Filed Pursuant to Rule 424(b)(3) Registration Statement No. 333-131184 PROSPECTUS RAPTOR NETWORKS TECHNOLOGY, INC. 27,575,824 SHARES OF COMMON STOCK An aggregate of 21,033,457 issued and outstanding shares of our common stock and an aggregate of 6,542,367 shares of our common stock underlying outstanding warrants are being offered for resale under this prospectus by some of our security holders identified in this prospectus for their own accounts. We will not receive any of the proceeds from the sale of shares by the selling security holders. Our common stock currently trades on the OTC Bulletin Board Market under the symbol "RPTN." On April 7, 2008, the high and low sale prices for a share of our common stock were $0.78 and $0.75, respectively. Our principal offices are located at 1241 E. Dyer Road, Suite 150, Santa Ana, California 92705 and our telephone number is (949) 623-9300. ------------------------ INVESTING IN OUR COMMON STOCK INVOLVES SUBSTANTIAL RISKS. PLEASE SEE "RISK FACTORS" BEGINNING ON PAGE 5. ------------------------ You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THOSE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THOSE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. THE DATE OF THIS PROSPECTUS IS MAY 22, 2008. 1 TABLE OF CONTENTS Description Page No. - ----------- -------- PROSPECTUS SUMMARY...........................................................3 RISK FACTORS.................................................................5 USE OF PROCEEDS.............................................................15 PRICE RANGE OF COMMON STOCK.................................................15 CAPITALIZATION..............................................................16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................................................17 BUSINESS....................................................................30 MANAGEMENT..................................................................39 EXECUTIVE COMPENSATION AND RELATED INFORMATION..............................42 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................48 PRINCIPAL STOCKHOLDERS......................................................49 SELLING SECURITY HOLDERS....................................................51 PLAN OF DISTRIBUTION........................................................79 DESCRIPTION OF CAPITAL STOCK................................................82 LEGAL MATTERS...............................................................83 EXPERTS.....................................................................83 WHERE YOU CAN FIND MORE INFORMATION.........................................85 INDEX TO FINANCIAL STATEMENTS............................................. F-1 2 PROSPECTUS SUMMARY TO FULLY UNDERSTAND THIS OFFERING AND ITS CONSEQUENCES TO YOU, YOU SHOULD READ THE FOLLOWING SUMMARY ALONG WITH THE MORE DETAILED INFORMATION AND OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. IN THIS PROSPECTUS, THE WORDS "WE," "US," "OUR" AND SIMILAR TERMS REFER TO RAPTOR NETWORKS TECHNOLOGY, INC. UNLESS THE CONTEXT PROVIDES OTHERWISE. OUR COMPANY We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. We originally were engaged in the business of offering EDGAR filing services to companies outsourcing the formatting and electronic filing of registration statements, periodic reports and other forms with the U. S. Securities and Exchange Commission ("SEC" or "Commission"), but generated minimal revenues from these operations. On October 17, 2003, we completed a business combination transaction with Raptor Networks Technology, Inc., a California corporation ("Raptor"). We acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary. With completion of the acquisition transaction, we changed our name to Raptor Networks Technology, Inc., terminated our EDGAR filing services operations and, by and through our subsidiary Raptor, became engaged in the data network switching industry, including the design, production, sales and service of standards-based and proprietary high-speed switching technology applied to sophisticated inter-networking systems, operating in a large variety of new and existing government and private sector network systems. We continue to be in the early stages of commercial operations and have realized minimal revenues as of April 7, 2008. We have designed a series of related products branded the Ether-Raptor line, which consists of a modular set of Ethernet switching components based on a common set of proprietary hardware and software modules which can be produced with line cards from base units. We believe that our Ether-Raptor family of products have nearly universal application to a user's internetworking requirements and can be utilized anywhere on an ethernet network where an advanced switch is required. Our first product, the ER-1010, enables an entire network to be architected from common, high performance building blocks. The patent-pending scalable switch architecture of the ER-1010 reduces inter-network disconnects and moves data at very high speeds. This topology improves redundancy, keeps latency low, engenders wirespeed performance, has simple management, is scalable and is priced lower than chassis-based alternatives. In March 2008, we made available an advanced version of the ER-1010, the ER-1010E. For additional information regarding the ER-1010, ER-1010E and our other products, please see our discussion under the caption "Business" beginning on page 30 of this prospectus. Our principal headquarters are located at 1241 E. Dyer Road, Suite 150, Santa Ana, California 92705 and our phone number is 949-623-9300. Our Internet address is www.raptor-networks.com. 3 THE OFFERING Common stock offered by selling security holders 27,575,824 (1) Common stock outstanding prior to this offering 68,167,374 (2) Common stock outstanding following this offering if all shares are sold 74,709,741 (1)(2) Use of Proceeds All proceeds of this offering will be received by selling security holders for their own accounts. Risk Factors You should read the "Risk Factors" section beginning on page 5, as well as other cautionary statements throughout this prospectus, before investing in shares of our common stock. - ------------- (1) Includes 6,542,367 shares of common stock issuable upon exercise of outstanding warrants. (2) As of April 7, 2008, a total of 68,167,374 shares of our common stock were outstanding, excluding: o 6,542,367 shares of common stock issuable upon exercise of warrants whose underlying shares of common stock are covered by this prospectus; and o approximately 94,907,287 shares of common stock issuable or to become issuable upon exercise or conversion of outstanding warrants, options, and convertible notes, other than the shares of common stock underlying the warrants whose underlying shares are registered for resale under this prospectus. 4 RISK FACTORS AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE DECIDING TO INVEST IN SHARES OF OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, IT IS LIKELY THAT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS WOULD BE HARMED. AS A RESULT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE PART OR ALL OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS OUR INDEPENDENT AUDITORS HAVE ISSUED A REPORT QUESTIONING OUR ABILITY TO CONTINUE AS A GOING CONCERN. THIS REPORT MAY IMPAIR OUR ABILITY TO RAISE ADDITIONAL FINANCING AND ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK. Our independent auditors have qualified their opinion with respect to our 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, 2007. Reports of independent auditors 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 our 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 certified public accountants and our consolidated financial statements and related notes beginning on page F-1 of this prospectus and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us. 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 financial statements and financial information included in this prospectus do not reflect any adjustments that might be necessary if we are unable to continue as a going concern. OUR SUBSTANTIAL ACCUMULATED DEFICIT, LIMITED WORKING CAPITAL AND EXPECTATION OF FUTURE LOSSES MAY REQUIRE THAT WE OBTAIN ADDITIONAL FINANCING TO CONTINUE OPERATIONS, WHICH WE MAY NOT BE ABLE TO SECURE ON ACCEPTABLE TERMS, IF AT ALL. We are an early stage company and have had no significant revenues from operations to date. As of December 31, 2007, we had an accumulated deficit of $70,198,322. We have operated at a loss since our inception and expect to continue to experience losses from our operations for the foreseeable future. Our net losses for fiscal 2007 and 2006 were $9,509,247 and $19,078,578, respectively. We will be required to conduct product feature enhancement and testing activities which, together with expenses to be incurred for the establishment of a sustainable marketing and sales presence and other general and administrative expenses, are expected to result in operating losses through the foreseeable future. Accordingly, there is a risk that we will not achieve profitable operations in the near future, if at all. Our management has attempted and continues to attempt to address these conditions by obtaining additional debt and equity financing to fund our continuing operations. In July 2007, we raised gross proceeds of $3.5 million through a senior secured convertible note financing. In April 2008, we raised an additional $3.125 million in gross proceeds from an additional convertible note financing with the same investors. We believe these capital raises provide sufficient funding for our operations into August 2008. There can be no assurance, however, that additional funding needs will not develop sooner or that sufficient revenues will be generated thereafter to fund our operating requirements. 5 We currently have no commitments for any additional financing. In addition, the terms of our 2006, 2007 and 2008 convertible note financings subject us to financial and other covenants that significantly restrict our flexibility to conduct future securities offerings and incur debt. There can be no assurance that we will be able to obtain requisite financing on acceptable terms, if at all. Should we be unable to raise additional capital, our investors could lose their entire investment. Moreover, in the event we raise additional funds through the sale of shares of our common stock or other interests in us, our investors may experience significant dilution of their equity invested in us. IF WE DEFAULT UNDER OUR SENIOR SECURED CONVERTIBLE NOTES, WE COULD LOSE ALL OF OUR ASSETS. Pursuant to our July 2007 and April 2008 senior secured convertible note financings, we granted the investors a security interest in all of our assets. If we default on our obligations relating to these notes, the investors could foreclose on all of our assets, both tangible and intangible, leaving us with no assets. WE HAVE NO PROFITABLE OPERATING HISTORY AND MAY NEVER ACHIEVE PROFITABILITY. We are an early stage company and have a limited history of operations and have not generated meaningful revenues from operations since our inception. We are faced with all of the risks associated with a company in the early stages of development. Our business is subject to numerous risks associated with a relatively new, low-capitalized company engaged in the network switch industry. Such risks include, but are not limited to, competition from well-established and well-capitalized companies, technological obsolescence and unanticipated difficulties regarding the development and marketing of our products. There can be no assurance that we will ever generate significant commercial sales or achieve profitability. Should this be the case, investors in our common stock or other securities could lose their entire investment. WE DO NOT PRESENTLY HAVE A TRADITIONAL CREDIT FACILITY WITH A FINANCIAL INSTITUTION. THIS ABSENCE MAY ADVERSELY IMPACT OUR OPERATIONS. We do not presently have a traditional credit facility with a financial institution. The absence of a traditional credit facility could adversely impact our operations. If adequate funds are not otherwise available, we may be required to delay, scale back or eliminate portions of our operations and product development efforts. In addition, the terms of our senior convertible note financings subject us to certain covenants that prohibit us from borrowing additional funds unless certain conditions are satisfied, including, but not limited to, the closing price of our common stock being greater than $1.00 per share for 40 consecutive trading days or the aggregate dollar trading volume of our common stock being greater than $200,000 per day for 40 consecutive trading days. Further, the terms of our July 2007 and April 2008 senior secured convertible note financings provide that, while the notes are outstanding, we will not conduct any other securities offerings or be party to any solicitations, negotiations or discussions regarding any other securities offerings, except for offerings solely to one or more of the investors. OUR LEVEL OF INDEBTEDNESS REDUCES OUR FINANCIAL AND OPERATIONAL FLEXIBILITY, AND OUR LEVEL OF INDEBTEDNESS MAY INCREASE. As of April 7, 2008, the principal amount of our total indebtedness under promissory notes was $12,722,434. Our level of indebtedness affects our operations in several ways, including the following: o A significant portion of our cash flow may be required to service our indebtedness; o A high level of debt increases our vulnerability to general adverse economic and industry conditions; o The covenants contained in the agreements governing our outstanding indebtedness significantly limit our ability to borrow additional funds, dispose of assets, pay dividends, sell common stock and make certain investments; o Our debt covenants may also affect our flexibility in planning for, and reacting to, changes in the economy or in our industry; o A high level of debt may impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes; and 6 o A default under our debt covenants could result in required principal payments that we may not be able to meet, resulting in higher penalty interest rates, debt maturity acceleration and/or foreclosure on our assets. We may incur additional debt, including significant secured indebtedness, in order to fund our continuing operations or to develop and/or improve our products. A higher level of indebtedness increases the risk that we may default on our debt obligations. Our ability to meet our debt obligations and to reduce our level of indebtedness depends on our future performance. General and industry specific economic, financial and business conditions and other factors affect our operations and our future performance. Many of these factors are beyond our control. We may not be able to generate sufficient cash flow to fulfill our interest or principal payment obligations on our debt and future working capital, borrowings or equity financing may not be available to pay or refinance such debt. THERE IS A RISK THAT THERE MAY BE PROCEDURAL ISSUES RELATED TO OUR ACQUISITION OF RAPTOR NETWORKS TECHNOLOGY, INC., A CALIFORNIA CORPORATION, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. On October 17, 2003, we completed a transaction with Raptor Networks Technology, Inc., a California corporation ("Raptor"), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary. With the completion of the acquisition transaction, we changed our name to Raptor Networks Technology, Inc., terminated our previous operations (consisting of the "EDGARization" of SEC securities filings) and, by and through our subsidiary Raptor, became engaged in the data network switching industry. After the transaction, our Board of Directors engaged new management to, among other things, review our operating and legal status. As a result of management's review of our historical corporate records, it appears that certain material documents and approvals regarding the transaction were not properly retained. Furthermore, it appears that, from a review of the records available to us, certain procedural irregularities may exist regarding the structure and approval of the acquisition transaction under applicable law. After a review of available documents and records relating to the acquisition transaction, Colorado counsel engaged by us has determined that the shares issued in the transaction were lawfully issued. However, there is a risk, given the lack of complete records regarding the transaction, that the acquisition was not properly structured or approved. The inability to resolve such deficiencies, should such deficiencies exist, could have a material adverse effect on our business, financial condition and results of operations. Furthermore, there is a risk that we may be subject to currently unknown liabilities resulting from our operations, or the operations of Raptor, prior to the acquisition transaction. Should a claimed liability arise, we could expend significant time and resources defending or satisfying such claim, including, without limitation, the amount of any judgment or settlement required to satisfy any such claim and the payment of attorneys' fees and other costs incurred in defending any such claim. EVALUATION OF INTERNAL CONTROL AND REMEDIATION OF POTENTIAL PROBLEMS MAY BE COSTLY AND TIME CONSUMING AND COULD EXPOSE WEAKNESSES IN FINANCIAL REPORTING. Our independent auditors will be required to confirm in writing whether management's assessment of the effectiveness of the internal control over financial reporting is fairly stated in all material respects, and separately report on whether they believe management maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008. This process may be expensive and time consuming, and may require significant attention of management. Management can give no assurance that material weaknesses in internal controls will not be discovered. If a material weakness is discovered, corrective action may be time consuming, costly and further divert the attention of management. The disclosure of a material weakness, even if quickly remedied, could reduce the market's confidence in our financial statements and harm our stock price, especially if a restatement of financial statements for past periods is required. 7 OUR INABILITY TO SUCCESSFULLY ACHIEVE SUSTAINABLE MARKET PENETRATION COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION. No assurance can be given that we will be able to successfully achieve sustainable market penetration with any of our products. Our success in marketing our products will be substantially dependent on educating our targeted markets as to the unique topologies, as well as what we believe are the performance and cost benefits, of our distributed Ethernet switch architecture. There can be no assurance that our efforts or the efforts of others will be successful in fostering acceptance of our technology among the targeted markets. MANY COMPANIES WITH GREATER RESOURCES AND OPERATING EXPERIENCE OFFER TECHNOLOGY SIMILAR TO OUR PRODUCTS. THESE COMPANIES COULD SUCCESSFULLY COMPETE WITH US AND NEGATIVELY AFFECT OUR OPPORTUNITY TO ACHIEVE PROFITABILITY. We operate in a competitive industry with many established and well-recognized competitors. In particular, Cisco Systems maintains a dominant position in our industry and several of its products compete directly with our products. We also compete with Extreme Networks, Juniper Networks, Nortel Networks, Enterasys Networks, 3Com, Huawei Technologies, Force 10 Networks, and Alcatel, among others. Most of our competitors (including all of the competitors referenced above) have substantially greater market leverage, distribution networks, and vendor relationships, longer operating histories and industry experience, greater financial, technical, sales, marketing and other resources, more name recognition and larger installed customer bases than we do and can be expected to react strongly to our marketing efforts. In addition, many competitors exist who, because of their substantial resources, distribution relationships and customer base, could temporarily drop prices to stave off a potential successful market launch by us. Other competitive responses might include, without limitation, intense and aggressive price competition and offers of employment to our key marketing or management personnel. There can be no assurance that we will be successful in the face of increasing competition from existing or new competitors, or that competition will not have a material adverse effect on our business, financial condition and results of operations. OUR MARKETING EFFORTS HAVE YIELDED NEGLIGIBLE REVENUES AND THERE CAN BE NO ASSURANCE THAT OUR FUTURE MARKETING EFFORTS WILL LEAD TO SALES OF OUR PRODUCTS. Our marketing efforts have yielded negligible revenues and we believe we will have to significantly expand our sales and marketing capabilities in order to establish sufficient awareness to launch broader sales of our products and support services. There can be no assurance that we will be able to expand our sales and marketing efforts to the extent we believe necessary or that any such efforts, if undertaken, will be successful in achieving substantial sales of our products or support services. THE INDUSTRY OF NETWORK SWITCH PRODUCTS IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE. OUR PRODUCTS COULD BECOME OBSOLETE AT ANY TIME AND OUR LIMITED CAPITAL PROHIBITS US FROM DEVOTING A SIGNIFICANT AMOUNT OF RESOURCES TO RESEARCH AND DEVELOPMENT. Evolving technology, updated industry standards, and frequent new product and service introductions characterize the network switching market. Our current products could become obsolete at any time. Competitors could develop products similar to or better than ours, finish development before us, or market their products more successfully than ours, any of which could hinder our potential success. In order to be competitive, we must continue to develop and bring to market new products that offer substantially greater performance and support a greater number of users, all at lower price points than our competitors. Our future success depends in significant part on our ability to evolve the performance and software of our existing products and develop and introduce new products and technologies in response to the evolving demands of the market and competitive product offerings. However, unless we are able to raise additional capital or significantly increase revenues, we will not be able to devote a significant amount of resources to research and development, which could increase the likelihood that our current products become obsolete and prevent us from developing new products to keep up with the industry's rapid technological advancements. BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS, MISAPPROPRIATION OF THOSE RIGHTS OR CLAIMS OF INFRINGEMENT OR LEGAL ACTIONS RELATED TO INTELLECTUAL PROPERTY COULD ADVERSELY IMPACT OUR FINANCIAL CONDITION. Our success is dependent on our ability to protect our proprietary technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the U.S. We currently have patent-pending protection for our proprietary technology and plan to rely on non-disclosure 8 agreements to further protect this technology. There can be no assurance that these patents will be granted or that nondisclosure agreements will provide us meaningful protection. In addition, the network industry is subject to frequent claims and related litigation regarding patent and other intellectual property rights. In particular, some companies in the network industry claim extensive patent portfolios. As a result of the existence of a large number of existing patents and the rate of issuance of new patents in the network industry, it is extremely difficult to determine in advance whether a product or any of its components may infringe upon the intellectual property rights claimed by others. Third parties may in the future assert patent, copyright, trademark and other intellectual property rights claims against us with respect to existing or future products or technology. Regardless of the merits of our position, we may incur substantial legal fees and related costs defending against third party claims, in addition to monetary damages that may be assessed against us. If there is a successful claim of infringement and we fail or are unable to develop non-infringing technology or license the infringed or similar technology on a timely basis, our business and results of operations may be seriously harmed. WE RELY HEAVILY ON OUR MANAGEMENT AND OTHER KEY PERSONNEL, AND THE LOSS OF THEIR SERVICES (OR OUR INABILITY TO RECRUIT AND RETAIN ADDITIONAL QUALIFIED EMPLOYEES) COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS. Our future success depends to a significant degree on the continued service of our key personnel and on our ability to attract, motivate and retain highly qualified employees. In particular, we are dependent upon the services of our senior management, including, without limitation: Chief Executive Officer and President, Thomas M. Wittenschlaeger; and Chief Financial Officer and Secretary, Bob van Leyen. The loss of the services of our senior management or other key employees would have a material adverse effect on our business, financial condition and results of operations. In addition, there are a number of other key management, sales and support positions (including many for which individuals have not yet been hired) the loss of which (or the inability to recruit and retain) would have a material adverse effect on our business. If we experience the growth we hope to achieve, our ability to operate successfully during periods of growth (if any) will depend on our ability to attract and retain managers and develop adequate systems and procedures to manage such growth. There can be no assurance that we will be able to attract and retain additional key management personnel with the skills and expertise necessary to manage our business should any such period of growth occur. OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN COMPONENTS, SOFTWARE AND SERVICES FROM OUTSIDE SUPPLIERS AND VENDORS. Our products are architected and manufactured through the use of third-party electronic components, device level software and services. We are highly dependent on the services and products of these other companies. A discontinuance, disruption or other similar occurrence to the components, software or services supplied by our vendors and suppliers could materially diminish our ability to operate efficiently. We acquire components through purchase orders and have no long-term commitments regarding supply or pricing from these suppliers. We depend on anticipated product orders to determine our material requirements. If orders for our products do not match forecasts, or if we do not manage inventory effectively, we may have either excess or insufficient inventory of materials and components, which could negatively affect our operating results and financial condition. OUR RELIANCE ON THIRD-PARTY MANUFACTURING VENDORS TO MANUFACTURE OUR PRODUCTS MAY CAUSE A DELAY IN OUR ABILITY TO FILL ORDERS. We subcontract a significant amount of our manufacturing to one third-party manufacturer and may in the future subcontract with other third-party manufacturers. In addition, some Company-branded products are manufactured by third-party original equipment manufacturers ("OEMs"). We may experience delays in product manufacturing and shipments from our manufacturers, which in turn could delay product shipments to our customers. In addition, we may experience problems such as inferior manufacturing quality or failure to manufacture products according to specifications, any of which could have a material adverse effect on our business and operating results. In the event we introduce new products or product enhancements, we may be required to rapidly achieve volume production by coordinating our efforts with suppliers and manufacturers. The inability of our manufacturers or OEMs to provide us with adequate supplies of high-quality products, the loss of any of our third-party manufacturers, or the inability to obtain components and raw materials could cause a delay in our ability to fulfill orders. 9 THE AVERAGE SELLING PRICES OF OUR PRODUCTS, AND OUR GROSS MARGINS RESULTING FROM THE SALE OF SUCH PRODUCTS, MAY DECLINE AS A RESULT OF COMPETITIVE PRESSURES, INDUSTRY TRENDS AND OTHER FACTORS. The network industry has experienced an erosion of the average product selling prices due to a number of factors, particularly competitive and macroeconomic pressures and rapid technological advancements. Our competitors have and will likely continue to lower sales prices from time to time in order to gain market share or create more demand. We may have to reduce the sales prices of our products in response to such intense pricing competition, which could cause our gross margins to decline and may adversely affect our business, operating results and financial condition. Our gross margins could also be adversely affected if we are unable to reduce manufacturing costs and effectively manage our inventory levels or by fluctuations in manufacturing volumes, component costs, the mix of products sold and the mix of distribution channels through which our products are sold. IF OUR PRODUCTS CONTAIN DEFECTS OR ERRORS, WE COULD INCUR SUDDEN AND SIGNIFICANT EXPENSES AND LOST SALES AND BE SUBJECT TO PRODUCT LIABILITY CLAIMS. Our products are complex and may contain undetected defects or errors, particularly when first introduced or as new enhancements and versions are released. Despite our testing procedures, these defects and errors may be discovered after they have been shipped to customers. Any defects or errors in our products or failures of our customers' networks, regardless of whether the failure is caused by our products, could result in: o negative customer reactions; o product liability claims; o negative publicity regarding us and our products; o delays in or loss of market acceptance of our products; o product returns; and o unexpected expenses to remedy defects or errors. OUR SUCCESS IS SUBSTANTIALLY DEPENDENT ON GENERAL ECONOMIC CONDITIONS AND BUSINESS TRENDS, PARTICULARLY IN THE INFORMATION TECHNOLOGY INDUSTRY, A DOWNTURN OF WHICH COULD ADVERSELY AFFECT OUR OPERATIONS. The success of our operations depends to a significant extent upon a number of factors relating to business spending. These factors include economic conditions such as employment rates and labor supply, general business conditions, cost of goods and materials, inflation, interest rates and taxation. Our business is affected by the general condition and economic stability of our customers as well as our vendors, suppliers and partners and their continued willingness to work with us in the future. Our business is particularly sensitive to information technology ("IT") spending patterns and preferences. There can be no assurance that IT spending will not be adversely affected by general business trends and economic conditions, thereby impacting our growth, net sales and profitability. OUR FAILURE TO MANAGE GROWTH EFFECTIVELY COULD IMPAIR OUR SUCCESS. In order for us to expand successfully, management will be required to anticipate the changing demands of a growth in operations, should such growth occur, and to adapt systems and procedures accordingly. There can be no assurance that we will anticipate all of the changing demands that a potential expansion in operations might impose. If we were to experience growth, we might be required to hire and train a large number of sales and support personnel, and there can be no assurance that the training and supervision of a large number of new employees would not adversely affect the high standards that we seek to maintain. Our future will depend, in part, on our ability to integrate new individuals and capabilities into our operations, should such operations expand in the future, and there can be no assurance that we will be able to achieve such integration. We will also need to continually evaluate the adequacy of our management information systems, including our website. Failure to upgrade our information systems or unexpected difficulties encountered with these systems during an expansion in our operations (should such an expansion occur) could adversely affect our business, financial condition and results of operations. 10 CHANGES IN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION, CASH FLOWS, REVENUE AND RESULTS OF OPERATIONS. We are subject to changes in and interpretations of financial accounting matters that govern the measurement of our performance. Based on our reading and interpretations of relevant guidance, principles or concepts issued by, among other authorities, the American Institute of Certified Public Accountants, the Financial Accounting Standards Board, and the United States Securities and Exchange Commission, our management believes that our current contract terms and business arrangements have been properly reported. However, there continue to be issued interpretations and guidance for applying the relevant standards to a wide range of contract terms and business arrangements that are prevalent in the industries in which we operate. Future interpretations or changes by the regulators of existing accounting standards or changes in our business practices could result in future changes in our revenue recognition and/or other accounting policies and practices that could have a material adverse effect on our business, financial condition, cash flows, revenue and results of operations. RISKS RELATED TO THIS OFFERING OUR COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK. The market prices of securities of technology-based companies (such as ours) currently are highly volatile. The market price of our common stock has fluctuated significantly in the past. During 2007, the high and low closing sale prices of a share of our common stock were $2.22 and $0.60, respectively. On April 7, 2008, the last reported sale price of a share of our common stock was $0.75. The market price of our common stock may continue to fluctuate in response to the following factors, in addition to others, many of which are beyond our control: o conversion of our convertible notes and exercise of our warrants and the sale of their underlying common stock; o changes in market valuations of similar companies and stock market price and volume fluctuations generally; o economic conditions specific to the network switching or related information technology industries; o announcements by us or our competitors of new or enhanced products, technologies or services or significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments; o delays in our introduction of new products or technological innovations or problems in the functioning of our current or new products or innovations; o third parties' infringement of our intellectual property rights; o changes in our pricing policies or the pricing policies of our competitors; o regulatory developments; o fluctuations in our quarterly or annual operating results; o additions or departures of key personnel; and o future sales of our common stock or other securities. The price at which you purchase shares of common stock may not be indicative of the price of our stock that will prevail in the trading market. You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you. Moreover, in the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert our management's attention and resources. 11 SHARES OF OUR COMMON STOCK ELIGIBLE, OR TO BECOME ELIGIBLE, FOR PUBLIC SALE COULD ADVERSELY AFFECT OUR STOCK PRICE AND MAKE IT DIFFICULT FOR US TO RAISE ADDITIONAL CAPITAL THROUGH SALES OF EQUITY SECURITIES. We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of common stock for sale will have on the market price prevailing from time to time. As of April 7, 2008, we had outstanding 68,167,374 shares of common stock, of which approximately 14,848,105 shares were restricted under the Securities Act of 1933, as amended (the "Securities Act"). As of April 7, 2008, we also had outstanding options, warrants, and convertible promissory notes that were exercisable for or convertible into approximately 101,449,654 shares of common stock, which if exercised or converted in full would cause the amount of our outstanding common stock to more than double. Sales of shares of our common stock in the public market, or the perception that sales could occur, could adversely affect the market price of our common stock. Any adverse effect on the market price of our common stock could make it difficult for us to raise additional capital through sales of equity securities at a time and at a price that we deem appropriate. THE CONVERSION OF CONVERTIBLE SECURITIES AND THE EXERCISE OF OUTSTANDING OPTIONS AND WARRANTS TO PURCHASE OUR COMMON STOCK COULD SUBSTANTIALLY DILUTE YOUR INVESTMENT, IMPEDE OUR ABILITY TO OBTAIN ADDITIONAL FINANCING, AND CAUSE US TO INCUR ADDITIONAL EXPENSES. Under the terms of existing notes convertible into our common stock, warrants to purchase our common stock, non compensatory options to acquire our common stock, and other outstanding options to acquire our common stock issued to employees and others, the holders thereof are given an opportunity to profit from a rise in the market price of our common stock that, upon the exercise of such warrants and/or options or conversion of such notes, could result in dilution in the interests of our other shareholders. The terms on which we may obtain additional financing may be adversely affected by the existence and potentially dilutive impact of such convertible notes, options and warrants. In addition, holders of certain convertible notes, options and warrants have registration rights with respect to the common stock underlying such convertible notes, options and warrants, the registration of which will cause us to incur a substantial expense. THE VOTING POWER AND VALUE OF YOUR INVESTMENT COULD DECLINE IF OUR CONVERTIBLE NOTES AND WARRANTS ARE CONVERTED AT A REDUCED PRICE DUE TO OUR ISSUANCE OF LOWER-PRICED SHARES OR MARKET DECLINES WHICH TRIGGER RIGHTS OF THE HOLDERS OF OUR CONVERTIBLE NOTES AND WARRANTS TO RECEIVE ADDITIONAL SHARES OF OUR STOCK. As part of our 2006, 2007 and 2008 senior convertible note financings, we issued a significant additional amount of convertible notes and warrants, the exercise or conversion of which could have a substantial negative impact on the price of our common stock and could result in a dramatic decrease in the value of your investment. The initial conversion price of some of our senior convertible notes is subject to market-price protection that may cause the conversion price of the notes to be reduced in the event of a downward fluctuation in the market price of our common stock. In addition, the initial conversion price of our convertible notes and the initial exercise price of a majority of our warrants will be subject to downward anti-dilution adjustments in most cases, from time to time, where we issue securities at a purchase, exercise or conversion price that is less than the then-applicable conversion price of our outstanding convertible notes or exercise price of our outstanding warrants. Consequently, the voting power and value of your investment in each such event would decline if our convertible notes or warrants are converted or exercised for shares of our common stock at the new lower price as a result of such declining market-price or sales of our securities are made below the conversion price of the notes and/or the exercise price of the warrants. The market-price protection feature of some of our senior convertible notes could also allow those notes to become convertible into a greatly increased number of additional shares of our common stock, particularly if a holder of the notes sequentially converts portions of the note into shares of our common stock at alternate conversion prices and resells those shares into the market. If a holder of the notes sequentially converts portions of the notes into shares of our common stock at alternate conversion prices and resells those shares into the market, then the market price of our common stock could decline due to the additional shares available in the market, particularly in light of the relatively thin trading volume of our common stock. Consequently, if a holder of the notes repeatedly converts portions of the notes at alternate conversion prices and then resells those underlying shares into the market, a continuous downward spiral of the market price of our common stock could occur that would benefit a holder of our senior convertible notes at the expense of other existing or potential holders of our common stock, potentially creating a divergence of interests between a holder of our senior convertible notes and investors who purchase the shares of common stock resold by a holder of the notes following conversion of the notes. 12 THE MARKET PRICE OF OUR COMMON STOCK AND THE VALUE OF YOUR INVESTMENT COULD SUBSTANTIALLY DECLINE IF OUR CONVERTIBLE NOTES, WARRANTS OR OPTIONS ARE CONVERTED INTO SHARES OF OUR COMMON STOCK AND RESOLD INTO THE MARKET, OR IF A PERCEPTION EXISTS THAT A SUBSTANTIAL NUMBER OF SHARES WILL BE ISSUED UPON CONVERSION OR EXERCISE OF OUR CONVERTIBLE NOTES, WARRANTS OR OPTIONS AND THEN RESOLD INTO THE MARKET. If the conversion prices at which the balances of our convertible notes, warrants and options are converted are lower than the price at which you made your investment, immediate dilution of the value of your investment will occur. In addition, sales of a substantial number of shares of common stock issued upon conversion of our convertible notes, warrants and options, or even the perception that such sales could occur, could adversely affect the market price of our common stock, which would mean that certain convertible notes would be convertible into an increased number of shares of our common stock in cases where, as described elsewhere in these risk factors, the conversion price is based upon a discount from the market price of our common stock. You could, therefore, experience a substantial decline in the value of your investment as a result of both the actual and potential conversion of our outstanding convertible notes, warrants or options. THE ISSUANCE OF SHARES UPON THE CONVERSION OF CONVERTIBLE NOTES AND THE EXERCISE OF OUTSTANDING OPTIONS AND WARRANTS COULD RESULT IN A CHANGE OF CONTROL OF OUR COMPANY. As of April 7, 2008, we had outstanding options, warrants, and convertible promissory notes that were exercisable for or convertible into approximately 101,449,654 shares of common stock. In addition, as discussed elsewhere in these Risk Factors, the number of shares exercisable under outstanding warrants and convertible under outstanding notes may be subject to increase in the event of our future issuance of securities or a downward fluctuation in the market price of our common stock. A change of control of our Company could occur if a significant number of shares are issued to the holders of our outstanding warrants or convertible notes. If a change of control occurs, then the stockholders who historically have controlled our Company would no longer have the ability to exert significant control over matters that could include the election of our directors, changes in the size and composition of our Board of Directors, and mergers and other business combinations involving our Company. Instead, one or more other stockholders could gain the ability to exert this type of control and may also, through control of our Board of Directors and voting power, be able to control certain decisions, including decisions regarding the qualification and appointment of officers, dividend policy, access to capital (including borrowing from third- party lenders and the issuance of additional equity securities), and the acquisition or disposition of our assets. IF WE ARE UNSUCCESSFUL IN MAINTAINING COMPLIANCE WITH OR MODIFYING OUR REGISTRATION OBLIGATIONS WITH REGARD TO OUR SENIOR CONVERTIBLE NOTES AND RELATED WARRANTS, WE MAY INCUR SUBSTANTIAL MONETARY PENALTIES. The registration rights agreements we entered into in connection with our 2006, 2007 and 2008 senior convertible note financings require us to, among other things, register for resale the shares of common stock issued or issuable under our senior convertible notes and the warrants issued by us in connection with those notes, and maintain the effectiveness of the registration for an extended period of time. We will be required to file a number of registration statements to ensure that all shares to be issued in connection with the convertible note financings will be registered. If we are unable to have any one of these registration statements declared effective by the SEC, or maintain effectiveness of the required registration statements, or to modify our registration obligations, then we may be required to pay liquidated damages in an amount up to approximately $263,000 on the date of such failure and on every 30th day thereafter until such failure is cured. The total liquidated damages payable by us for our failure to meet these filing and effectiveness requirements are capped at $1,653,125. The payment of liquidated damages would adversely affect our business, operating results, financial condition, and ability to service our other indebtedness by adversely affecting our cash flows. In addition, failure to meet our registration requirements may result in an event of default under the convertible notes. Among other things, upon an event of default the convertible note holders are entitled to demand that we immediately pay the entire principal balance of the notes in full, plus a significant cash redemption penalty beyond the full payment of such principal. If one or more of the note holders exercised their redemption rights upon an event of default, it would have a significant negative impact on our financial condition and would likely render us insolvent. In addition, upon an event of default of our 2007 and 2008 senior secured convertible notes, the holders are entitled to foreclose on all of our assets. If our assets were to be foreclosed upon, we would not be able to operate. 