our provision for excess and obsolete inventories decreased from $245,506 at December 31, 2010 to $155,139 at June 30, 2011 due to the sale of inventory for which we had previously provided an obsolescence reserve and the return of inventory on loan that was previously included in the obsolescence reserve.

Derivative Financial Instruments

Our senior convertible notes are classified as non-conventional convertible debt. In the case of non-conventional convertible debt, we bifurcate our embedded derivative instruments and record them at their fair value as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives is higher at the subsequent balance sheet date, we will record a non-operating, non-cash charge. If the fair value of the derivative is lower at the subsequent balance sheet date, we will record non-operating, non-cash income.

To determine the fair value of the derivative instruments, we make certain assumptions regarding the expected term of exercise. Because the expected term of the warrants impacts the volatility and risk-free interest rates used in the Black-Scholes calculations, these must be selected for the same time period as the expected term of the warrants.

Deferred Income Taxes

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

RESULTS OF OPERATIONS

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2011 and 2010

The following table sets forth selected financial data regarding our financial position and operating results for the three and six months ended June 30, 2011 and 2010. This data should be read in conjunction with our consolidated financial statements and related notes thereto beginning on page F-1 of this report.

	For the Three Months Ended												For the Six Months Ended
	June 30,			June 30,			Change						June 30,			June 30,			Change
	2011			2010			($)			(%)			2011			2010			($)			(%)
REVENUE, NET	$	171		$	392,449		$	(392,278	)		-100	%	$	353,281		$	819,688		$	(466,407	)		-57	%
COST OF SALES		27,008			243,065			(216,057	)		-89	%		218,489			459,250			(240,761	)		-52	%
GROSS (LOSS) PROFIT		(26,837	)		149,384			(176,221	)		-118	%		134,792			360,438			(225,646	)		-63	%
OPERATING EXPENSES
Salary expense and salary related costs		108,707			153,067			(44,360	)		-29	%		221,447			372,245			(150,798	)		-41	%
Research and development		108			479			(371	)		-77	%		5,537			17,142			(11,605	)		-68	%
Selling, general and administrative		64,378			87,483			(23,105	)		-26	%		154,878			227,010			(72,132	)		-32	%
Total operating expenses		173,193			241,029			(67,836	)		-28	%		381,862			616,397			(234,535	)		-38	%
Loss from operations		(200,030	)		(91,645	)		(108,385	)		118	%		(247,070	)		(255,959	)		8,889			-3	%
OTHER INCOME (EXPENSE)
Other income		4			2			2			100	%		5			4			1			25	%
Change in fair value of warrant and conversion option liabilities		(1,869,994	)		(2,786,132	)		916,138			-33	%		(3,710,618	)		(1,157,088	)		(2,553,530	)		221	%
Amortization of discount on convertible debt		(24,494	)		(590,473	)		565,979			-96	%		(184,082	)		(1,638,372	)		1,454,290			-89	%
Interest expense		(266,913	)		(251,911	)		(15,002	)		6	%		(534,503	)		(502,102	)		(32,401	)		6	%
Loss on sale of property and equipment		-			-			-			0	%		(1,697	)		-			(1,697	)		0	%
Miscellaneous income		525,065			86,619			438,446			506	%		525,065			86,619			438,446			506	%
Total other income (expense)		(1,636,332	)		(3,541,895	)		(1,905,563	)		54	%		(3,905,830	)		(3,210,939	)		(694,891	)		22	%
Loss before income taxes		(1,836,362	)		(3,633,540	)		(1,797,178	)		49	%		(4,152,900	)		(3,466,898	)		(686,002	)		20	%
Income tax benefit		-			-			-			0	%		-			-			-			0	%
NET LOSS	$	(1,836,362	)	$	(3,633,540	)	$	(1,797,178	)		49	%	$	(4,152,900	)	$	(3,466,898	)	$	(686,002	)		20	%

Net Revenues

Net revenues decreased by $392,278 for the three months ended June 30, 2010 to $171 for the three months ended June 30, 2011. Net revenues decreased from $819,688 for the six months ended June 30, 2010 to $353,281 for the six months ended June 30, 2011. By 2010, the Company had become largely dependent on U.S. Government contracts as its source of revenue. In March 2011, funding for government contracts ran out because the government had not approved its budget for fiscal 2011. In addition, the Company was unable to generate significant commercial business due to its lack of sales resources.