13 THE VOTING POWER OF YOUR INVESTMENT AND OUR EARNINGS PER SHARE WOULD BE SUBSTANTIALLY DILUTED IF ALL OR A SIGNIFICANT PORTION OF OUR CONVERTIBLE NOTES, WARRANTS OR OPTIONS WERE CONVERTED INTO SHARES OF OUR COMMON STOCK. If the aggregate number of shares of common stock underlying our convertible notes, warrants or options had been issued and outstanding as of this date, substantial dilution of the voting power of your investment and of our earnings per share would occur. BECAUSE WE ARE SUBJECT TO "PENNY STOCK" RULES, THE LEVEL OF TRADING ACTIVITY IN OUR COMMON STOCK MAY BE REDUCED. Our stock is listed on the Over the Counter Bulletin Board (OTC Bulletin Board) and constitutes "Penny Stock." Broker-dealer practices in connection with transactions in Penny Stocks are regulated by rules adopted by the SEC. Penny Stocks are generally equity securities with a price per share of less than $5.00 (other than securities registered on certain national exchanges). The Penny Stock rules require a broker-dealer, prior to a transaction in Penny Stocks not exempt from the rules, to deliver a standardized risk disclosure document that provides information about Penny Stocks and the nature and level of risks in the Penny Stock Market. The broker-dealer must also provide the customer with current bid and offer quotations for the Penny Stock, the compensation of the broker-dealer and the salesperson in the transaction, and monthly accounting statements showing the market value of each Penny Stock held in the customer's account. In addition, the broker-dealer must make a special written determination that the Penny Stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These requirements may have the effect of reducing the level of trading activity in a Penny Stock, such as our common stock, and investors in our common stock may find it difficult to sell their shares. BECAUSE OUR COMMON STOCK IS NOT LISTED ON A NATIONAL SECURITIES EXCHANGE, YOU MAY FIND IT DIFFICULT TO DISPOSE OF OR OBTAIN QUOTATIONS FOR OUR COMMON STOCK. Our common stock trades under the symbol "RPTN" on the OTC Bulletin Board. Because our stock trades on the OTC Bulletin Board, rather than on a national securities exchange, you may find it difficult to either dispose of, or to obtain quotations as to the price of, our common stock. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements, including statements concerning future conditions in the network switching industry, and concerning our future business, financial condition, operating strategies, and operational and legal risks. We use words like "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, to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as to our expectations as of the date of this prospectus. These forward-looking statements are subject to a number of risks and uncertainties, including those identified under "Risk Factors" and elsewhere in this prospectus. Although we believe that the expectations reflected in these forward-looking statements are reasonable, actual conditions in the network switching industry, and actual conditions and results in our business, could differ materially from those expressed in these forward-looking statements. In addition, none of the events anticipated in the forward-looking statements may actually occur. Any of these different outcomes could cause the price of our common stock to decline substantially. Except as required by law, we undertake no duty to update any forward-looking statement after the date of this prospectus, either to conform any statement to reflect actual results or to reflect the occurrence of unanticipated events. 14 USE OF PROCEEDS We will not receive any of the proceeds from the sale of the shares of common stock offered under this prospectus by the selling security holders. Rather, the selling security holders will receive those proceeds directly. PRICE RANGE OF COMMON STOCK MARKET INFORMATION Our $0.001 par value common stock trades under the symbol "RPTN" on the OTC Bulletin Board. The following table sets forth, for the quarters indicated, the high and low bid information for our common stock as reported by Pink Sheets, LLC, a research service that compiles quote information reported on the National Association of Securities Dealers composite feed or other qualified interdealer quotation medium. The quotations reflect inter-dealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions. Fiscal 2008 ------------------ Fiscal Quarter Ended: High Low -------- ------- March 31 $0.95 $0.68 Fiscal 2007 ------------------ Fiscal Quarter Ended: High Low -------- ------- December 31 $1.09 $0.60 September 30 $1.41 $0.84 June 30 $2.22 $1.19 March 31 $1.67 $0.71 Fiscal 2006 ------------------ Fiscal Quarter Ended: High Low -------- ------- December 31 $0.91 $0.27 September 30 $0.54 $0.27 June 30 $0.76 $0.42 March 31 $0.83 $0.59 On April 7, 2008 the high and low sale prices for a share of our common stock as reported by Pink Sheets, LLC, were $0.78 and $0.75, respectively. HOLDERS On April 7, 2008, we had 68,167,374 shares of our common stock outstanding held by approximately 425 record shareholders. This number of shareholders does not include beneficial owners whose shares are held in nominee or "street" name. DIVIDENDS We have never paid a cash dividend with respect to our common stock, and have no present intention to pay cash dividends in the foreseeable future. The current policy of our Board of Directors is to retain earnings to provide funds for the operation and expansion of our business. Our Board of Directors, in light of the circumstances then existing, including our earnings and financial requirements and general business conditions, will determine the timing and amount of future dividends, if any. In addition, the terms of our senior convertible notes prohibit us from paying cash dividends for the term of the loan arrangements. 15 CAPITALIZATION The following table sets forth our capitalization as of December 31, 2007. The information in the table below should be read in conjunction with our consolidated financial statements and related notes beginning on page F-1 of this prospectus. DECEMBER 31, 2007 ----------------- Short-term debt.................................................... Warrant liability............................................... $ 8,911,086 Conversion option liability..................................... $ 4,079,890 Senior convertible notes payable................................ $ 3,251,947 ------------ Total short-term debt ........................................ $16,242,923 ------------ Total stockholders' deficit ........................................ $(13,830,023) ------------ Total capitalization .......................................... $ 2,412,900 ------------ 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes beginning on page F-1 of this prospectus. This prospectus and our consolidated financial statements and notes to financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, but not limited to: o those identified under "Risk Factors" beginning on page 5 of this prospectus, o adverse economic conditions, o entry of new and stronger competitors, o our inability to raise additional capital, o unexpected costs and operating deficits, o lower sales and revenues than forecast, o failure to establish relationships with and capitalize upon access to new customers, o litigation and administrative proceedings involving us or our products, o adverse publicity and news coverage, o inability to carry out our marketing and sales plans, o changes in interest rates and inflationary factors, and o other specific risks that may be referred to in this prospectus or in other reports that we have issued. We do not undertake to update, revise or correct any forward-looking statements. Any of the factors described above or in the "Risk Factors" section could cause our financial results, including our net income or loss or growth in net income or loss, to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (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 inventory valuations, license fees and the accounting treatment of derivatives. 17 Inventory Valuations - -------------------- We determine our inventory value at the lower of average cost or market. When required, a provision is made to reduce excess and obsolete inventory to estimated net realizable value. For example, our provision for excess and obsolete inventory has increased from $103,290 at December 31, 2006 to $204,758 at December 31, 2007. This increase of obsolescence was mainly due to the write-off of our ER-1808 inventory parts in the second quarter of 2007, a product the release of which was initially postponed and later cancelled altogether in June 2007. Accounting Treatment for Derivatives - ------------------------------------ EMBEDDED CONVERSION FEATURE Paragraph 12 of Statement of Financial Accounting Standards ("SFAS") No. 133 indicates that the conversion features of an instrument should be considered a derivative if the following criterion are met: o The economic characteristics and risks differ between the host and embedded conversion feature. This condition, relative to our senior convertible notes, is met because the embedded conversion feature valuation depends on factors such as volatility, stock price and expected life whereas the valuation of the host is not impacted by these factors. SFAS 133, paragraph 61 (k), further confirms the above position as this paragraph states that "the changes in fair value of an equity interest and the interest rates on a debt instrument are not clearly and closely related. Thus, for a debt security that is convertible into a specified number of shares of the debtor's common stock or another entity's common stock, the embedded derivative (that is, the conversion option) must be separated from the debt host contract and accounted for as a derivative instrument provided that the conversion option would, as a freestanding instrument, be a derivative instrument subject to the requirements of this Statement." o The contract that includes the host and the conversion feature is not re-measured at fair value. This condition is met because the contract (our senior convertible notes) is not re-measured. o A separate instrument with the same terms as the embedded conversion feature would be derivative as per paragraphs 6 of SFAS 133. Our review of paragraph 6 revealed that the embedded conversion feature without a host would be considered a derivative because the embedded conversion feature (1) has underlying and notional amounts (2) requires no initial net investments and (3) permits net settlement. Based on the above considerations, it is implied that the embedded conversion feature related to our senior convertible notes is a derivative that must be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in earnings. However, before reaching a final conclusion on whether we are dealing with an embedded conversion feature that needs to be considered a derivative, we needed to review paragraph 11(a) of SFAS 133. Paragraph 11(a) states that "contracts issued or held are both (1) indexed to its own stock and (2) classified in stockholders equity shall not be considered derivative instruments." Our contract is indexed to our own stock. To determine the correct classification of the embedded conversion feature with respect to possible stockholders equity classification, we reviewed the guidelines provided in Emerging Issues Task Force ("EITF") Issue No. 00-19. Specifically, EITF 00-19, paragraph 4, and EITF 05-2 indicate that an embedded conversion feature is conventional if the holder is entitled to convert their position into a fixed number of shares. The embedded conversion features of our senior convertible note financings and subject of this review entitles the holder, under certain circumstances beyond our control, to convert their position into a variable number of shares. This implies that the embedded conversion feature under discussion does not qualify as a conventional convertible instrument. Because the embedded conversion feature does not qualify as a conventional convertible instrument, we then had to analyze paragraphs 12-32 of EITF 00-19 to determine whether the embedded conversion feature should be accounted for as a equity or as a liability. 18 Paragraph 19 of EITF 00-19 stipulates that in order to qualify for equity treatment, we must have sufficient authorized and unissued shares available to settle the contract after considering all other commitments that may require the issuance of stock during the maximum period the derivative contract could remain outstanding. The total number of shares that we could need to settle the current contract could exceed the level of authorized shares available for issuance and this would result in a situation where we do not control settlement of shares. Consequently, the embedded conversion feature is classified as a liability under EITF 00-19 and therefore does not qualify for paragraph 11 scope exception in SFAS 133. As a result, the embedded conversion feature will be accounted for as a derivative at fair value, with changes in fair value recorded in earnings. Based on before mentioned criteria, we classified the conversion feature as a liability on our balance sheet measured at fair value using the Black-Scholes option pricing model. WARRANTS The warrants that were issued as part of our convertible note financings represent freestanding instruments. We analyzed these warrants as to their characteristics similarly to our analysis of the embedded conversion feature discussion above. Based on the conclusions we reached while evaluating the embedded conversion feature we determined that the warrants (1) are derivatives as per the definitions of paragraphs 6-9 of SFAS 133 and (2) will be accounted for as a liability based on paragraph 19 of EITF 00-19. As such, the warrants are classified as a liability and are measured at fair value, with changes in fair value reported in earnings. We will review the warrants under EITF 00-19 at each balance sheet reporting date to determine if circumstance exist requiring a reclassification of the warrants to equity. COST OF FINANCING DERIVATIVE INSTRUMENTS The fair value of the conversion features and warrants in excess of the face value of the debt host instrument is expensed at the time of closing the financing. These transactions are analogous to paragraph 6 of EITF 98-5, which states, "... IN CERTAIN CIRCUMSTANCES, THE INTRINSIC VALUE OF THE BENEFICIAL CONVERSION FEATURE MAY BE GREATER THAN THE PROCEEDS ALLOCATED TO THE CONVERTIBLE INSTRUMENT. IN THOSE SITUATIONS, THE TASK FORCE REACHED A CONSENSUS THAT THE AMOUNT OF THE DISCOUNT ASSIGNED TO THE BENEFICIAL CONVERSION FEATURE IS LIMITED TO THE AMOUNT OF THE PROCEEDS ALLOCATED TO THE CONVERTIBLE INSTRUMENT." The discount amount up to the face value of the debt host instrument is amortized over the life of the note. Stock-Based Compensation Expense - -------------------------------- On January 1, 2006, we adopted SFAS No. 123 (revised 2004), "Shared Based Payment," which requires the measurement and recognition of compensation cost for all stock-based payment awards made to employees and directors based on estimated fair values. We have elected to use the modified prospective transition method for adopting SFAS No. 123(R), which requires the recognition of stock-based compensation cost on a prospective basis. Our Consolidated Statement of Operations as for the year ended December 31, 2007 on page F-5 of this prospectus reflects the impact of SFAS No. 123(R). In accordance with the modified prospective transition method, our Consolidated Statement of Operations for periods prior to January 1, 2006 have not been restated to reflect, and do not take into account, the impact of SFAS No. 123(R). As of December 31, 2007, there was $119,817 of total unrecognized compensation cost related to all of our outstanding non-vested stock-based payment awards. This total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. The additional stock-based compensation expense for any new stock-based payment awards granted after December 31, 2007 cannot be predicted at this time because calculation of that expense depends upon, among other factors, the amount of stock-based payment awards granted by us in the future. 19 Deferred Assets - --------------- In 2004, we paid $260,000 to a supplier for a software platform related to our ER-1010 product. This software platform license fee is being amortized and charged to cost of sales over the projected number of systems expected to be sold using the platform. As of December 31, 2007, a total amount of $33,310 in amortization expense has been included in cost of sales. In the fourth quarter of 2007, we revised our estimate for the projected number of systems expected to be sold utilizing the current capitalized software. The estimated number of units to be sold utilizing this software was changed from 1,000 units through the end of 2006 to 500 units beginning in 2007. The revised estimate is thought to provide a better estimate of amortization expense with sales. The effect of the change in estimate was to decrease our 2007 net income by $10,944. SELECTED FINANCIAL DATA The following table sets forth selected financial data regarding our financial position and operating results. This data should be read in conjunction with our consolidated financial statements and related notes thereto beginning on page F-1 of this prospectus. RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007, COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 2006 (IN THOUSANDS) December 31, December 31, 2007 2006 ------------ ------------ Net Sales $ 1,035 $ 849 Cost of Sales 385 320 ------------ ------------ Gross Profit 650 529 Operating expenses Salary expense 2,597 2,100 Marketing expense 97 230 Research and development costs 1,356 1,336 Selling, general and administrative 2,999 2,975 ------------ ------------ Total operating expenses 7,049 6,641 Net Other Income (loss) (3,110) (12,967) Loss before Income tax provision (9,509) (19,079) Income tax provision - - ------------ ------------ Net loss $ (9,509) $ (19,079) ============ ============ NET SALES For the fiscal years ended December 31, 2006 and December 31, 2007, we realized revenues of $849,285 and $1,035,108 respectively. This $185,823 increase (an increase of 22%) in revenues between 2006 and 2007 resulted primarily from the first significant sales of our products to a division of the U.S. federal government in the third quarter of 2007. In 2007, we sold 38 ER-1010 core switch units and 25 OR-1048 edge switch units versus the sale of 30 ER-1010 units and 23 OR-1048 units in 2006. 20 From a strategic point of view, we believe the most important sales realized during 2007 were the sales to a division of the federal government in the third quarter and the sale to one of the leading cable service providing companies in the fourth quarter. Within the year 2007, our third quarter was the strongest quarter with revenues totaling $431,336. Revenues for the other 2007 quarters amounted to $162,771, $237,857 and $203,144 for the first, second and fourth quarters respectively. The decrease of revenues in the fourth quarter of 2007 compared to the third quarter of 2007 is mainly due to the relatively large order received in the third quarter from the federal government. Another important reason for the lower fourth quarter level of revenues is the fact that in March-July 2007, we re-organized our entire sales team. Taking into account selling cycles which amount to some 6-9 months, the positive impact on revenues from this reorganization can be expected to occur in early to mid 2008. In 2006, we realized that our products have attractive features for government networks. Such features are price, security, resiliency and speed. Agreements that were signed in 2006 and 2007 with large systems integrators who provide products and services to the government sector along with the fact that one of our products was certified by a government test organization in 2007, helped result in our first significant order with a division of the federal government in the third quarter. As a result of this sale and our other 2007 sales efforts directed at the government sector, we believe that we have made significant progress toward establishing ourselves as an on-going supplier of products and services to the federal government. During 2007, we also made progress in introducing our products to cable service providers. Our ER-1010 is an attractive network product for the cable industry which needs low-latency switches for video streaming. Evaluation units were placed in various leading cable companies and a first order was received in the fourth quarter of 2007. We expect that cable service providers, together with the government customers as described above will be an important contributor towards growth in the foreseeable future. With respect to industry verticals other than government and cable, we noticed that during 2007 selling cycles shortened. We expect that with the new selling team getting on speed, we will see higher growth rates in these verticals in 2008 and beyond. The most important examples of these verticals are manufacturing services, banking, call centers, entertainment and education. GROSS MARGIN Our gross margin was $529,212 and $649,997 in 2006 and 2007, respectively, representing an increase of $120,785 or 23% in line with the increase of revenues during the same period of approximately 22%. OPERATING EXPENSES Total operating expenses were approximately $6,641,096 and $7,048,741 in 2006 and 2007, respectively, representing an increase of $407,645 or 6%. This increase was mainly due to an increase of salaries partially offset by a decrease of marketing expenses. The following descriptions detail our total operating expenses by expense category. SALARY EXPENSE Total salary expenses (excluding R&D related salaries which are captured under "Research and "development costs") increased from $2,099,946 in 2006 to $2,596,537 in 2007, an increase of $496,591 or 24%. The main reason for this increase was the increased charges booked for expensing stock options in 2007 as compared to 2006. The total increase in this respect amounted to approximately $200,000 and was mainly caused by the fact that our actual employee turnover was less than forecasted resulting in a higher expense charge for stock options. Another reason for the increase in salary expense was increased health premiums, which increased by approximately $90,000 in 2007 over 2006. The remaining increase in salary expenses in 2007 over 2006 amounted to approximately $200,000, and was caused by salary increases, bonus payments and an average headcount increase over the year by one person. 21 MARKETING EXPENSES Marketing expenses decreased from $229,381 in 2006 to $97,237 in 2007, a decrease of $132,144 or 58%. The main reason for this decrease was that in 2006 we engaged in a marketing campaign through a third party in connection with lead generation. In 2007, we did not engage any third parties for these activities. RESEARCH AND DEVELOPMENT We spent $1,336,518 and $1,356,326 on research and development (R&D) in 2006 and 2007, respectively, an increase of $19,808 or 1%. This increase was due in part to increases in salaries of $131,000 as a result of a slight R&D headcount increase, increased use of prototypes resulting in an expense increase of $40,000 and an increase of charges in 2007 over 2006 for parts consumption of $52,000. These increases were offset by reduced costs for design tools (down by $160,000) and reduced project charges and costs of obsolescence (down by $80,000). SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative (SG&A) expenses increased from $2,975,251 in 2006 to $2,998,641 in 2007, an increase of $23,390 or 1%. The main increases were: a $39,000 increase of consulting expenses in connection with increased engagement of sales consultants in important verticals such as the government and cable industries; an $87,000 increase of legal expenses, mainly in connection with patent application-related fees and opinion letters required with various financings during 2007; an increase of $151,000 in connection with increased use of contract labor used for business development; issuance of warrants in April 2007 for investment relation services valued at $165,000 (such an expense did not occur in 2006; an increase in expenses for audit and accounting services of $131,000 over 2006, in connection with the engagement of a new audit firm and support required for the analysis of derivative instruments included in our financial statements. These increases were largely offset by decreases of employee recruitment expenses by $92,000; bank charges which decreased by $40,000; a decrease of inventory variances of $206,000; decreased depreciation expenses of $137,000 (a large portion of fixed assets was fully written off in early 2007) and a $159,000 decrease in finder's fees expenses resulting from a lower level of fund raising in 2007 compared to 2006. OTHER INCOME/(LOSS) Other income (loss) improved from a loss in 2006 of $12,966,694 to a loss in 2007 of $3,110,503. The primary reason for the improvement of other income is the decrease of our stock price during most of 2007, which resulted in the recognition of substantial gains related to the change in the fair value of the conversion features embedded in our senior convertible notes at December 31, 2007. In 2006, our stock price increased during the year resulting in substantial re-measurement losses for that period. Additional detail regarding Other Income/Loss follows: o We are required by EITF 96-19 to record the extinguishment of the July 31, 2006 senior convertible notes as valued at January 18, 2007, resulting in a gain of $11,571,860. o With respect to all three of our senior convertible note financing transactions that took place between July 2007 and August 2007, as prescribed by SFAS No. 133 and EITF 00-19, we are required to account for the warrants and the embedded conversion feature associated with the transactions as liabilities at their respective estimated fair values. In connection with the forced conversion of a portion of the notes which took place in the third quarter of 2007, the main portion of the M-1 and M-2 warrants became due to investors. Therefore, starting in the third quarter of 2007, we included the impact of the valuation of M-1 and M-2 Warrants. We are also required to adjust the estimated fair values of these liabilities at each period-end, with the resultant gain or loss recorded against earnings. For the year 2007, ending December 31, the price of our common stock decreased by $0.27 22 from $0.94 per share at January 1, 2007 to $0.67 per share at December 31, 2007, resulting in a gain of $18,956,186. In 2006, we charged an amount of $9,080,794 in connection with the adjustment of fair values of these liabilities regarding conversions and warrants. The warrants and conversion feature are valued using the Black-Scholes option pricing model. We believe that the closing price of our common stock, the estimated life of the financial instrument and the applicable volatility rates are the key assumptions used in the valuation calculation. In connection with our three separate senior convertible note financing transactions, we have expensed the excess value of the debt discount over the proceeds of the notes totaling $12,304,909 for a total amount of $24,557,055. In July 2006, an amount of $2,499,794 representing the excess value of the debt discount over the $5,000,000 in proceeds from the 2006 note was written off. o The total net discount cost associated with our senior convertible notes amounted to $12,304,909 and is amortized over the lifetime of the respective notes. The total charge for 2007 amounts to $6,073,699. In 2006, we incurred $1,041,666 in discount cost amortization expense. o In connection with the restructuring of the July 31, 2006 financing, we agreed to increase the principal amount of the related senior convertible notes by $2,204,909 and recorded this increase of principal after deduction of interest for a total restructuring amount of $2,089,284 as a cost of financing our senior convertible notes in January 2007. o Interest expense increased from $346,049 in 2006 to $941,839 in 2007. The primary reason for this difference is the increased amount of convertible notes which are subject to interest payments on a quarterly basis. In 2006, the convertible notes outstanding in the period of July 30, 2006 to December 31, 2006 amounted to $5,000,000. In 2007, the outstanding amount during the entire year was on an average basis, approximately $9,164,363. THIRD QUARTER 2007 RESTATEMENT On July 30, 2007 we effected a mandatory conversion in the amount of $2,707,475 carrying a corresponding conversion feature, valued at $3,607,648. In our third quarter 2007 statement of operations this amount was recognized as a gain to "other income/loss" whereas this amount should have been accounted for as an increase to "additional paid in capital" (APIC). This restatement was corrected in our fourth quarter of 2007 financial statements as filed with our Annual Report of Form 10-KSB for December 31, 2007. The adjustments in the fourth quarter of 2007 regarding the third quarter 2007 did not affect the our cash position. For further details on this matter, please see explanations under "Third Quarter 2007 Restatement" in Note 1 to our consolidated financial statements on Page F-9 of this prospectus. 23 LIQUIDITY AND CAPITAL RESOURCES Our independent auditors have qualified their opinion with respect to our financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their report for each of our fiscal years ended December 31, 2006 and 2007. Reports of independent auditors 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 certified public accountants and our consolidated financial statements and related notes beginning on page F-1 of this prospectus, the cautionary statements included in the "Risk Factors" section beginning on page 5 of this prospectus, and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us. For the years ended December 31, 2006 and 2007, we sustained net losses of $19,078,578 and $9,509,247, respectively. Since our inception, including the period ended December 31, 2007, 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 December 31, 2007, we had a deficit in working capital of $ 14,158,731, of which $12,990,976 relates to the fair value of derivative financial instruments. Our management has attempted and continues to attempt to address these financial conditions by seeking additional debt and equity financing to fund our continuing operations, as more fully described below. However, we anticipate that additional capital must be raised to fund operations beyond August 2008 and there can be no assurance that sufficient revenues will be generated thereafter to fund our operating requirements. We currently have no commitments for any additional financing and there can be no assurance that we will be able to obtain requisite financing on acceptable terms, if at all. July 2006 Senior Convertible Note Financing - ------------------------------------------- On July 30, 2006, we entered into a Securities Purchase Agreement with three institutional accredited investors in connection with a private placement transaction providing for, among other things, our issuance of senior convertible notes in the aggregate principal amount of $5 million, Series L Warrants to purchase up to an aggregate of 17,065,623 shares of our common stock and Series M Warrants to purchase up to an aggregate of 7,395,103 shares of our common stock. We received aggregate gross proceeds of $5 million from the investors for our issuance of these notes and warrants. 24 We subsequently entered into Amendment and Exchange Agreements, dated January 18, 2007 and amended and restated on January 22, 2007, with the investors from the July 30, 2006 private placement providing for certain amendments to the senior convertible notes, Series L Warrants, Series M Warrants and registration rights agreement. These amendments include, but are not limited to, an increase in the principal amount of the notes from an aggregate of $5 million to an aggregate of approximately $7.2 million, an increase in the aggregate number of shares of common stock issuable upon exercise of the Series L Warrants by 5,688,540 (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 Warrants and the Series M Warrants from $0.5054 per share to $0.43948 per share. We also modified our registration obligations to require that we initially register 15,267,292 shares of our common stock underlying the senior convertible notes with the SEC, with the remaining shares underlying the senior convertible notes and the shares underlying the Series L Warrants and Series M Warrants to be registered by subsequent registration statements to be filed at a later date as permitted by the SEC. We did not receive any additional cash consideration for these amendments. The amendments provided for by the Amendment and Exchange Agreements were reflected by our issuance of amended and restated notes, our issuance of Series L-1 Warrants and Series M-1 Warrants that replaced the Series L and Series M Warrants and our entry into an amended and restated registration rights agreement with the investors. In addition, the Amendment and Exchange Agreements provided for an additional private placement transaction with one of the investors, which resulted in our issuance of an additional senior convertible note in the principal amount of $1.6 million, Series L-2 Warrants to purchase an aggregate of 7,281,332 shares of our common stock and Series M-2 Warrants to purchase an aggregate of 2,366,433 shares of our common stock. We received aggregate gross proceeds of $1.6 million from the investor for our issuance of these additional note and warrants. July 2007 Senior Secured Convertible Note Financing - --------------------------------------------------- On July 31, 2007, we entered into a securities purchase agreement with three investors for total gross proceeds of $3.5 million in a private placement transaction providing for our issuance on August 1, 2007 of Senior Secured Convertible Notes in the aggregate principal amount of $3.5 million ("2007 Secured Notes"), Series N Warrants to purchase up to an aggregate of 2,909,636 shares of our common stock, Series O Warrants to purchase up to an aggregate of up to 1,891,263 and Series P Warrants to purchase up to an aggregate of 1,246,987 shares of our common stock. We also entered into a security agreement granting the investors a first priority perfected security interest in all of our assets and our subsidiary has guarantied our obligations under the 2007 Secured Notes. In addition, we have entered into private placement transactions with these same investors in July 2006 and January 2007, as described under the caption "July 2006 Senior Convertible Note Financing" above, and in April 2008, as described under the caption "April 2008 Senior Convertible Note Financing" below. The 2007 Secured Notes carry an interest rate of 9.25% per annum, which rate may be increased to 15% upon the occurrence of an event of default, and mature on August 1, 2010. This date may be extended, at the option of the investors, by up to two years. Interest will be payable quarterly, starting October 1, 2007. The 2007 Secured Notes are immediately convertible and had an initial conversion price of $1.2029 per share. However, pursuant to the full- ratchet anti-dilution provisions described below, our subsequent issuance of securities in our April 2008 private placement has resulted in a reduced conversion price of $0.50 per share. The entire outstanding principal balance and any outstanding fees or interest shall be due and payable in full on the maturity date. Under certain conditions, we may require investors to convert up to either 50% or 100% of the outstanding balances of the 2007 Secured Notes at any time shares of our common stock are trading at or above $1.80435 or $2.105075, respectively. 25 The N Warrants, O Warrants and P Warrants each carried an initial strike price of $1.2029 per share. However, pursuant to the full-ratchet anti-dilution provisions of the warrants, our subsequent issuance of securities in our April 2008 private placement has resulted in a reduced strike price of $0.50 per share and an increased number of shares issuable under the warrants as follows: N Warrants - 7,000,000 shares, O Warrants - 4,550,000, P Warrants - 3,000,000. The N Warrants are immediately exercisable and expire on the earlier of August 1, 2016 or seven years after the date all of the shares issuable upon conversion of the 2007 Secured Notes have been included on an effective registration statement. The O Warrants will only become exercisable by an investor if we conduct mandatory conversions, and then only to the extent of 65% of the number of shares issued to such investor upon each mandatory conversion. The O Warrants expire on the earlier of August 1, 2016 or seven years after the date all of the shares issuable upon conversion of the 2007 Secured Notes have been included on an effective registration statement. The P Warrants are immediately exercisable and expire on the earlier of the maturity date of the 2007 Secured Notes of August 1, 2010, which date may be extended by up to two years at the option of the investors, and the date we have satisfied our payment obligations under the warrant holder's 2007 Secured Note. In the event of a default or upon the occurrence of certain fundamental transactions as defined in the 2007 Secured Notes, the investors will have the right to require us to redeem the 2007 Secured 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 Secured Notes by requiring that we 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 our common stock, or at our option, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of our common stock over the prior 20-trading day period. The conversion price of the 2007 Secured Notes and the exercise price of the N Warrants, O Warrants and P 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 we issue or are 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 2007 Secured Notes and the N Warrants, O Warrants and P 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 our outstanding shares of common stock (subject to an increase or decrease, upon at least 61-days' notice, by the investor to us, of up to 9.99%). We have agreed to register the shares of common stock underlying the 2007 Secured Notes, N Warrants, O Warrants and P Warrants. If we fail to meet the filing or effectiveness requirements, subject to certain grace periods, we may be required to pay liquidated damages of $70,000 on the date of such failure and on every 30th day thereafter until such failure is cured. The total liquidated damages payable by us for failure to meet the filing and effectiveness requirements are capped at $437,500. 26 April 2008 Senior Secured Convertible Note Financing - ---------------------------------------------------- On March 31, 2008, we entered into a securities purchase agreement with three investors, which closed on April 1, 2008, for total gross proceeds of $3.125 million, which agreement provided for the issuance of Senior Secured Convertible Notes in the aggregate principal amount of $3.125 million ("2008 Secured Notes"), Series Q Warrants and 3,125,000 shares of our common stock in a private placement transaction. We also entered into a security agreement granting the investors a first priority perfected security interest in all of our assets and our subsidiary has guarantied our obligations under the 2008 Secured Notes. The 2008 Secured Notes and Series Q Warrants are or may become convertible into or exercisable for the following number of shares of our common stock: Notes: 3,125,000 Series Q Warrants: 6,250,000 ---------------------------------------------------- Total: 9,375,000 In addition, we previously entered into private placement transactions with these same investors in July 2006, January 2007 and July 2007 as described under the captions "July 2006 Senior Convertible Note Financing" and "July 2007 Senior Secured Convertible Note Financing" above. The 2008 Secured Notes carry an interest rate of 10% per annum, which rate may be increased to 15% upon the occurrence of an event of default. Interest in the amount of $625,000, representing two years of interest, was prepaid to the investors on April 1, 2008. The 2008 Secured Notes mature on March 31, 2010. This date may be extended, at the option of the investors, by up to two years. The 2008 Secured Notes are immediately convertible at a conversion price of $1.00 per share. The entire outstanding principal balance and any outstanding fees or interest shall be due and payable in full on the maturity date. The Series Q Warrants carry a strike price of $1.00 for each share and are immediately exercisable. The Series Q Warrants expire on March 31, 2017. In the event of a default or upon the occurrence of certain fundamental transactions as defined in the 2008 Secured Notes, the investors will have the right to require us to redeem the 2008 Secured Notes at a premium. In addition, at any time on or after September 30, 2008, the investors may accelerate the payment of the 2008 Secured Notes by requiring that we convert, or at our option, redeem in cash, up to an amount equal to 100% of the aggregate dollar trading volume of our common stock over the prior 20-trading-day period. If we elect to use shares of our common stock to satisfy an accelerated payment, we must deliver shares to the investors in an amount equal to the accelerated payment amount divided by the lower of the conversion price and a 15% discount to the recent volume weighted average price of out common stock. 27 The conversion price of the 2008 Secured Notes and the exercise price of the Series Q 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 we issue or are 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 2008 Secured Notes and the Series Q 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 our outstanding shares of common stock (subject to an increase or decrease, upon at least 61-days' notice, by the investor to us, of up to 9.99%). We have agreed to register the shares of common stock underlying the 2008 Secured Notes and Series Q Warrants. If we fail to meet the filing or effectiveness requirements of our registration obligations, subject to certain grace periods, we may be required to pay liquidated damages of $62,500 on the date of such failure and on every 30th day thereafter until such failure is cured. The total liquidated damages payable by us for failure to meet the filing and effectiveness requirements are capped at $390,625. The foregoing raises during fiscal years ended December 31, 2006 and 2007 and in April 2008 have enabled us to further enhance and stabilize product performance, reduce the cost of manufacturing by redesign, start new product development, generate a certain level of interest in the marketplace and support our continuing operations. However, if we do not experience a significant increase in revenues by August 2008, we expect that additional capital will need to be raised to fund our continuing operations, and there can be no assurance that we will be able to obtain requisite financing on acceptable terms, if at all. 28 CAPITAL EXPENDITURES For the years ended December 31, 2006 and 2007, we incurred $6,464 and $45,160, respectively, in capital expenditures for property and equipment. Capital expenditures during 2007 were mostly related to the purchase of computer and engineering test equipment, while in 2006 capital expenditures related to general furniture and office purchases. Effective August 1, 2007, we extended the lease for our corporate headquarters in Santa Ana, California. The lease has a scheduled termination date of July 31, 2009. The base rent as of August 1, 2007 is $23,348 per month ($2.10 per rentable square foot). On August 1, 2008, the monthly rent will increase to $24,126 ($2.17 per rentable square foot), which will be the monthly rate until termination of the lease on July 31, 2009. . CONTRACTUAL OBLIGATIONS The following table outlines as of December 31, 2007 payments due under our significant contractual obligations over 2008, 2009 and thereafter, exclusive of interest: CONTRACTUAL OBLIGATIONS PAYMENT DUE BY PERIOD DECEMBER 31, 2007 --------------------- - ----------------------- TOTAL 2008 2009 AFTER 2009 ------------ ------------ ------------ ------------ Short-Term Debt $ 9,597,434 $ 6,097,434 $ -- $ 3,500,000 Long-Term Debt -- -- -- -- Operating Leases 459,921 291,039 168,882 -- Total Contractual Cash Obligations $ 10,057,355 $ 6,388,473 $ 168,882 $ 3,500,000 ------------ ------------ ------------ ------------ - --------------- 29 BUSINESS OVERVIEW We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. We originally were engaged in the business of offering EDGAR filing services to companies outsourcing the formatting and electronic filing of registration statements, periodic reports and other forms with the SEC, but generated minimal revenues from these operations. On October 17, 2003, we completed a business combination transaction with Raptor Networks Technology, Inc., a California corporation ("Raptor"), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary. Upon the completion of this acquisition transaction, we changed our name to Raptor Networks Technology, Inc., terminated our EDGAR filing services operations and, by and through our subsidiary Raptor, became engaged in the data network switching industry. Since that time, our focus has been to design, produce and sell standards-based, proprietary high-speed network switching technologies. Our "distributed network switching technology" allows users to upgrade their traditional networks with our switches to allow for more efficient management of high-bandwidth applications. The implementation of our products in a user's network provides increased speed and greater capacity and, we believe, a cost-effective alternative to existing switching and routing technologies. We have designed a family of modular network switch 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 sharp 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 switch to exist in multiple locations at distances spanning over 1,000 kilometers and to transport data over that network at very high speeds. This functionality is essential to new high-bandwidth applications such as Voice over Internet Protocol ("VoIP"), streaming video, Internet Protocol Television ("IPTV") and high-speed digital access, none of which existed when traditional chassis-based network switch designs were created. We believe that our Ether-Raptor architecture and associated products may redefine the manner in which data distribution occurs for service providers offering VOIP, streaming video, IPTV and other high-bandwidth applications. Due to the full, open-standards compatibility of our Ether-Raptor product line, our network switches have nearly universal applicability on legacy as well as newly-installed Ethernet networks where speed, high bandwidth, redundancy and high reliability are essential. We believe the unique features of our products can best be summarized as follows: o we were first to market with "distributed common core fabric," a network switch technology that eliminates dependency on complex and costly chassis products; o our simplified architectures improve redundancy and resiliency; o the reduced complexity, tighter hardware integration, and common components (including common software components) of our products provides users the opportunity for economies of scale and reduced costs; o the open standards of our products provide for compatibility with legacy products; o our products' low transport latency can support emerging converged video, voice and data applications without sacrificing Quality-of-Service; and o the Layer 2-7 Classification of our products provides full feature sets across a user's network. 