Gross (Loss) Profit

Gross profit for the three months ended June 30, 2010 was $149,384 as compared to gross loss of $26,837 for the three months ended June 30, 2011. The change from 2010 is attributable to lower revenues. Additionally, the Company wrote off $16,425 of license fees in each quarter of 2011 due to lower revenue expectations. In 2011, the Company also wrote off $5,676 of inventory on loan to third parties that we were unable to get back and we charged $4,000 related to post-sales support and royalty settlements with third parties. Cost of good sold in 2010 was attributable to normal margins on our products and services.

Operating Expenses

The decrease in operating expenses in the second quarter of 2011 compared to the same period of 2010 was $67,836 or 28%. The decrease in operating expenses in for the six months ended June 30, 2011 compared to the same period of 2010 was $234,535 or 38%. These decreases resulted from the following.

Salary Expenses

Salary and salary-related expenses decreased by $44,360 in the second quarter of 2011 compared to the same period in 2010, a 29% decrease and by $150,798 in the second half of 2011 compared to the same period in 2010, a 41% decrease. The decrease of expenses incurred in 2011 partially resulted from the complete vesting of stock-options in the fourth quarter of 2010. Accordingly, no stock-based compensation costs were recorded in 2011. Additionally, effective March 31, 2011, due to the lack of revenues, the Company terminated 4 of its engineering and R&D personnel due to lack of revenues.

Research and Development

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

Selling, General and Administrative

Selling, general and administrative expenses (SG&A) decreased from $87,483 in the second quarter of 2010 to $64,378 or 26% in the first quarter of 2011. SG&A decreased from $227,010 to $154,878 or 32% for the six months ended June 30, 2011 compared to the same period of 2010 and resulted from the following:

Audit fees decreased by $8,659 in the second quarter of 2011 as compared to 2010 and by $6,638 in the first half of 2011 compared to 2010. The decrease results from the Company not engaging our predecessor auditors to review our financial statements and Form 10-Q for the first and second quarters of 2010.

Legal fees increased by $11,636 and $14,766, respectively, for the three and six months ended June 30, 2011 over the three and six months ended June 30, 2010. These increases are due to additional work for legal advice, drafting legal agreements for contracts entered into in the second and third quarters of 2011 and assistance with the Forms 8-K required as a result of the above-mentioned contracts.

Office expense decreased by $3,404 during the second quarter of 2011 compared to 2010 and by $8,970 during the first half of 2011 compared to 2011 due to lower freight costs due to a reduction of product sales in 2011. Additionally, in 2011, office expenses for copying and mailing decreased due to lower levels of sales/procurement activity.

Consulting expenses decreased from $12,730 in the second quarter of 2010 to $1,630 in the same period in 2011 and decreased from $48,945 in the first half of 2010 to $2,430 in the first half of 2011 due to the lack of revenues. The decrease in revenues resulted in decreased sales commissions in 2011.

Accounting fees decreased by $3,331 and $5,761, respectively, for the three and six months ended June 30, 2011 compared to the same periods in 2010. The decrease is attributable to less time incurred by our consultant due to familiarity and no financings in 2011. Additionally, the Company was able to negotiate a lower rate in 2011 over 2010.

Travel expenses increased by $2,625 in the second quarter of 2011 compared to the same period in 2010 and decreased by $2,627 for the first half of 2011 compared to the first half of 2010. The increase was due to gross travel expenses of $14,914 in the second quarter of 2010 compared to gross travel expenses of $7,170 in the comparable period of 2011. However, in 2010, travel expenses were reduced by $7,455 that we were able to bill the government. Travel expenses decreased by $2,627 in the first half of 2011 compared to the first half of 2011 due to a reduction in the number of trips taken in 2011 a result of lower product sales and other cost-cutting measures.

Personal property tax expense decreased by $6,067 for the three and six months ended June 30, 2011 over the same period in 2010 due to a timing difference in the receipt of the tax bill. The tax bill was received in the third quarter of 2011. Due to immateriality, the Company does not accrue for personal property taxes on a monthly basis.

Marketing expense in 2010 was mainly comprised of $10,019 related to equipment loaned to a company for a two-year period. We believe that at the end of the two-year period, the equipment will have no residual value and therefore we expensed the entire amount as marketing costs in the first quarter of 2010. We did not incur any marketing expense in 2011.

Insurance expense increased by $2,258 for the second quarter of 2011 compared to the second quarter of 2010 due to an increase in the premium on our D&O policy. The increase in insurance for the first half of 2011 compared to the first half of 2010 was not material.

The inventory variance was ($131) in the second quarter of 2010 compared to ($7,024) in the second quarter of 2011 as a result of timing differences. The change in inventory variance was not material for the first half of 2011 compared to the same period in 2010.

Net Other Income (Expense)

Net other expense was $1,636,332 for the three months ended June 30, 2011 as compared to net other expense of $3,541,895 for the same period in 2010 and was $3,905,820 for the six months ended June 30, 2011 as compared to $3,212,636 for the same period in 2010. These changes resulted from the following:

For the three months ended June 30, 2011, the fair values of our conversion option and warrant liabilities increased by $1,869,994 compared to an increase in their fair value of $2,786,132 for the three months ended June 30, 2010. For the six months ended June 30, 2011, the fair values of our conversion option and warrant liabilities increased by $3,710,618 compared to an increase of $1,157,088 for the comparable period in 2010. The increase in fair value in 2011 is mainly due to substantially increased volatilities during the period than those calculated in 2010. In 2010, our stock price increased from $0.17 at December 31, 2009 to $0.18 at March 31, 2010 and $0.28 at June 30, 2010, resulting in an increase in the fair values of our derivatives in 2010. This increase was partially offset by a decrease in volatilities ranging from 141% to 178% at December 31, 2009 to volatilities ranging from 108% to 148% at June 30, 2010.

Amortization of the discount on convertible debt was $24,494 for the three months ended June 30, 2011 as compared to $590,473 for comparable period in 2010. Amortization of the discount on convertible debt was $184,082 for the six months ended June 30, 2011 as compared to $1,638,372 for the comparable period in 2010. The decreases resulted primarily from all of the notes except the July 2010 Note becoming fully amortized by December 31, 2010. Additionally, in the second quarter of 2011, the note holders no longer allowed the Company to add the accrued interest payable to the principal balance of the Notes. Since all of the Notes, except the July 2010 Notes were past due, the increase in the fair value of the conversion feature due to the increased principal was being amortized immediately through March 31, 2011. During the three months ended June 30, 2011, the principal balance of the Notes did not increase and consequently, additional amortization expense was not recorded.

Interest expense increased by 6% for the three and six months ended June 30, 2011 as compared to the comparable periods in 2010. The slight increase is attributable to the July 2010 Note entered into in the third quarter of 2010 and increase principal balances due to the addition of accrued interest added to principal through March 31, 2011.

Miscellaneous income increased to $525,065 for the three and six months ended June 30, 2011 from $86,619 for the comparable periods in 2010. In both 2011 and 2010, miscellaneous income resulted from the write-off of liabilities accrued in prior years to their ultimate settlement amounts.

Liquidity and Capital Resources

Our independent registered public accounting firm has qualified their opinion with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2010 and 2009. Reports of independent registered public accounting firms questioning a company's ability to continue as a going concern generally are viewed very unfavorably by analysts and investors. There are a number of risks and challenges associated with such a qualified report including, but not limited to, a significant impediment to our ability to raise additional capital or seek financing from entities that will not conduct such transactions in the face of such increased level of risk of insolvency and loss, increased difficulty in attracting talent and the diversion of the attention of executive officers and other key employees to raising capital or financing rather than devoting time to the day-to-day operations of our business. We urge potential investors to review the report of our independent registered public accounting firm included in the Company’s annual report on Form 10-K for the year ended December 31, 2010 and our consolidated financial statements and related notes beginning on page F-1 of this Report, the cautionary statements included in the “Risk Factors” section under Item 1A of this Report and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us, or to maintain an investment in us.