30 We remain an early stage technology company and, commencing with our inception, have operated, and are now operating, at a significant loss. There can be no assurance that we will not encounter unforeseen and unanticipated obstacles to near-term revenue or ultimately achieving profitability. Our principal headquarters are located at 1241 E. Dyer Road, Suite 150, Santa Ana, California 92705 and our phone number is 949-623-9300. Our Internet address is www.raptor-networks.com. Our Code of Ethics, Audit Committee Charter, Nominating and Governance Committee Charter, and Compensation Committee Charter may be found on our website at the Internet address set forth above. Our filings with the SEC may be read and copied at the SEC's Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, such as us, that file electronically with the SEC. The SEC's web site address is www.sec.gov. INDUSTRY BACKGROUND Distributed computing and accelerating use of the Internet for information access as well as communication have driven an exponential expansion in the use of internetworking for more than thirty years. Most of today's networks were engineered based upon standards and technology optimized for handling a single data type - character data, which was previously the prevalent form of data. However, today's sophisticated applications often require multiple data types with speed and bandwidth requirements so high that prevailing network technology is simply not up to the task. Often times the system upgrades required to support these new applications is not cost justifiable, thereby slowing the rate of adoption and utilization of advanced network applications. New applications such as video on demand, remote synchronous data storage mirroring, global server clustering, business continuity, disaster recovery and distance collaboration are just a few of the high-bandwidth network applications that can have great value to an enterprise embracing them. However, the cost to replace or upgrade existing networks with the requisite efficient, high- bandwidth infrastructure to support these new applications is, in many cases, financially prohibitive. For example, a typical chassis-based upgrade, the type of which is offered by some of our competitors, involves replacing the power supplies, management units, backplane, fan trays and interconnect blades in the unit being upgraded. It is not unusual for the upgrade to cost as much or more than the original machine. OUR STRATEGY Our answer to the cost barrier to the adoption of high-bandwidth (full 10 Gigabit) networking is the introduction of next-generation networking products that are fundamentally less complex, more architecturally flexible, compatible with legacy products, and faster than traditional chassis-based alternatives. We believe that being in a position to offer customers a low cost-of-entry network alternative will ultimately allow us to achieve success in the network switch market. The core philosophy underlying our technological approach is to strive to do at Layer 2 (the Data Link Layer) in hardware what traditional network switch architectures require Layer 3 protocols (the Network Layer) in software to achieve. Our "distributed switch fabric" approach provides a means to achieve seamless and coherent peer-to-peer communication between physically separated switches at Layer 2. The result is, effectively, a single network switch consisting of a cluster of standalone, high-performance blades physically separated from one another by currently up to 120 kilometers per hop (in line with what optics technology allows; this distance can be increased using lighted fiber). This flexibility permits the use of unique network topologies that allow for highly-robust, super-redundant networks to be designed and implemented that provide data transport at wire-speed (the maximum speed at which the equipment is built to operate) with the versatility to run the new latency-sensitive data applications (such as VoIP or streaming video) at a cost-effective price without sacrificing quality. 31 The ultimate goal in networking is to maximize effective transport bandwidth without sacrificing quality. In our architecture, Quality-of-Service is maintained by providing for intelligent management of the different data types traveling from the same source to the same destination. Latency variations caused by heavy traffic can be devastating to certain data types and applications. In traditional centralized architectures, latency problems are resolved with the costly deployment of dedicated parallel networks, increasing system complexity and hampering system scalability. Our technology optimizes the handling of all data packets on a single, common network by monitoring and differentiating between data types and adjusting transport parameters accordingly, thus assuring low latency on common transport paths. Our proprietary Raptor Adaptive Switch Technology ("RAST") provides an innovative new way to connect local and wide area networks, allowing users new options in the way they design their distribution networks. Simply stated, RAST allows discrete network elements, separated in distance by more than 1,000 kilometers, to "bind" into a common "virtual switch," providing for ultra-fast Layer 2 transport across those distances. Compatible with existing open standards legacy products, RAST allows customers to add significant capability to converge voice, video, and all data types on to their existing network without the need for expensive, end-to-end upgrades. RAST also allows highly- resilient networks to be created at lower costs, both in terms of initial capital expenditure and ongoing operating costs, than traditional legacy chassis-based systems. Because RAST allows virtually any network size and topology to be engineered from our common "building block" switches, the cost of adoption, as well as the cost of support, is minimized. One of the most difficult data types for networks to handle is VoIP. By optimizing the handling of all data packet types on a given network, treating them as though they were all video data, our architecture enables the construction of true wire-speed networks and achieves multiple objectives for the user community. First, it allows for voice, video, storage, and other sophisticated applications that can improve operations and establish new revenue streams. Second, it augments, rather than replaces, the existing internetworking infrastructure already in place, leveraging the user's existing capital investment and minimizing the incremental capital outlay required to support these new applications. We have filed patents with respect to both distributed fabric over long range distances and for certain security features of our products. We believe the combination of these pending patents gives us a strong competitive advantage because of the added level of security these technologies provide to our products. Users increasingly require high security for their distributed networks and our products provide additional security because of both the patented distributed fabric technology and the additional security features now submitted for a patent. Although our sales to date have been minimal, in 2006 and 2007 we entered into contracts with large systems integrators, including government contractors, which we believe may add significantly to our distribution structure. Important milestones for us in 2007 were the certification of our product by a government-approved test lab in April 2007, opening the federal-government market for our products. Other important milestones for us were the first-time sales of our product to one of the leading cable providing companies in the United States and the first sale of our product in connection with a storage application that provides storage of large data warehouses in servers located in geographically-remote locations. In addition, we continue to focus our sales efforts on those business segments where we have had sales in prior years - namely education, internet media and financial institutions. We also continue to pursue OEM business, private labeling and licensing opportunities. Taking into account the price and performance value of our technologies and the increased acceptance of our core technology in the networking world, we believe the before-mentioned opportunities may be a potential source of revenues in the future. It should be noted, however, that our efforts to get into the OEM, private labeling and licensing business has not yet resulted in any final commitments and there can be no assurance that we will ever generate revenues from these activities. OUR PRODUCTS Our flagship product is a core switch, the Ether-Raptor-1010 ("ER-1010), which is a combination 10Gb/GbE switch. In line with what we believe to be current market requirements, in June 2007 we cancelled development and production of a pure 10GbE core switch, the ER-1818, a product the release of which we had previously postponed on several occasions. In late 2006 we started development of an advanced version of the ER-1010, the ER-1010E, which was finalized and became available for shipment in late March 2008. We also offer a pure edge switch, the Ovi-Raptor-1048 ("OR-1048") and three types of NIC cards. All our switches are based upon a common family of merchant silicon and embedded software. 32 ER-1010/ER-1010E ---------------- Our ER-1010 1Gb/GbE and 10Gb/GbE network switch significantly reduces the cost of adoption of ten gigabit networking by allowing for the construction of an entire network from a series of our common, high performance "building blocks." The ER-1010 consists of 24 ports of 1Gb/GbE and six ports of 10Gb/GbE. The ER-1010 is built in a 1U high, self-powered, self-managed enclosure. Unlike the large and complex chassis-based switches from which they evolved, our network switches are physically placed near the devices or clients they serve. When these switches are then subsequently connected together, either over copper or fiber links, they collectively "bind" into a single "virtual" network switch. This patent-pending "distributed virtual switch" architecture, filed under Raptor Networks Technology, Inc.'s name, scales linearly, reduces inter-network disconnects and moves data at very high speeds. Because the topology consists of a collection of self-managed, interconnected building blocks of identical composition, the architecture of the ER-1010 improves redundancy, keeps latency very low across broad distances, allows for simpler management, and is priced lower than chassis-based alternatives. The ER-1010E enhances the ER-1010 performance substantially. The CPU speed, which was 300 Mhz in the ER-1010, is now 1Gh in the ER-1010E, resulting in lower latency and higher performance, including stacking capabilities. In addition, memory has been increased by 400% and functionality of the system's user interface has been substantially improved. We have also completed the development of an ER-1010E version with dual redundant power supply capabilities. OR-1048 ------- The OR-1048 is a 48-port 1GbE edge switch with the option for two 10GbE uplinks and four optional 1GbE fiber ports. The OR-1048's standard features include comprehensive management functions and Web management. Network Interface Cards (NICs) ------------------------------ Raptor provides three types of NIC cards providing users with 2, 4, or 6 1Gigabit Ethernet ports for hooking up personal computers and servers to the network through Ethernet switches. MARKET TRENDS AND OUR RESPONSE We believe that the Ethernet switching and routing market is poised for growth. Based on recent research issued by the firm Infonetics Research, the Ethernet switch market surged in 2007 to $17 billion in worldwide revenues - a 9% jump from the 2006. Researchers have forecasted that global Ethernet switch market sales will grow to $18.3 billion in 2010. Infonetics Research has further reported that increased shipments of Layer 3 Ethernet switch products, driven by strong 1G and 10G port shipments, jumped 35% worldwide during 2007. We see two business drivers that are pacing the growth and viability of any network switching company in today's marketplace: (1) the presence of a leader in the industry who commands in excess of 66% market share, and (2) the market entry of low cost replicas of the market leader's products, largely from Far East competitors. We believe that the key to success for any network switching company is to successfully compete with the market leader in the developed world, while addressing the availability of low cost replica products in the developing world. We believe our solution is unique with respect to both of these challenges. Our patent-pending distributed network switch architecture is significantly less expensive and more efficient than the products offered by our competitors, which allows us to compete with the industry leader on performance, while simultaneously competing with the low cost replicas products on price. Given the advantages of our products, we believe that the most significant impediment to our success is developing brand awareness and acceptance of the quality and technological features of our products. For this reason, we have pursued and continue to pursue OEM partnerships with companies having well established channels to market competitively undifferentiated networking products. However, we have yet to generate any sales from these efforts. 33 The key architectural driver we see in the current marketplace is the conflict between the desire for new features, such as network security, and the need for increased speed to handle latency-sensitive applications such as VoIP, streaming video and other high-bandwidth applications. However, increased speed demands that network transport occur at Layer 2, yet the function of inline network security and similar functions occur at Layer 3 or 4, and the two cannot both be met by current technologies. Customers must choose between the speed of Layer 2 transport networks or the functionality, such as security, offered by slower Layer 3 and Layer 4 transport. We believe that the market's requirement for speed outweighs the benefits of additional functionality and we have designed our products to operate at wire-speed, rather than adding functionalities that would impede the speed and efficiency by which our products transport data. The importance of network transport speed is illustrated by the emerging applications of VoIP, streaming video, IPTV and high-speed digital access, referred to as the "triple play" service offering due to their high sensitivity to time delays in the network over which they operate. Users have discovered that VoIP on traditional networks, which were originally designed to handle uncomplicated traffic such as email and simple data transfers, suffers from poor voice quality and, under heavy network load, can cease to function entirely. These problems can be even more pronounced when running IPTV on traditional networks. The fundamental cause of these problems is that the latencies inherent in traditional centralized networks are incongruent with the speed requirements of these "triple play" applications. It was a desire to create a practical, cost-effective solution to these problems that drove the development of our distributed network architecture, which provides for seamless Layer 2 transport at wire-speed over significant distances. Internet Protocol version 6 ("IPv6") is a standard providing a much larger global address space than its predecessor IPv4. Interest in and adoption of IPv6 is gaining momentum in international markets, and the U.S. Federal Government has made IPv6 a requirement for its upcoming procurements in the next several years. However, we believe the widespread adoption of IPv6 in the U.S. commercial sector is likely to take several years. Given that our primary focus is to offer products with ultra-high-speed transport, while we are currently capable of implementing full IPv6 software in our products, we have elected not to do so at this time because it would result in slower network transport performance. Instead, our products are configured as protocol agnostic transport pipes operating at wire speed that seamlessly pass IPv6 traffic. At such time as IPv6 functionality is fully implemented in hardware rather than in software, we intend to design, develop and offer fully compliant IPv6 switch products that operate at wire-speed. Taking into account the increased demand for IPv6 functionality, we plan to accelerate availability of IPv6 in our products implementation of IPv6 is available at the hardware level. Security is another Layer 3 or Layer 4 function generating great interest in today's marketplace. We have recognized that network security is a major concern for many customers and have incorporated several major security features into our systems. These include IEEE 802.1X support with Radius authentication, Layer 2 ACLs and MAC filters, and Layer 3 and 4 ACLs. More unique, however, is the fact that our distributed fabric technology, RAST, is inherently more secure from monitoring because it is a unique and unrecognizable protocol to those attempting to breach the network fabric from outside the network. We consider our products among the most secure on the market today, but plan to continuously evaluate the possible addition of new security functions so long as such additions do not compromise the wire-speed performance of our products. RESEARCH AND DEVELOPMENT We spent $1,336,518 and $1,356,326 in 2006 and 2007, respectively, on research and development. We commenced our transition into the data network switching industry in October 2003. From October 2003 until early 2005, we worked to develop our first flagship product, the ER-1010. By the end of the third quarter of 2004, our design team had finalized the design work on a fiber based RAST card. This card enables all of our network switching systems employed in a network connected through fiber to work as one "virtual chassis" system, even if such systems are located up to 120 kilometers apart. In September and October 2004, we developed a 10-Giga-fiber card, which enables our systems to communicate with other brands of network switches. 34 During 2005, our research and development resources were mainly focused on adding features to the ER-1010, such as Data Management Software (software enabling analysis of data flows handled by the ER-1010) and other enriching functions. Throughout 2005, substantial testing of the ER-1010 was carried out internally for the purpose of ensuring that product features worked as expected and extensive external testing was conducted to validate the quality of our products. In the fourth quarter of 2005, certain parts of the ER-1010 were upgraded, including the replacement of certain cables to reduce manufacturing costs, and an upgrade to a more powerful processor. We also made significant progress in 2005 debugging software included in the ER-1010, resulting in substantial improvement of the ER-1010's performance in terms of reduced failover time, increased stacking possibilities, and smooth running of jumbo frames. During 2006, our research and development team completed various enhancements to the ER-1010, resulting in an improvement of the control plane and increasing memory and processing power. We also began work on upgrading the ER-1010 to be a more powerful product. During the second half of 2006, we continued testing various applications to better position our products for various markets. We also began testing our products with a U.S. Federal Government-approved test organization. In 2007, we successfully finished testing of our product with the U.S. Federal Government-approved test organization. The research and development team also spent considerable time on developing the ER-1010E, an enhanced version of the ER-1010 as described above under the caption "Our Products." In addition, we developed a redundant power supply version of the ER-1010E and designed various new boards, which improved the stability of the ER-1010 and ER-1010E and suitability of our core system for the data storage market. In 2007, our software development group upgraded our software to include additional protocols addressing various customer-reported issues. In first quarter of 2008, we finished the development of the ER-1010E, including the redundant power supply version, which we made available for shipment in late March 2008. During the remainder of 2008, we expect to begin development on a number of new products aimed at addressing the needs of those markets where we have been successful in 2007, such as the cable service provider industry and the Federal Government sector. Features considered for development are IPv6, MPLS and various security-related enhancements. None of our research and development to date has been customer specific. Therefore, we have not billed any of our customers for non-recurring engineering or other research and development expenses. In the future, we expect that there may be periodic opportunities to engage in customer specific projects for which we can bill a portion of our research and development expenses to such customers. SALES AND MARKETING We market and sell our products to customers through a combination of direct sales to end users and sales through resellers. Our sales offices are located at our principal headquarters in Santa Ana, California and we have sales employees in California, Maryland and Virginia. In addition, we have finder's fee and consulting agreements in place with a number of independent third parties to facilitate the sale of our products on a global basis. We anticipate that original equipment manufacturers (OEMs) may eventually constitute another important sales channel. Potential OEMs may include our product in their offerings to end users and system integrators. While we are currently pursuing multiple OEM relationships, at this time none have been secured and there can be no assurance that we will succeed in securing such relationships. COMPETITION We believe the key competitive factors in today's network switching market are, in order of priority: price, speed, capacity, level of security, brand recognition and interoperability (compatibility with legacy products). We intend to become competitive by offering products that offer architectural performance, resiliency and power efficiency advantages at a price that cannot be matched by today's centrally-architected legacy networks alternatives. We seek to gain and expand a market presence through aggressive marketing and sales efforts. However, our market continues to evolve and we may not be able to compete successfully against current and future competitors. 