For the years ended December 31, 2010 and 2009, we incurred net losses of $468,871 and $12,694,997, respectively. Since our inception, including the year ended December 31, 2010, we have realized negligible revenues and have financed our operations almost exclusively from cash on hand raised through the sale of our securities and borrowings. As of June 30, 2011, we had a deficit in working capital of $21,973,012, of which $10,647,766 related to the fair value of derivative financial instruments.

Throughout 2009 and 2010, the Company was not able to service any of its note debt in cash and all interest on the 2006, 2007 and 2008 notes was, with the approval of the note holders, added to the principal balances of the notes. Additionally, notes with an aggregate principal balance of $10,936,383 as of June 30, 2011 have now matured and are subject to repayment in full upon demand.. The July 2010 Note matured on July 31, 2011 and is subject to repayment in full upon demand. The Company does not have the funds to repay the July 2010 Note.

As mentioned before under the heading “Subsequent events” in this quarterly report the Company sold an exclusive right to its registered patents effective July 1, 2011 and on July 6, 2011, the noteholder provided the Company with notice of default on the notes payable and demanded repayment in full. On August 1, 2011 all of the Company’s remaining assets were sold during a public foreclosure sale leaving the Company without any rights to its intellectual property and without any assets.

2006, 2007 and 2008 Note Financings

On July 30, 2006, we entered into financing agreements with 3 accredited investors. On January 22, 2007, we subsequently entered into Amendment and Exchange Agreements with the same investors providing certain amendments to the July 30, 2006 agreements and increasing the total financing to $8,804,909. The 2006 Notes, as amended, are convertible into shares of the Company’s common stock at the lower of $0.43948 or the optional conversion price, defined as 90% of the arithmetic average of the weighted-average prices of the common stock on each of the five consecutive trading days immediately preceding the applicable optional conversion/redemption date. In the aggregate, we issued series L-1 warrants to purchase an aggregate of 22,754,163 shares of common stock, series L-2 warrants to purchase an aggregate of 7,281,332 shares of common stock, series M-1 warrants to purchase an aggregate of 7,395,103 shares of common stock and series M-2 warrants to purchase an aggregate of 2,366,433 shares of common stock. All these warrants have a strike price of $0.43948. The Company received aggregate gross proceeds from these financings of $6.6 million. These notes bear interest at 9.25% per annum, which increases to 15% in case of a default. The entire outstanding principal balance of $4,987,137 as of June 30, 2011, including any outstanding fees or interest, is currently due and payable in full since the original maturity date of the notes was July 31, 2008.

On July 31, 2007, we entered into a financing agreement with the same investors involved in the June 2006 and January 2007 financings for total gross proceeds of $3.5 million for the issuance of senior secured convertible notes in the aggregate principal amount of $3.5 million, series N warrants to purchase up to an aggregate of 7,000,000 shares of the Company’s common stock (includes dilution from the April 1, 2008 financing), series O warrants to purchase up to an aggregate of 4,550,000 shares of the Company’s common stock (includes dilution from April 2008 financing) and series P warrants to purchase up to an aggregate of 3,000,000 shares of common stock (includes dilution from April 2008 financing). The agreement also granted the investors a first priority perfected security interest in all of our assets. The secured notes bear interest at 9.25% per annum, which may be increased to 15% in case of default. The initial fixed conversion price of the note was $1.20 but was reduced to $0.50 per share in April 2008. The July 2007 Notes are convertible into shares of the Company’s common stock at the lower of $0.50 or the optional conversion price, defined as the lower of (i) 90% of the arithmetic average of the lowest weighted-average price of the common stock during the fifteen consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date and (ii) 90% of the arithmetic average of the lowest weighted average price of the common stock during any three consecutive trading day period during the fifteen consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date. The strike price for the N, O and P warrants was initially $1.20 but was reduced to $0.50 in April 2008. The N and P warrants were immediately exercisable. The O warrants become exercisable on a mandatory conversion called by the Company. The entire outstanding principal of $3,084,046 at June 30, 2011, including any outstanding fees or interest, is currently due and payable in full since the notes matured on August 1, 2010.

On April 1, 2008, we entered into a financing agreement with the same investors involved in the previous financings. For total gross proceeds of $3.125 million, we issued senior secured convertible notes in the aggregate principal amount of $3.125 million, series Q warrants to purchase up to an aggregate of 6,250,000 shares of the Company’s common stock and 3,125,000 shares of our common stock. The agreement grants the investors a first priority perfected security interest in all of the Company’s assets. The notes bear interest at 10% per annum, which may be increased to 15% in the event of default. The April 2008 Notes are convertible into shares of the Company’s common stock at the lower of $1.00 or the optional conversion price, defined as the lower of (i) 85% of the arithmetic average of the weighted-average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date (“measuring period”) and (ii) 85% of the arithmetic average of the weighted average price of the common stock during the first three consecutive trading day period of such measuring period and (iii) the arithmetic average of the weighted average price of the common stock during the last three consecutive trading day period of such measuring period. The Q warrants initially carried a strike price of $1.00 that was reduced to $0.50 in July 2008 and were immediately exercisable. The entire outstanding principal balance of $2,288,392 at June 30, 2011, including any outstanding fees and interest is currently due and payable in full since the maturity date was March 31, 2010.

On July 28, 2008 we entered into a financing agreement with the same investors involved in the 2006, 2007 and April 2008 financings. For total gross proceeds of $1.25 million, we issued senior secured convertible notes in the aggregate principal amount of $1.25 million, series R warrants to purchase up to an aggregate of 2,500,000 shares of the Company’s common stock and 1,250,000 shares of the Company’s common stock. The agreement grants the investors a first priority perfected security interest in all of the Company’s assets. The notes bear interest at 10% per annum, which may be increased to 15% in the event of default. The July 2008 notes are convertible into shares of the Company’s common stock at the lower of $1.00 or the optional conversion price, defined as the lower of (i) 85% of the arithmetic average of the weighted-average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date and (ii) 85% of the arithmetic average of the weighted average price of the common stock during the three lowest trading days with the lowest weighted average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date. The R warrants carry a strike price of $0.50 per share and are immediately exercisable. The entire outstanding principal balance of $576,808 at June 30, 2011 including any outstanding fees or interest, is currently due and payable in full since the maturity date was July 28, 2010.

During July 2011, the note holders of all of the above notes demanded repayment of all principal and accrued interest. The Company was unable to make the payment and, as a result, the note holders foreclosed on substantially all of the Company’s assets on August 1, 2011.

July 2010 Note Financing

On July 27, 2010, pursuant to the terms of a securities purchase agreement with one of our investors involved in the previous financings, we issued an unsecured convertible note payable in the principal amount of $176,471. We received net proceeds of $150,000 from the note as explained below.

The note bears interest at 15% per annum, which may be increased to 21% upon the occurrence of an event of default, and matures on July 27, 2011. This date may be extended, at the option of the investor, by up to two years. Interest on the notes of $26,471, representing one year of interest, was prepaid to the investors at the closing.

The 2010 note is convertible into shares of the Company’s common stock at the lower of $1.00 or the optional conversion price, defined as the lesser of (i) 85% of the arithmetic average of the weighted-average price of the common stock for the 30 consecutive trading days immediately preceding the conversion date and (ii) 85% of the arithmetic average of the weighted-average price of the common stock for the 3 lowest trading days during the 30 consecutive trading days immediately preceding the conversion date. However, following the disclosure of a SEC event, as defined in the 2010 Notes, the conversion price will be computed using the lowest of (i) 50% of the amounts determined as above; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.