35 We operate in a competitive industry with many established and well-recognized competitors. In particular, Cisco Systems maintains a dominant position in our industry and several of its products compete directly with our products. We also compete with, among others, Extreme Networks, Nortel Networks, Enterasys Networks, 3Com, Huawei Technologies, Force 10 Networks, Juniper Networks and Alcatel. Most of our competitors (including all of the competitors referenced above) have substantially greater market leverage, distribution networks and vendor relationships, longer operating histories and industry experience, greater financial, technical, sales, marketing and other resources, more name recognition and larger installed customer bases than we do and can be expected to react strongly to our marketing efforts. In addition, many competitors exist who, because of their substantial resources, distribution relationships and customer base, could temporarily drop prices to stave off a potential successful market launch by us. Other competitive responses might include, without limitation, intense and aggressive price competition and offers of employment to our key marketing or management personnel. There can be no assurance that we will be successful in the face of increasing competition from existing or new competitors, or that competition will not have a material adverse effect on our business, financial condition and results of operations. Competitive pressures and other factors, such as new product or new technology introductions by us or our competitors, may result in price or market share erosion that could have a material adverse effect on our business, results of operations and financial condition. In addition, there can be no assurance that our products and services will achieve broad market acceptance or will successfully compete with other products targeting the same customers. MANUFACTURING AND SUPPLIERS Our success will depend on partnerships in both technology and related support. Our primary technology provider is Broadcom Corporation. Broadcom's 10 Gigabit Ethernet, Gigabit Ethernet and fast Ethernet transceivers provide the Ethernet and 10 Gigabit switching fabric in our distributed architecture. Another major supplier is TTM Corporation, which supplies PCB fabrication and PCB design and analyses support. Our operating system is based on WindRiver's VxWorks, which is widely used throughout the information technology industry. All of our manufacturing activities have been outsourced to Express Manufacturing Inc. ("EMI"), a subcontractor located in the same vicinity as our principal headquarters. EMI's manufacturing activities for us consist of printed circuit board assembly and final assembly of our products. All of our inventory is stored at our principal headquarters and we supply it to EMI as needed to meet our orders. We currently conduct final systems testing at our principal headquarters, but we anticipate that this responsibility will be transferred to EMI sometime during 2008. We utilize high-quality providers of merchant silicon, embedded software, production circuit boards, and loss-free interconnects to craft our switch products. No extraordinary investments in custom ASICs, software or infrastructure was required to engineer our family of products. In furtherance of our dedication to cost consciousness, in August 2004 we relocated our operations to a Federal Empowerment Zone and local enterprise zone, directly between EMI, our contract manufacturer, and Broadcom, our merchant silicon provider, in order minimize facility costs and speed the design-to-production transition of new silicon switching innovations. EMPLOYEES As of April 7, 2008 we had 23 full-time employees. None of our employees are a party to any collective bargaining agreements with us. We consider our relations with our employees to be good. PATENTS, TRADEMARKS, AND LICENSING AGREEMENTS We have seven U.S. patent applications pending, one allowed, two foreign applications pending, and eight additional U.S. provisional applications pending with broad claim sets covering numerous aspects of our Ethernet Distributed Switch Fabrics. Due to delays at the patent office, the latest application was filed using the new accelerated examination procedure. The foreign applications pending are in Europe (EPO) and Japan. 36 While we believe that the technology encompassed in the Ethernet Distributed Switch Fabrics patent applications is neither infringed upon by any third party, nor infringes on any prior art of any third party, we are unable to assess the validity, scope, or defensibility of our patent applications, and any challenge to or claim of infringement relating to one or more of the patent applications could materially and adversely affect our business and results of operations. We have not entered into any licensing or franchising agreements for revenue generating purposes. ORGANIZATION We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. We originally were engaged in the business of offering EDGAR filing services to companies outsourcing the formatting and electronic filing of registration statements, periodic reports and other forms with the SEC, but generated minimal revenues from these operations. On October 17, 2003, we completed a business combination transaction with Raptor Networks Technology, Inc., a California corporation ("Raptor"), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary (the "Raptor Acquisition"). Immediately prior to the Raptor Acquisition, we had 4,034,000 shares of common stock issued and outstanding. Of those shares, 3,000,000 were "restricted securities," as defined in Rule 144 ("Rule 144") under the Securities Act, held by our founder, Tina Bogani, who was our sole officer and director immediately prior to the Raptor Acquisition. The remaining 1,034,000 shares were sold and issued by us pursuant to our Registration Statement on Form SB-2 filed with the Commission on May 22, 2002 (Registration No. 333-74846) and were held by approximately 25 holders as of the Raptor Acquisition. Raptor was organized under the laws of the State of California on July 24, 2003. At the time of the Raptor Acquisition, Raptor was a start-up, development stage company working on the design and development of data network switching technologies based on the pre-incorporation design efforts of its founders. Immediately prior to the Raptor Acquisition, Raptor had 19,161,256 shares of its common stock issued and outstanding, all of which were "restricted securities" as defined under Rule 144. Of those shares, 10,000,000 were held by Raptor's three founders in the following amounts: Lyle Pearson, 4,000,000 shares; Eddie Hoffman, 3,000,000 shares; and Ananda Perera, 3,000,000. The remaining 9,161,256 shares were issued to private investors and service providers in reliance upon the exemption from registration available under Section 4(2) of the Securities Act, among others, as transactions not involving a public offering, and were held by approximately 32 holders as of the Raptor Acquisition. The Raptor Acquisition was structured as a share-for-share exchange whereby we issued to Raptor's shareholders, on a one-for-one basis, an aggregate of 19,161,256 shares of our authorized but previously unissued common stock in exchange for the 19,161,256 shares of Raptor common stock collectively held by them. As a material term of the Raptor Acquisition, we redeemed the 3,000,000 shares of our common stock held by Tina Bogani in consideration for us transferring to Ms. Bogani all of the assets held by us immediately prior to the Raptor Acquisition. As a result of these transactions, Raptor became our wholly-owned subsidiary, with the former shareholders of Raptor owning 19,161,256, or 94.9%, of our issued and outstanding common stock. Concurrently with the Raptor Acquisition, Tina Bogani appointed Raptor's directors, Lyle Pearson and Edwin Hoffman, as our directors and, immediately thereafter, Ms. Bogani resigned as our officer and director. Concurrently with Ms. Bogani's resignation, Lyle Pearson and Edwin Hoffman, in their capacity as directors, appointed the officers of Raptor as our officers as follows: Lyle Pearson, President and Chief Executive Officer; Edwin Hoffman, Vice President and Chief Technical Officer; Ananda Perera, Vice President of Engineering; and Bob van Leyen, Chief Financial Officer. As of the date of the Raptor Acquisition, both we and Raptor were start-up, development stage companies and had each realized negligible revenues. We are unable to locate any documentation or other information regarding how the value of our common stock or Raptor's common stock was calculated in determining that the stock be exchanged on a one-for-one basis in the Raptor Acquisition. In addition, there was no public market for either our or Raptor's stock at the time of the Raptor Acquisition on which to base such an evaluation. We have no reason to believe the Raptor Acquisition was not an arms-length transaction or that the terms of the Raptor Acquisition were not reasonable at the time the transactions were entered into. However, we can provide no assurance that our common stock or Raptor's common stock was not over-valued or under-valued in the Raptor Acquisition. 37 Based on our review of the Raptor Acquisition documentation, our discussions with Edwin Hoffman, Ananda Perera and Bob van Leyen (each of which was an officer of Raptor as of the date of the Raptor Acquisition), and our communications with various other parties related to the Raptor Acquisition, we believe that the Raptor Acquisition was planned and structured for the most part by our former CEO and President, Lyle Pearson, while he was CEO and President of Raptor prior to the Raptor Acquisition. Mr. Pearson resigned as our officer and director on March 12, 2004, however, we were able to contact Mr. Pearson to confirm certain details surrounding the Raptor Acquisition as follows: Mr. Pearson informed us that his actions in conjunction with the Raptor Acquisition were based on advice he received from one of the early investors in Raptor, Mr. Mirco Teta. Mr. Teta, who we are informed later deceased in 2005, informed Mr. Pearson approximately in July 2003 that he would be able to secure investors and funding for Raptor contingent upon the consummation of Raptor's reverse merger with a publicly traded company. Mr. Teta then introduced Mr. Pearson to Mr. Keith Webb who, in turn, set up meetings with, and introduced Mr. Pearson to, Sierra West Capital ("Sierra") and an attorney, Mr. Randall Lanham, to assist Raptor in finding a suitable publicly traded "shell" company with which Raptor could enter into a reverse merger transaction. It is our understanding that Sierra enabled Mr. Pearson to make contact with our pre-Raptor Acquisition management, who together with Mr. Pearson and Mr. Lanham negotiated the terms of the Raptor Acquisition. It is our belief that Marc Bogani, brother to Tina Bogani, also had some involvement in bringing us and Raptor together and facilitating the Raptor Acquisition. As consideration for the services rendered by them in connection with the Raptor Acquisition, we granted Keith Webb a total of 250,000 shares of our common stock and we granted Jeff Chatfield (a representative of Sierra) and Mark Bogani each warrants to purchase 100,000 shares of our common stock at an exercise price of $0.01 per share. Messrs. Chatfield and Bogani each exercised their respective warrants in December 2003. To our knowledge, other than (i) the shares granted to Mr. Webb, (ii) the warrants granted to Messrs. Chatfield and Bogani, (iii) the payment of attorneys' fees, and (iv) the issuance of 19,161,256 shares of our common stock in exchange for an equal number of shares of Raptor, no other consideration was paid by us in conjunction with the Raptor Acquisition. The issuances of shares and warrants in connection with the Raptor Acquisition were made in reliance upon the exemption from registration available under Section 4(2) of the Securities Act, among others, as transactions not involving a public offering. This exemption was claimed on the basis that these transactions did not involve any public offering and the purchasers in each offering were accredited or sophisticated and had sufficient access to the kind of information registration would provide. In each case, appropriate investment representations were obtained and certificates representing the securities were issued with restrictive legends. Upon the completion of the Raptor Acquisition, we changed our name to Raptor Networks Technology, Inc., terminated our EDGAR filing services operations and, by and through our subsidiary Raptor, became engaged in the data network switching industry. The Raptor Acquisition has been treated as a reverse merger, with Raptor being considered the acquiring entity for accounting purposes. LEGAL MATTERS 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. However, 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. 38 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS Set forth below is certain information with respect to our directors and executive officers. NAME AGE POSITION WITH COMPANY - ---- --- --------------------- Thomas M. Wittenschlaeger 50 Chief Executive Officer, President, Director and Chairman of the Board Bob van Leyen 64 Chief Financial Officer and Secretary Ken Bramlett 48 Director (1) (2) (4) Larry L. Enterline 55 Director (1) (3) - -------------------- (1) Member of the Audit, Nominating and Governance, and Compensation Committees. (2) Chairperson of the Nominating and Governance Committee. (3) Chairperson of the Audit Committee. (4) Chairperson of the Compensation Committee. THOMAS M. WITTENSCHLAEGER, (age 50), is our Chief Executive Officer, President, a director and Chairman of the Board. Mr. Wittenschlaeger has accumulated more than twenty-three years of experience in the high technology products and services area, much of it in general management with leadership positions in operating units ranging in size from $3 million to $500 million in annual revenues. From 2002 to 2004, he was Senior Vice President of Corporate Development and Chief Technical Officer at Venturi Partners, Inc., a leading provider of information technology and professional staffing services nationwide. From 2000 to 2002, he was Senior Vice President and General Manager of ViaSat Satellite Networks, the commercial arm of ViaSat, Inc. He is a 1979 graduate of the U.S. Naval Academy in Annapolis, Maryland with a B.S. in electrical engineering and post-graduate work in nuclear engineering. He is also a graduate of the UCLA Executive Program in Business and co-founder of UCLA's Executive Program in Marketing. Mr. Wittenschlaeger has recently authored and is pending on 12 Raptor patents related to distributed core transport architectures and processing. Mr. Wittenschlaeger serves on the board of directors of Lantronix, Inc. as Chairman of the Nominating and Governance Committee. Mr. Wittenschlaeger has been our Chairman of the Board, President and Chief Executive Officer since March 15, 2004. LARRY L. ENTERLINE, (age 55), is one of our directors and Chairperson of the Audit Committee. In February 2006, Mr. Enterline was reappointed as the Chief Executive Officer of COMSYS IT Partners, Inc., a leading provider of information technology services, having previously served from December 2000 to September 2004 as the Chief Executive Officer of Venturi Partners, Inc. (the predecessor to COMSYS IT Partners prior to the September 2004 merger between Venturi Partners and COMSYS Holding, Inc.). Mr. Enterline has also served as a director of COMSYS IT Partners since the 2004 merger, previously having served as a director of Venturi Partners from December 2000 to March 2003 and as chairman of the board of Venturi Partners from April 2003 until the date of the merger. From 1989 to November 2000, Mr. Enterline served in various management roles with Scientific Atlanta, Inc., a leading national global manufacturer and supplier of cable network products, the last of which was Corporate Senior Vice President for Worldwide Sales and Service. He also held management positions in the marketing, sales, engineering and products areas with Bailey Controls Company and Reliance Electric Company from 1974 to 1989. Mr. Enterline brings decades of market-defining successes to our Board. Mr. Enterline is also a member of the board of directors of Concurrent Computer Corp. and COMSYS IT Partners, Inc. Mr. Enterline has been one of our directors since October 18, 2004. KEN BRAMLETT, (age 48), is one of our directors and Chairperson of the Nominating and Governance Committee and the Compensation Committee. Mr. Bramlett has served as Senior Vice President and General Counsel of COMSYS IT Partners, Inc., since January 2006. Prior to that he served as a partner with the Charlotte, North Carolina law firm of Kennedy Covington Lobdell & Hickman, L.L.P. from March 2005 to December 2005. Mr. Bramlett is also a director of World Acceptance Corporation, where he has served on the board of directors 39 since 1994. From 1996 to 2004, Mr. Bramlett served as Senior Vice President and General Counsel of Venturi Partners, Inc., a leading national provider of information technology and professional staffing services and from 1990 to 1996 as a partner with the law firm of Robinson, Bradshaw and Hinson, P.A. Mr. Bramlett brings 20 years of experience in corporate law and governance, public and private equity, and mergers and acquisitions to our Board. Mr. Bramlett has been one of our directors since December 2, 2004. BOB VAN LEYEN, (age 64), is our Chief Financial Officer and Secretary. Mr. van Leyen has more than twenty-five years of experience working in the high-tech industry, holding various executive positions in finance, operations and general management. From 2002 to 2003, Mr. van Leyen served as a partner with Tatum CFO, L.L.C. where he provided financial and operational support to start-up companies in the high-tech industry. From 1999 to 2001, he was a divisional Chief Financial Officer at Wyle Electronics. During his twenty-four years of employment, Mr. van Leyen has managed extensive financial operations organizations in Europe, Asia, and the United States, providing financial support to operations. Mr. van Leyen attended the Dutch Institute of Chartered Auditors and holds a Dutch degree equivalent to a U.S. Bachelor's degree in Business Administration. Mr. van Leyen has served as our Chief Financial Officer and Secretary since September 29, 2003. TERM OF OFFICE AND FAMILY RELATIONSHIPS All directors hold office until the next annual meeting of shareholders or until their respective successors are elected or until their earlier death, resignation or removal. Executive officers are appointed by and serve at the discretion of our Board of Directors. There are no family relationships among our executive officers and directors. BOARD COMMITTEES Our Board of Directors currently has an Audit Committee, a Nominating and Governance Committee, and a Compensation Committee. Our Board of Directors has determined that Larry L. Enterline and Ken Bramlett are each "independent" as defined in NASD Marketplace Rule 4200(a)(15) and that Messrs. Enterline and Bramlett meet the applicable NASD listing standards for designation as an "Audit Committee Financial Expert." AUDIT COMMITTEE The Audit Committee consists of two Board members, Larry L. Enterline and Ken Bramlett. Mr. Enterline is the chairperson of the Audit Committee. The duties of the Audit Committee include meeting with our independent public accountants to review the scope of the annual audit and to review our quarterly and annual financial statements before the statements are released to our shareholders. The Audit Committee also evaluates the independent public accountants' performance and has sole authority to appoint or replace the independent auditor (subject, if applicable, to shareholder ratification) and to determine whether the independent public accounting firm should be retained for the ensuing fiscal year. In addition, the Audit Committee reviews our internal accounting and financial controls and reporting systems practices. A copy of the Audit Committee's current charter may be found at our website at www.raptor-networks.com. NOMINATING AND GOVERNANCE COMMITTEE The Nominating and Governance Committee consists of two Board members, Larry L. Enterline and Ken Bramlett. Mr. Bramlett is the chairperson of the Nominating and Governance Committee. The Nominating and Governance Committee identifies and reviews the qualifications of candidate nominees to the Board of Directors. The Nominating and Governance Committee utilizes a variety of methods for identifying and evaluating nominees for director, including candidates that may be referred by stockholders. Stockholders that desire to recommend candidates for the board for evaluation may do so by contacting our Secretary in writing, including the candidate's name and qualifications and a statement from the candidate that he or she consents to being named in our proxy statement and will serve as a director if elected. Candidates may also come to the attention of the Nominating and Governance Committee through current board members, professional search firms and other persons. A copy of the Nominating and Governance Committee's current charter may be found at our website at www.raptor-networks.com. 40 COMPENSATION COMMITTEE The Compensation Committee consists of two Board members, Larry L. Enterline and Ken Bramlett. Mr. Bramlett is the chairperson of the Compensation Committee. The Compensation Committee is responsible for advising the Board of Directors regarding our responsibilities relating to compensation of our executive officers and Board members. The Compensation Committee is also responsible for evaluating and recommending to the Board of Directors our executive compensation plans, policies and programs. A copy of the Compensation Committee's current charter may be found at our website at www.raptor-networks.com. CODE OF ETHICS Our board of directors has adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees and an additional Code of Ethics that applies to our Chief Executive Officer and our senior financial officers. We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to amendments to or waivers from provisions of these codes that relate to one or more of the items set forth in Item 406(b) of Regulation S-B by describing on our Internet website, located at www.raptor-networks.com, within four business days following the date of a waiver or a substantive amendment, the date of the waiver or amendment, the nature of the amendment or waiver, and the name of the person to whom the waiver was granted. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires our executive officers and directors, and persons who beneficially own more than 10% of our common stock, to file initial reports of ownership and reports of changes in ownership with the SEC. These officers, directors and shareholders are required by SEC regulations to furnish us with copies of all such reports that they file. Based solely upon a review of copies of these reports furnished to us during 2007 and thereafter, or written representations received by us from reporting persons that no other reports were required, we believe that all Section 16(a) filing requirements applicable to our reporting persons during 2007 were complied with. 41 EXECUTIVE COMPENSATION AND RELATED INFORMATION COMPENSATION OF EXECUTIVE OFFICERS The following section contains information about the compensation paid to our executive officers and directors during the years ended December 31, 2006 and 2007. SUMMARY COMPENSATION TABLE The following table provides information concerning the compensation for the years ended December 31, 2006 and 2007 for our principal executive officer and our principal financial officer, who were the only persons that served as executive officers during 2007 (collectively, the "named executive officers"). SUMMARY COMPENSATION TABLE NON-EQUITY NONQUALIFIED INCENTIVE DEFERRED STOCK OPTION PLAN COMPENSATION ALL OTHER NAME AND SALARY BONUS AWARDS AWARDS COMPENSATION EARNINGS COMPENSATION TOTAL PRINCIPAL POSITION YEAR ($) ($) ($) ($)(1) ($) ($) ($) ($) - --------------------------- ---- ---------- --------- ------ -------- ------------ ------------ ------------ ------- Thomas M. Wittenschlaeger, 2006 164,375(2) 70,000(3) -- 148,050 -- -- 30,613(5) 413,038 Chief Executive Officer 2007 180,000(2) 10,000(4) -- 162,269 -- -- 33,437(6) 385,706 and President Bob van Leyen, 2006 134,377(7) 30,000(8) -- 18,750 -- -- 17,983(9) 201,110 Chief Financial Officer 2007 150,000(7) 10,000(4) -- 8,403 -- -- 22,608(10) 191,011 - -------------------- (1) This column represents the dollar amount recognized for financial statement reporting purposes with respect to the fiscal year specified in the table for the fair value of stock options granted to each of our named executive officers calculated in accordance with SFAS 123R. Pursuant to SEC rules, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to these option grants, refer to Note 1 of our financial statements and related notes beginning on page F-1 of this prospectus. These amounts reflect only our accounting expense for these option grants and do not correspond to the actual value that may be recognized by our named executive officers. See our "Outstanding Equity Awards at December 31, 2007" table below for more information on options held by the named executive officers. (2) Effective August 8, 2006, our Compensation Committee approved an increase to Mr. Wittenschlaeger's annual salary from $155,000 to $180,000. Mr. Wittenschlaeger's annual salary had previously been decreased from $195,000 to $155,000 in November 2004 in an effort to reduce our expense run rates. (3) Consists of a $70,000 cash performance bonus in August 2006. (4) Consists of a $10,000 cash performance bonus in September 2007. (5) Consists of $23,730 in reimbursement of living expenses for an apartment in Southern California and $6,883 in health and life insurance premiums. (6) Consists of $24,000 in reimbursement of living expenses for an apartment in Southern California and $9,437 in health and life insurance premiums. (7) Effective August 8, 2006, our Compensation Committee approved an increase to Mr. van Leyen's annual salary from $125,000 to $150,000. Mr. van Leyen's annual salary had previously been decreased from $190,000 to $125,000 in November 2004 in an effort to reduce our expense run rates. (8) Consists of a $30,000 cash performance bonus in August 2006. (9) Consists of $17,983 in health and life insurance premiums. (10) Consists of $22,608 in health and life insurance premiums. 42 EMPLOYMENT AGREEMENTS AND EXECUTIVE COMPENSATION There are no employment contracts, termination agreements, or change-in-control arrangements between us and any of our named executive officers. The Compensation Committee reviews and, if deemed appropriate, adjusts the annual salaries of our named executive officers on at least an annual basis. The Compensation Committee may from time to time grant performance or similar cash bonuses to our named executive officers at its discretion. The Compensation Committee may also periodically award options or restricted stock grants to our named executive officers under our existing option and incentive plans at its discretion. OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END The following table sets forth information about outstanding equity awards held by our named executive officers as of December 31, 2007. OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2007 STOCK AWARDS ----------------------------------------- EQUITY EQUITY INCENTIVE OPTION AWARDS INCENTIVE PLAN ----------------------------------------------------------- PLAN AWARDS: EQUITY NUMBER AWARDS: MARKET OR INCENTIVE OF MARKET NUMBER PAYOUT PLAN SHARES VALUE OF OF VALUE OF AWARDS: OR SHARES UNEARNED UNEARNED NUMBER NUMBER NUMBER UNITS OR SHARES, SHARES, OF OF OF OF UNITS OF UNITS UNITS OR SECURITIES SECURITIES SECURITIES STOCK STOCK OR OTHER OTHER UNDERLYING UNDERLYING UNDERLYING THAT THAT RIGHTS RIGHTS UNEXERCISED UNEXERCISED UNEXERCISE OPTION HAVE HAVE THAT THAT OPTIONS OPTIONS UNEARNED EXERCISE OPTION NOT NOT HAVE NOT HAVE NOT (#) (#) OPTIONS PRICE EXPIRATION VESTED VESTED VESTED VESTED NAME EXERCISABLE UNEXERCISABLE (#) ($) DATE (#) ($) (#) ($) - ----------------- ----------- ------------- ---------- -------- ---------- ------ ------ ------ ------ Thomas M. Wittenschlaeger 350,000 -- -- 1.00 07/15/2012 -- -- -- -- Bob van Leyen 300,000 -- -- 1.00 09/29/2011 -- -- -- -- - -------------------- 43 COMPENSATION OF DIRECTORS Each of our non-employee directors is entitled to receive cash compensation in the amount of $15,000 per year for service on our board of directors. We reimburse all directors for out-of-pocket expenses incurred in connection with attendance at board and committee meetings. We currently have a policy in place to grant each non-employee director an option to purchase shares of our common stock on the date of his or her commencement of service as a director. We may also periodically award options or warrants to our directors under our existing option and incentive plans. The following table provides information concerning the compensation of our directors for the year ended December 31, 2007. DIRECTOR COMPENSATION CHANGE IN PENSION VALUE AND NON-EQUITY NONQUALIFIED FEES EARNED INCENTIVE DEFERRED OR PAID STOCK OPTION PLAN COMPENSATION ALL OTHER IN CASH AWARDS AWARDS COMPENSATION EARNINGS COMPENSATION TOTAL NAME ($) ($) ($)(1) ($) ($) ($) ($) - ------------------------- ----------- -------- ---------- ------------ ------------ ------------ --------- Larry L. Enterline 15,000 -- 28,356(2) -- -- -- 43,356 Ken Bramlett 15,000 -- 33,104(3) -- -- -- 48,104 Albert Wong 3,750(4) -- -- -- -- -- 3,750 - -------------------- (1) This column represents the dollar amount recognized for financial statement reporting purposes with respect to the year ended December 31, 2007 for the fair value of stock options granted to each of our directors calculated in accordance with SFAS 123R. Pursuant to SEC rules, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to these option grants, refer to Note 1 of our financial statements and related notes beginning on page F-1 of this prospectus. These amounts reflect only our accounting expense for these option grants and do not correspond to the actual value that may be recognized by our directors. (2) At December 31, 2007, Mr. Enterline held options to purchase an aggregate of 100,000 shares of common stock at an exercise price of $1.00 per share, of which 91,666 options were vested at December 31, 2007. The remaining 8,334 options vested on February 15, 2008. (3) At December 31, 2007, Mr. Bramlett held options to purchase an aggregate of 100,000 shares of common stock at an exercise price of $1.00 per share, of which all 100,000 options were vested at December 31, 2007. (4) On February 28, 2007, Albert Wong announced his intention to resign as our director effective April 30, 2007, the date of our 2007 annual meeting of shareholders. 44 STOCK OPTION PLAN GENERAL Our 2005 Stock Plan was approved by our Board of Directors on April 7, 2005, approved by our shareholders on June 9, 2005, and amended and restated as the First Amended and Restated 2005 Stock Plan ("2005 Plan") by our Board of Directors on June, 29, 2007. We filed a registration statement on Form S-8 with the SEC in May 2007 to cover the issuance of up to 3,000,000 shares of common stock underlying options and stock purchase rights authorized for issuance under the 2005 Plan and qualified for issuance the underlying securities with the California Department of Corporations in July, 2007. All stock options issued prior to shareholder approval of our 2005 Plan were granted outside of a formal stock option plan ("Non-Plan Options"). As of April 7, 2008, options to purchase a total of 1,145,000 shares of common stock were outstanding under Non-Plan Options. As of April 7, 2008, there were 1,321,333 outstanding options to purchase common stock under the 2005 Plan. Excluding these 1,321,333 outstanding options, 1,678,667 shares remain available for issuance under the 2005 Plan, subject to the limitations of authorized common stock. We anticipate that future stock options will be issued pursuant to our 2005 Plan or other stock option plans as may be approved by our Board and shareholders in the future. SHARES SUBJECT TO THE PLAN A total of 3,000,000 shares of common stock are authorized for issuance under the 2005 Plan. Any shares of common stock that are subject to an award but are not used because the terms and conditions of the award are not met, or any shares that are used by participants to pay all or part of the purchase price of any option, may again be used for awards under the 2005 Plan. ADMINISTRATION The 2005 Plan is to be administered by our Board of Directors or an appropriate committee of our Board of Directors. It is the intent of the 2005 Plan that it be administered in a manner such that option grants and exercises would be "exempt" under Rule 16b-3 of Exchange Act. Our Board of Directors or an appropriate committee is empowered to select those eligible persons to whom options shall be granted under the 2005 Plan, to determine the time or times at which each option or stock purchase right shall be granted, whether options will be incentive stock options ("ISOs") or nonqualified stock options ("NQOs"), and the number of shares to be subject to each option, and to fix the time and manner in which each such option may be exercised, including the exercise price and option period, and other terms and conditions of such options, all subject to the terms and conditions of the 2005 Plan. Our Board of Directors or an appropriate committee has sole discretion to interpret and administer the 2005 Plan, and our decisions regarding the 2005 Plan are final. The 2005 Plan may be wholly or partially amended or otherwise modified, suspended or terminated at any time and from time to time by our Board of Directors. Neither our Board of Directors nor any committee may materially impair any outstanding options without the express consent of the optionee or increase the number of shares subject to the 2005 Plan, materially increase the benefits to optionees under the 2005 Plan, materially modify the requirements as to eligibility to participate in the 2005 Plan or alter the method of determining the option exercise price without shareholder approval. No option may be granted under the 2005 Plan after April 7, 2015. 45 OPTION TERMS ISOs granted under the 2005 Plan must have an exercise price of not less than 100% of the fair market value of the common stock on the date the ISO is granted and must be exercised, if at all, within ten years from the date of grant. In the case of an ISO granted to an optionee who owns more than 10% of our total voting securities on the date of grant, the exercise price may not be less than 110% of the fair market value of the common stock on the date of grant, and the option period may not exceed five years. NQOs granted under the 2005 Plan must have an exercise price of not less than 85% of the fair market value of the common stock on the date the NQO is granted. Options may be exercised during a period of time fixed by our Board of Directors or an appropriate committee, except that no option may be exercised more than ten years after the date of grant. In the discretion of our Board of Directors or an appropriate committee, payment of the purchase price for the shares of stock acquired through the exercise of an option may be made in the manner and for the type of consideration determined by our Board of Directors or an appropriate committee, which may include cash, check, one or more promissory notes, shares of our common stock, consideration received under a cashless exercise program implemented in connection with the 2005 Plan, or any combination of the foregoing. STOCK PURCHASE RIGHTS Stock purchase rights may be issued either alone, in addition to, or in tandem with other awards granted under the 2005 Plan and/or cash awards made outside of the 2005 Plan. After the administrator determines that it will offer stock purchase rights under the 2005 Plan, it must advise the offeree in writing or electronically of the terms, conditions and restrictions related to the offer, including the number of shares that the person will be entitled to purchase, the price to be paid, and the time within which the person must accept the offer by execution of a restricted stock purchase agreement. Unless the administrator determines otherwise, the restricted stock purchase agreement will grant us a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser's service with us for any reason. The purchase price for shares repurchased pursuant to the restricted stock purchase agreement will be the original price paid by the purchaser. The purchase price may be paid by cancellation of any indebtedness of the purchaser to us. The repurchase option will lapse at a rate determined by the administrator. Except with respect to shares purchased by officers, directors and consultants, the repurchase option will in no case lapse at a rate of less than 20% per year over five years from the date of purchase. FEDERAL INCOME TAX CONSEQUENCES Holders of NQOs do not realize income as a result of a grant of the option, but normally realize compensation income upon exercise of an NQO to the extent that the fair market value of the shares of common stock on the date of exercise of the NQO exceeds the exercise price paid. We will be required to withhold taxes on ordinary income realized by an optionee upon the exercise of a NQO. In the case of an optionee subject to the "short-swing" profit recapture provisions of Section 16(b) of the Exchange Act, the optionee realizes income only upon the lapse of the six-month period under Section 16(b), unless the optionee elects to recognize income immediately upon exercise of his or her option. Holders of ISOs will not be considered to have received taxable income upon either the grant or the exercise of the option. Upon the sale or other taxable disposition of the shares, long-term capital gain will normally be recognized on the full amount of the difference between the amount realized and the option exercise price paid if no disposition of the shares has taken place within either two years from the date of grant of the option or one year from the date of exercise. If the shares are sold or otherwise disposed of before the end of the one-year or two-year periods, the holder of the ISO must include the gain realized as ordinary income to the extent of the lesser of the fair market value of the option stock minus the option price, or the amount realized minus the option price. Any gain in excess of these amounts, presumably, will be treated as capital gain. We will be entitled to a tax deduction in regard to an ISO only to the extent the optionee has ordinary income upon the sale or other disposition of the option shares. 46 Upon the exercise of an ISO, the amount by which the fair market value of the purchased shares at the time of exercise exceeds the option price will be an "item of tax preference" for purposes of computing the optionee's alternative minimum tax for the year of exercise. If the shares so acquired are disposed of prior to the expiration of the one-year and two-year periods described above, there should be no "item of tax preference" arising from the option exercise. Stock purchase rights will generally be taxed in the same manner as NQOs. However, restricted stock is generally purchased upon the exercise of the stock purchase rights. At the time of purchase, restricted stock is subject to a "substantial risk of forfeiture" within the meaning of Section 83 of the Internal Revenue Code of 1986, as amended ("Code"). As a result, the purchaser will not recognize ordinary income at the time of purchase. Instead, the purchaser will recognize ordinary income on the dates when the stock ceases to be subject to a substantial risk of forfeiture. The stock will generally cease to be subject to a substantial risk of forfeiture when it is no longer subject to our right to repurchase the stock upon the purchaser's termination of service. At those times, the purchaser will recognize ordinary income measured as the difference between the purchase price and the fair market value of the stock on the date the stock is no longer subject to a substantial risk of forfeiture. The purchaser may accelerate to the date of purchase his or her recognition of ordinary income, if any, and the beginning of any capital gain holding period by timely filing an election pursuant to Section 83(b) of the Code. In that event, the ordinary income recognized, if any, is measured as the difference between the purchase price and the fair market value of the stock on the date of purchase and the capital gain holding period commences on that date. The ordinary income recognized by a purchaser who is an employee will be subject to tax withholding by us. THE TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL INFORMATION ONLY AND IS BASED UPON PRESENT LAW. EACH HOLDER OF OPTIONS UNDER THE 2005 PLAN SHOULD CONSULT HIS OR HER OWN TAX ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES OF THE TRANSACTION TO HIM OR HER, INCLUDING APPLICATION AND EFFECT OF FEDERAL, STATE, LOCAL AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER LAWS. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 7-109-102 of the Colorado Business Corporations Act (the "Colorado Act") authorizes a Colorado corporation to indemnify any director against liability incurred in any proceeding if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. Unless limited by a corporation's articles of incorporation, Section 7-109-105 of the Colorado Act authorizes a director to apply for indemnification to the court conducting the proceeding or another court of competent jurisdiction. Unless limited by the articles of incorporation, Section 7-109-107 of the Colorado Act extends this same right to officers of a corporation as well. 47 Unless limited by a corporation's articles of incorporation, Section 7-109-103 of the Colorado Act requires that a Colorado corporation indemnify a director who was wholly successful in defending any proceeding to which he or she was a party against reasonable expenses incurred in connection therewith. Unless limited by the articles of incorporation, Section 7-109-107 of the Colorado Act extends this same protection to officers of a corporation as well. Pursuant to Section 7-109-104 of the Colorado Act, a Colorado corporation may advance a director's expenses incurred in defending any action or proceeding upon receipt of an undertaking and a written affirmation of his or her good faith belief that he or she has met the standard of conduct specified in Section 7-109-102 described above. Unless limited by the articles of incorporation, Section 7-109-107 of the Colorado Act extends this same protection to officers of a corporation as well. Regardless of whether a director or officer has the right to indemnity, Section 7-109-108 of the Colorado Act allows a Colorado corporation to purchase and maintain insurance on such directors or officers behalf against liability resulting from his or her role as director or officer. Our Articles of Incorporation do not limit any of the rights afforded to our directors and officers under the Colorado Act and Article VI of our Bylaws states that any director or officer who is involved in litigation by reason of his or her position with us as a director or officer shall be indemnified and held harmless by us to the fullest extent authorized by law as it now exists or may subsequently be amended (but, in the case of any such amendment, only to the extent that such amendment permits the corporation to provide broader indemnification rights). Our directors and officers are also presently covered by an insurance policy indemnifying them against certain liabilities, including certain liabilities arising under the Securities Act, which might be incurred by them in such capacities and against which they may not be indemnified by us. We believe that the indemnification and insurance provided to our directors and officers is necessary to attract and retain qualified persons as directors and officers. To the extent indemnification for liabilities arising under the Securities Act of 1933 may be permitted to our directors, officers and controlling persons under the above provisions, or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS There were no related party transactions in 2007 that require disclosure. 