If there is an event of default or a fundamental transaction as defined in the agreement, the investors have the right to redeem all or any portion of the 2010 note, at the greater of (i) up to 125% of the sum of the outstanding principal, interest and late fees, depending on the nature of the default, and (ii) the product of (a) the greater of (1) the closing sale price for the Company’s common stock on the date immediately preceding the event of default, (2) the closing sale price for the Company’s common stock on the date immediately after the event of default and (3) the closing sale price for the Company’s common stock on the date an investor delivers its redemption notice for such event of default, multiplied by (b) 200% of the number of shares into which the Note (including all principal, interest and late fees) may be converted.

The conversion price of the note is subject to customary anti-dilution provisions for stock splits and the like, and are also subject to full-ratchet anti-dilution protection such that if the Company issues or is deemed to have issued certain securities at a price lower than the then applicable conversion or exercise price, then the conversion or exercise price will immediately be reduced to such lower price.

The note contains certain limitations on conversion or exercise, including that a holder of those securities cannot convert or exercise those securities to the extent that upon such conversion or exercise, that holder, together with the holder’s affiliates, would own in excess of 4.99% of the Company’s outstanding shares of common stock (subject to an increase upon at least 61-days’ notice, by the investor to the Company, of up to 9.99%).

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

On July 31, 2011, the July 2010 Note matured and the Company did not repay the principal due to lack of funds.

Conclusion on Capital Resources and Liquidity

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

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

ITEM 4T. CONTROLS AND PROCEDURES.

Our Chief Executive Officer and Chief Financial Officer (the principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of June 30, 2011, that the design and operation of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated, recorded, processed, summarized and reported to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding whether or not disclosure is required.

During the quarter ended June 30, 2011 there were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

On October 2, 2008, the Company returned the keys of its previous operating facility to the landlord (PS Business Parks LP) and formally rendered possession of the facility to the landlord. The Company paid the rent for September 2008 but made no further rental payments upon vacating the facility. The remaining lease term ran through July 2009. On April 8, 2009, PS Business Parks LP filed a civil lawsuit in the Superior Court of California, County of Orange, case number 00121225, alleging breach of contract under the lease agreement with the Company.

In November 2009, we settled the matter for $216,000, plus simple interest at 10 percent per annum until such amount is paid in full. We paid $7,000 on the date of the agreement. Beginning January 15, 2010 and continuing through January 15, 2012, we will make monthly payments of $9,000. A final payment of $6,106 is due by February 15, 2012.

On July 25, 2011, the Company entered into another settlement agreement with the landlord for one final payment of $40,000. The balance due on the lease on the settlement date was $75,040. Accordingly, the Company recorded a gain on the settlement of the lease of $35,040 in the third quarter of 2011.

From time to time, we may be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination or breach of contract actions incidental to the operation of our business. Except as referred to above, we are not currently involved in any litigation which we believe could have a materially adverse effect on our financial condition or results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

See Form 8-K filed on August 4, 2011.

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

None.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

Exhibits

Exhibit Number		Description

10.1		Disclosures re entering into an agreement with California Capital Equity L.L.C. re the granting of an exclusive license of the Company’s intellectual property (incorporated herein by reference to a Form 8-K filed with the SEC on July 11, 2011.
10.2		Disclosure re completion of an acquisition of the Company’s assets by California Capital Equity L.L.C. (incorporated herein by reference to a Form 8K filed with the SEC on August 4, 2011).
31.1x		Certification of the Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2x		Certification of the Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1x		Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2x		Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

x Filed Herewith

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	RAPTOR NETWORKS TECHNOLOGY, INC.

Date: October 13, 2011	By:	/s/ Thomas M. Wittenschlaeger
		Thomas M. Wittenschlaeger
		Chief Executive Officer
		(principal executive officer)

Date: October 13, 2011	By:	/s/ Bob van Leyen
		Bob van Leyen
		Chief Financial Officer and Secretary
		(principal financial and accounting officer)

EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-Q

31.1	Certification of the Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of the Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Fonon Corp - FORM 10-Q - October 13, 2011

Attached files

Fonon Corp Reports