48 PRINCIPAL STOCKHOLDERS The following table sets forth, as of April 7, 2008, certain information with respect to the beneficial ownership of our stock by (i) each of our named executive officers, (ii) each of our directors, (iii) each person known to us to be the beneficial owner of more than 5% of each class of our outstanding voting securities, and (iv) all of our directors and executive officers as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission ("SEC"), and includes voting or investment power with respect to the securities. To our knowledge, except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. Shares of common stock underlying derivative securities, if any, that currently are exercisable or convertible or are scheduled to become exercisable or convertible for or into shares of common stock within 60 days after the date of the table are deemed to be outstanding in calculating the percentage ownership of each listed person or group but are not deemed to be outstanding as to any other person or group. Percentage of beneficial ownership is based on 68,167,374 shares of common stock outstanding as of April 7, 2008. NUMBER OF SHARES OF COMMON STOCK PERCENT OF COMMON STOCK NAME OF BENEFICIAL OWNER(1) BENEFICIALLY OWNED BENEFICIALLY OWNED - --------------------------- ------------------ ------------------ Thomas M. Wittenschlaeger 3,350,000 (2) 4.89% Bob van Leyen 700,000 (3) 1.02% Ken Bramlett 100,000 (4) * Larry L. Enterline 100,000 (5) * All executive officers and directors as a group (4 persons) 4,250,000 (6) 6.16% Castlerigg Master Investments Ltd. 40 West 57th St 26th Floor 7,329,889 (7) 9.99% New York, NY 10019 * Less than 1%. - -------------------- (1) Unless otherwise indicated, the address is c/o Raptor Networks Technology, Inc., 1241 E. Dyer Road, Suite 150, Santa Ana, California 92705. (2) Thomas M. Wittenschlaeger is our President, Chief Executive Officer and Chairman of the Board. Includes 350,000 shares of common stock issuable upon the exercise of options which were exercisable as of April 7, 2008 or exercisable within 60 days after April 7, 2008. (3) Bob van Leyen is our Chief Financial Officer and Secretary. Includes 300,000 shares of common stock issuable upon the exercise of options which were exercisable as of April 7, 2008 or exercisable within 60 days after April 7, 2008. (4) Ken Bramlett is one of our directors. Represents 100,000 shares of common stock issuable upon the exercise of options which were exercisable as of April 7, 2008 or exercisable within 60 days after April 7, 2008. (5) Larry L. Enterline is one of our directors. Represents 100,000 shares of common stock issuable upon the exercise of options which were exercisable as of April 7, 2008 or exercisable within 60 days after April 7, 2008. (6) Represents 3,000,000 shares of common stock and 350,000 shares issuable upon the exercise of options held by Thomas M. Wittenschlaeger; 400,000 shares of common stock and 300,000 shares issuable upon the exercise of options held by Bob van Leyen; 100,000 shares issuable upon the exercise of options held by Ken Bramlett; and 100,000 shares issuable upon the exercise of options held by Larry L. Enterline. 49 (7) Represents 2,125,000 issued and outstanding shares of common stock and 5,204,889 shares of common stock underlying convertible notes and warrants held by Castlerigg Master Investments Ltd. ("Master"). The number of shares beneficially owned by Master is capped by a contractual 9.99% beneficial ownership limitation set forth in the convertible notes and warrants held by Master. If the 9.99% beneficial ownership limitation is disregarded, Master would beneficially own 2,125,000 shares of common stock, approximately 14,229,312 shares underlying convertible notes and approximately 33,837,997 shares underlying warrants held by it. The actual number of shares of common stock issuable upon conversion of the convertible notes and exercise of the warrants may be subject to adjustment and could be materially more than 14,229,312 and 33,837,997 shares, respectively, depending on a number of factors including, among other factors, the future market price of our common stock and the price at which we may sell or may be deemed to have sold common stock in the future. Sandell Asset Management Corp. ("SAMC") is the investment manager of Master. Thomas Sandell is the sole shareholder of SAMC and may be deemed to have voting and dispositive power over the shares beneficially owned by Master. No other natural person has voting or dispositive power over the shares owned by Master. Castlerigg International Ltd. ("Castlerigg International") is the controlling shareholder of Castlerigg International Holdings Limited ("Holdings"). Holdings is the controlling shareholder of Master. Each of Holdings and Castlerigg International may be deemed to share beneficial ownership of the shares beneficially owned by Master. SAMC, Mr. Sandell, Holdings and Castlerigg International each disclaims beneficial ownership of the securities with respect to which indirect beneficial ownership is described. 50 SELLING SECURITY HOLDERS This prospectus covers the offer and sale by the selling security holders of up to an aggregate of 27,575,824 shares of common stock, including an aggregate of 21,033,457 issued and outstanding shares of our common stock and an aggregate of 6,542,367 shares of our common stock underlying warrants. The following table sets forth, to our knowledge, certain information about the selling security holders as of April 7, 2008, the date of the table, based on information furnished to us by the selling security holders. Except as indicated in the footnotes or private placement description following the table, each selling security holder has indicated to us that it is acting individually, not as a member of a group, and none of the selling security holders or their affiliates has held any position or office or had any other material relationship with us in the past three years. Beneficial ownership is determined in accordance with the rules of the Commission, and includes voting or investment power with respect to the securities. To our knowledge, except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. Shares of common stock underlying derivative securities, if any, that currently are exercisable or convertible or are scheduled to become exercisable or convertible for or into shares of common stock within 60 days after the date of the table are deemed to be outstanding in calculating the percentage ownership of each listed person or group but are not deemed to be outstanding as to any other person or group. Shares shown as beneficially owned after the offering assume that all shares being offered are sold. The shares of common stock being offered under this prospectus may be offered for sale from time to time during the period the registration statement of which this prospectus is a part remains effective, by or for the accounts of the selling security holders described below. SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- DMK Investments, LLC 138,889 (1) * 138,889 (d) (1) - - Uptrend Investment, Inc. 555,556 (2) * 555,556 (d) (2) - - Transglobal Investments, LLC 555,556 (3) * 555,556 (d) (3) - - Brandan M. Adams 50,000 (4) * 50,000 (e) (4) - - Bruce Charles Adams 332,500 (5) * 187,500 (e) (5) 145,000 * Linda Sue Adams 75,000 (6) * 62,500 (e) (6) 12,500 * Carla Adams-Goldman 31,250 (7) * 31,250 (e) (7) - - Steven J. and Donna J. Adelsberg 62,500 (8) * 62,500 (e) (8) - - Kathy Allred and Jerral Allred 62,500 (9) * 62,500 (e) (9) - - Robert F. Bader, M.D. 93,750 (10) * 93,750 (e) (10) - - Michael Bain 100,000 (11) * 100,000 (e) (11) - - Darryl Baker 93,750 (12) * 93,750 (e) (12) - - Gary Bakker and Connie Bakker JTWROS 62,500 (13) * 62,500 (e) (13) - - Rajeev Bal and Mari Miller-Bal JT TEN 31,250 (14) * 31,250 (e) (14) - - Morgan L. Beatty and Winnie M. Huff, TTEEs, Beatty-Huff Family Trust 125,000 (15) * 125,000 (e) (15) - - 51 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- Billy R. Beck 50,000 (16) * 50,000 (e) (16) - - Todd William Beck 81,250 (17) * 81,250 (e) (17) - - David B. Becker 125,000 (18) * 125,000 (e) (18) - - Jerry H. Beller and Cynthia H. Beller 62,500 (19) * 62,500 (e) (19) - - Mark Berman and Sharon Berman, TTEEs, 1999 Berman Family Trust dated 3-23-1999 (a) 62,500 (20) * 62,500 (e) (20) - - Donald E. Betz 125,000 (21) * 125,000 (e) (21) - - Shawn D. Bird 62,500 (22) * 62,500 (e) (22) - - Robert D. Bjork MDSC MPP& Trust #001 2002 Account 25,000 (23) * 25,000 (e) (23) - - Andrea Brito Bokosky 62,500 (24) * 62,500 (e) (24) - - Fred J. Boone 62,500 (25) * 62,500 (e) (25) - - Greg Bourdon and Patricia Bourdon 50,000 (26) * 50,000 (e) (26) - - Gregory Lee Brandon 31,250 (27) * 31,250 (e) (27) - - Dr. Larry B. Brashears and Linda V. Brashears 31,250 (28) * 31,250 (e) (28) - - Stanley Clifton Brooks (a) 1,312,864 (29) 1.92% 250,000 (e) (29) - - Gary F. Brown 250,000 (30) * 250,000 (e) (30) - - Randy S. Carlson 31,250 (31) * 31,250 (e) (31) - - Channel Capital, LLC 125,000 (32) * 125,000 (e) (32) - - Robert M. Clark 62,500 (33) * 62,500 (e) (33) - - David C. Clark and Sarah J. Clark JT TEN 62,500 (34) * 62,500 (e) (34) - - Andrea Leigh Cochran and Lyndsey Anne Aldridge 500,000 (35) * 500,000 (e) (35) - - John Cochran and Carole Cochran 1,000,000 (36) 1.46% 1,000,000 (e) (36) - - Melvin Cohen 31,250 (37) * 31,250 (e) (37) - - David C. Collins and Maura Kehoe Collins 54,500 (38) * 54,500 (e) (38) - - Nancy Boswell Colver 31,250 (39) * 31,250 (e) (39) - - Harold Rex Combs 37,500 (40) * 37,500 (e) (40) - - Larry R. Conley and Jan Conley JTWROS 12,500 (41) * 12,500 (e) (41) - - Beverly J. Copp 62,500 (42) * 62,500 (e) (42) - - Samuel W. Cowan 90,000 (43) * 62,500 (e) (43) 27,500 * David R. Cravens 93,750 (44) * 93,750 (e) (44) - - Chris Cruttenden 62,500 (45) * 62,500 (e) (45) - - Clark Cunningham 125,000 (46) * 125,000 (e) (46) - - Mary Chin Dang, M.D., TTEE, Mary Chin Dang Revocable Trust u/a 10/16/1979 31,250 (47) * 31,250 (e) (47) - - Bruce D. Davidson and Stacy L. Griffith 62,500 (48) * 62,500 (e) (48) - - Delmar E. Demaree, Jr., TTEE, Delmar E. Demaree Jr. Revocable Trust 250,000 (49) * 250,000 (e) (49) - - Frank A. Dobrovich 187,500 (50) * 62,500 (e) (50) - - 52 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- Frank A. Dobrovich and Linda K. Dobrovich 125,000 (51) * 125,000 (e) (51) - - Arthur W. Doty 31,250 (52) * 31,250 (e) (52) - - Stephen K. Drabek 62,500 (53) * 62,500 (e) (53) - - Scott Eisgrau and Suzanne Eisgrau 62,500 (54) * 62,500 (e) (54) - - Robert L. Eskay, Jr. and Jacqueline B. Eskay 62,500 (55) * 62,500 (e) (55) - - Ann Y. Ferrill 31,250 (56) * 31,250 (e) (56) - - Charles B. Ferrill (a) 18,750 (57) * 18,750 (p) (57) - - Michael S. Fitzgerald 62,500 (58) * 62,500 (e) (58) - - Daniel Forbes 375,000 (59) * 375,000 (e) (59) - - Darren E. Foster and Christy F. Foster 62,500 (60) * 62,500 (e) (60) - - Jeffrey W. Foster and Christy F. Foster JT TEN 62,500 (61) * 62,500 (e) (61) - - Christy F. Foster, TTEE, Farrell Family Trust - Trust B DTD 08/24/68 as restated 04/17/81 62,500 (62) * 62,500 (e) (62) - - Steven W. Foster and Christy F. Foster, TTEEs, The Foster Family Trust DTD 2/3/87 62,500 (63) * 62,500 (e) (63) - - Brian Frenzel 125,000 (64) * 125,000 (e) (64) - - Robert Y. Fukunaga (a) 70,000 (65) * 70,000 (p) (65) - - Luis Garcia and Iris Garcia 300,000 (66) * 300,000 (e) (66) - - William Tolin Gay 62,500 (67) * 62,500 (e) (67) - - Anthony R. Giglia 31,250 (68) * 31,250 (e) (68) - - Manny Gutsche 31,250 (69) * 31,250 (e) (69) - - Jeff Halpin 62,500 (70) * 62,500 (e) (70) - - Gregory Hardin 62,500 (71) * 62,500 (e) (71) - - John R. Harrington, Jr. 200,000 (72) * 75,000 (e) (72) - - Kenneth S. Head and Elizabeth W. Head JT TEN 62,500 (73) * 62,500 (e) (73) - - Joan E. Heiser 93,750 (74) * 31,250 (e) (74) - - J. Ken Heiser 93,750 (75) * 31,250 (e) (75) - - James K. Heiser and Joan E. Heiser JTWROS 62,500 (76) * 62,500 (e) (76) - - M. Charlene Hill and Carl Hill 31,250 (77) * 31,250 (e) (77) - - Howard F. Hill and Patricia A. Hill, TTEEs, The Hill Family Trust 62,500 (78) * 62,500 (e) (78) - - Don Ho, TTEE, Don Ho Revocable Living Trust 62,500 (79) * 62,500 (e) (79) - - William L. Holder, Jr. and Melinda J. Holder 62,500 (80) * 62,500 (e) (80) - - Dana Horne 62,500 (81) * 62,500 (e) (81) - - Michael Evan Jacques and Kim Diane Jacques JTWROS 93,750 (82) * 93,750 (e) (82) - - C. Kenneth Johnson 31,250 (83) * 31,250 (e) (83) - - Mark Porte Johnson 254,500 (84) * 162,500 (e) (84) 92,000 * Jennifer M. Johnson 25,000 (85) * 25,000 (e) (85) - - 53 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- Michael A. Kamen 125,000 (86) * 125,000 (e) (86) - - Helen Keilholtz 62,500 (87) * 62,500 (e) (87) - - Carl A. Keys, Jr. and Carol J. Keys (a) 41,250 (88) * 31,250 (e) (88) 10,000 * Thomas Kohli 62,500 (89) * 62,500 (e) (89) - - Frank X. Konigseder 62,500 (90) * 62,500 (e) (90) - - Kurt L. Konigseder 62,500 (91) * 62,500 (e) (91) - - Bruce M. Krall and Elisa San Miguel Krall, TTEEs, BEK Living Trust 2004 (a) 87,500 (92) * 87,500 (e) (92) - - Thomas R. Lawrence 31,250 (93) * 31,250 (e) (93) - - Augustine Lueras 62,500 (94) * 62,500 (e) (94) - - Paul H. Lundeen (a) 32,500 (95) * 32,500 (p) (95) - - Stephen Thomas Lutz and Nancy Denise Stutler 31,250 (96) * 31,250 (e) (96) - - T. Lynch 62,438 (97) * 62,438 (e) (97) - - William Madden 31,250 (98) * 31,250 (e) (98) - - J. David Maddox 87,500 (99) * 87,500 (e) (99) - - Susan C. Maki 31,250 (100) * 31,250 (e) (100) - - Beverly R. Marr 31,250 (101) * 31,250 (e) (101) - - John L. Marr 31,250 (102) * 31,250 (e) (102) - - Karen Mayfield 31,250 (103) * 31,250 (e) (103) - - Sam Maywood MD and Dawn Maywood JT TEN 250,000 (104) * 250,000 (e) (104) - - Kevin McKiever 31,250 (105) * 31,250 (e) (105) - - William H. McLeod 62,500 (106) * 62,500 (e) (106) - - Robert W. Mercer 62,500 (107) * 62,500 (e) (107) - - Alwin Michaelsen (a) 735,000 (108) 1.08% 625,000 (e) (108) 110,000 * Russell Wayne Moore 62,500 (109) * 62,500 (e) (109) - - David Mowbray 59,500 (110) * 59,500 (e) (110) - - Thomas A. Murrell and Donna M. Murrell, TTEEs, Thomas A. Murrell Family Trust 250,000 (111) * 250,000 (e) (111) - - Jerry W. Neel, Jr. 31,250 (112) * 31,250 (e) (112) - - Barry Mitchell Neichin 62,500 (113) * 62,500 (e) (113) - - Manuel Nevarez and Leticia Nevarez JTWROS 31,250 (114) * 31,250 (e) (114) - - Timothy C. Nicely and Marylyn K. Paik-Nicely JT TEN 62,500 (115) * 62,500 (e) (115) - - Barry Niswanger 62,500 (116) * 62,500 (e) (116) - - Donald M. Norman and Cynthia S. Norman, TTEEs, The Norman Living Trust 62,500 (117) * 62,500 (e) (117) - - Jeffrey S. Ortman 87,500 (118) * 87,500 (e) (118) - - Oweida Orthopedic Association PA Emp PSP TR, FBO: Sami J. Oweida 217,250 (119) * 217,250 (e) (119) - - Peter M. Pallotto 31,250 (120) * 31,250 (e) (120) - - Ronald J. Pang, M.D., TTEE, Ronald J. Pang Revocable Living Trust u/a 6-12-1991 78,500 (121) * 62,500 (e) (121) 16,000 * 54 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- Carol Ann Pilger 118,750 (122) * 118,750 (e) (122) - - Nicholas J. Pilger (a) 155,750 (123) * 155,750 (p) (123) - - Pilot Capital Group, LLC 62,500 (124) * 62,500 (e) (124) - - Ronald J. Piziali and Diane M. Piziali, TTEEs, R&D Piziali Family Living Trust DTD March 22, 2005 50,000 (125) * 50,000 (e) (125) - - Adriaan Pruyssers 31,250 (126) * 31,250 (e) (126) - - Gale H. Reed 31,250 (127) * 31,250 (e) (127) - - Kathy Richardson 62,500 (128) * 62,500 (e) (128) - - Heath Roberts 62,500 (129) * 62,500 (e) (129) - - Gary W. Rodgers 125,000 (130) * 62,500 (e) (130) - - Gary W. Rodgers and Sherrell Rodgers 62,500 (131) * 62,500 (e) (131) - - Scott A. Rogers 454,900 (132) * 250,000 (e) (132) 204,900 * Dr. Roy Rosen 237,500 (133) * 237,500 (e) (133) - - Richard L. Rusch, M.D. 37,500 (134) * 37,500 (e) (134) - - David J. SaoMarcos (a) 168,750 (135) * 137,500 (p) (135) - - David SaoMarcos and Shelly SaoMarcos (a) 31,250 (136) * 31,250 (e) (136) - - James E. Sargeant, Jr. and Pamela A. Sargeant, TTEEs, Sargeant Family Trust 62,500 (137) * 62,500 (e) (137) - - John F. Savaglio 62,500 (138) * 62,500 (e) (138) - - Robert J. Saville 62,500 (139) * 62,500 (e) (139) - - Holly B. Schimmel 62,500 (140) * 62,500 (e) (140) - - John E. Schulz 55,000 (141) * 45,000 (e) (141) 10,000 * James Gerard Schulze 93,750 (142) * 93,750 (e) (142) - - David D. Selmon and Ruth Selmon JT TEN 125,000 (143) * 125,000 (e) (143) - - Ashok C. Shah and Rahjan A. Shah 62,500 (144) * 62,500 (e) (144) - - Dennis Shaha and Eloise Shaha JTWROS 31,250 (145) * 31,250 (e) (145) - - W. Gary Shannon MD. PA. 62,500 (146) * 62,500 (e) (146) - - Alex Sharpe 62,500 (147) * 62,500 (e) (147) - - Laura D. Shinall 12,500 (148) * 12,500 (e) (148) - - George W. Sibley and Mary E. Sibley 31,250 (149) * 31,250 (e) (149) - - Arlene Silva 31,250 (150) * 31,250 (e) (150) - - David C. Singer and Patricia A. Singer JTWROS (a) 7,500 (151) * 7,500 (e) (151) - - David C. Singer (a) 25,750 (152) * 18,250 (p) (152) - - Patricia A. Singer 12,500 (153) * 5,000 (e) (153) - - John T. Singer and Theresa A. Singer 25,000 (154) * 25,000 (e) (154) - - Eric Sjolund and Kathleen Sjolund (a) 26,250 (155) * 26,250 (e) (155) - - Don L. Skaggs 1,756,250 (156) 2.56% 1,756,250 (e) (156) - - Daryl Shane Smith 62,500 (157) * 62,500 (e) (157) - - Janice B. Smith 31,250 (158) * 31,250 (e) (158) - - 55 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- Michael C. Smith 125,000 (159) * 125,000 (e) (159) - - Steven M. Smith (a) 211,500 (160) * 211,500 (p) (160) - - Scott Sorkin 31,250 (161) * 31,250 (e) (161) - - Sam C. Sowell and Martha N. Sowell 31,250 (162) * 31,250 (e) (162) - - Mark J. Staehler 62,500 (163) * 62,500 (e) (163) - - James B. Stanley (a) 490,704 (164) * 211,250 (p) (164) - - Mariel Manuela Stanley 45,000 (165) * 45,000 (e) (165) - - Paul B. Stanley 32,500 (166) * 32,500 (e) (166) - - Philip G. Stanley and Patricia M. Stanley 31,250 (167) * 31,250 (e) (167) - - Jackson W. Stieb, Jr. 250,000 (168) * 250,000 (e) (168) - - Sean Sullivan 75,000 (169) * 75,000 (e) (169) - - Bryan C. K. Tan 31,250 (170) * 31,250 (e) (170) - - Joseph S. Taormino and Rosemary A. Taormino, TTEEs, The Taormino Family Trust, dated 6/22/88 172,548 (171) * 172,548 (w) (171) - - Walter D. Tearse and Jeanne K. Tearse, TTEEs, Walter D Tearse & Jeanne K Tearse Revocable Living Trust 325,000 (172) * 125,000 (e) (172) 200,000 * Steven R. Teskey 62,500 (173) * 62,500 (e) (173) - - Richard E. Townsend 62,500 (174) * 62,500 (e) (174) - - Tru-Pak Moving Systems, Inc. 62,500 (175) * 62,500 (e) (175) - - Barbara Vasquez, TTEE, BV Family Trust 26,000 (176) * 26,000 (e) (176) - - Joseph J. Victor, Jr. and Andrea Victor 31,250 (177) * 31,250 (e) (177) - - Joseph J. Victor and Carolyn S. Victor, TTEEs, Joseph and Carolyn Victor Living Trust dtd 11/7/00 62,500 (178) * 62,500 (e) (178) - - Johnny C. Walker 31,250 (179) * 31,250 (e) (179) - - Gene T. Walker, MD 62,500 (180) * 62,500 (e) (180) - - Quinten E. Ward and Marian L. Ward, TTEEs, Quinten & Marian Ward Trust 125,000 (181) * 125,000 (e) (181) - - Douglass R. Waters 12,500 (182) * 12,500 (e) (182) - - Gordon J. West and Audrey C. West 16,250 (183) * 16,250 (e) (183) - - Dennis G. Williamson (a) 132,500 (184) * 130,000 (p) (184) 2,500 * Bruce C. Wilson, M.D. 62,500 (185) * 62,500 (e) (185) - - Steven S. Wilson (a) 142,500 (186) * 102,500 (p) (186) 40,000 * Gary K. Wohrle (a) 69,500 (187) * 49,500 (p) (187) 20,000 * Denis Y. Wong, TTEE, Denis Y. Wong Rev Living Trust U/A 4/29/1983 62,500 (188) * 62,500 (e) (188) - - Henry R. Yamamoto and Jane S. Yamamoto, TTEEs, Henry & Jane Yamamoto 1987 Trust 62,500 (189) * 62,500 (e) (189) - - Scott Zahren 50,000 (190) * 50,000 (e) (190) - - Adolf Zechel and Barbara Zechel 62,500 (191) * 62,500 (e) (191) - - 56 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- Kent Edward Zender and Kathleen Marie Zender 62,500 (192) * 62,500 (e) (192) - - Allen Solomon, TTEE, Allen Solomon Rev. Trust DTD 2/13/90 63,386 (193) * 63,386 (f) (193) - - Arthur Gronbach and Gail Gronbach 9,451 (194) * 9,451 (f) (194) - - Brian Herman (a) 140,231 (195) * 140,231 (q) (195) - - Brad Baker, TTEE, Bristol Edward Rudolf Trust 47,084 (196) * 47,084 (f) (196) - - BACI Associates LLC 108,315 (197) * 108,315 (f) (197) - - Dana Paul Boller 131,495 (198) * 131,495 (f) (198) - - David Chodosh 93,473 (199) * 93,473 (f) (199) - - David P. Garmus and Caren M. Garmus, TTEEs, Garmus Living Trust 9,508 (200) * 9,508 (f) (200) - - Diane Ventimiglia 78,658 (201) * 78,658 (f) (201) - - Federic Bauthier 95,080 (202) * 95,080 (f) (202) - - Nathaniel Orme 94,233 (203) * 94,233 (f) (203) - - Gerald Ferro 94,233 (204) * 94,233 (f) (204) - - Greg Downes 88,876 (205) * 88,876 (f) (205) - - Harry Falterbauer 235,973 (206) * 235,973 (f) (206) - - Howard Commander 157,315 (207) * 157,315 (f) (207) - - Jay J. Kopf 78,760 (208) * 78,760 (f) (208) - - Joe-Net, Inc. 93,473 (209) * 93,473 (f) (209) - - John P. Nasta 78,473 (210) * 78,473 (f) (210) - - John Simonelli 47,256 (211) * 47,256 (f) (211) - - Kelda Sledz 187,315 (212) * 187,315 (f) (212) - - Kenneth L. Gaspar 78,925 (213) * 78,925 (f) (213) - - Louis Cristan and Kathy Cristan 299,704 (214) * 299,704 (f) (214) - - Martin Mennes 75,140 (215) * 75,140 (f) (215) - - Mary Farrell 313,890 (216) * 313,890 (f) (216) - - Matthew Balk (a) 79,439 (217) * 79,439 (r) (217) - - Max Kaplan 78,473 (218) * 78,473 (f) (218) - - Ngoc-Tien Truong 79,439 (219) * 79,439 (f) (219) - - Peter A. Yaskowitz 60,888 (220) * 60,888 (f) (220) - - Robert L. Bonitz and Ann Bonitz 31,389 (221) * 31,389 (f) (221) - - Robert Murray Chaikin, TTEE, Revocable Trust DTD 7/9/93 78,473 (222) * 78,473 (f) (222) - - Ryan T. Mosley 78,473 (223) * 78,473 (f) (223) - - Scot A. Kane 313,890 (224) * 313,890 (f) (224) - - Sean M. Callahan (a) 105,644 (225) * 105,644 (r) (225) - - Steven R. Kleen 78,658 (226) * 78,658 (f) (226) - - SXJE LLC 1,304,559 (227) 1.90% 1,304,559 (f) (227) - - Thomas J. Franco 96,775 (228) * 96,775 (f) (228) - - Thomas K. Beard 78,925 (229) * 78,925 (f) (229) - - Thomas Leonard 47,540 (230) * 47,540 (f) (230) - - Mike Dean 88,375 (231) * 88,375 (f) (231) - - William Gonte 78,658 (232) * 78,658 (f) (232) - - 57 SHARES OF SHARES OF SHARES OF COMMON STOCK COMMON COMMON STOCK BENEFICIALLY OWNED STOCK BEING BENEFICIALLY OWNED PRIOR TO OFFERING OFFERED AFTER OFFERING NAME OF ----------------------------- -------------- ------------------------ BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE - --------------------------------------------- -------------- ------------ ------------ ---------- R. Gregory E. Ellis 386,260 * 386,260 (g) - - Brookstreet Securities Corporation (c) 1,020,094 (233) 1.50% 1,020,094 (s) (233) - - WWIII Enterprises, LLC (a) 406,406 (234) * 406,406 (t) (234) - - Acceleron Capital, Ltd. (a) 279,454 (235) * 279,454 (235) - - AJ Sexton, V (a) 34,769 (236) * 34,769 (s) (236) - - David V. Ferrari, TTEE, David V. Ferrari Exempt Trust 12/29/98 155,432 (237) * 135,432 (x) (237) 20,000 * Klenton L. McLemore (a) 134,106 * 134,106 (u) - - Pat McCann and Ingrid McCann JT TEN 127,301 * 127,301 (g) - - Annabel Lukens (a) 8,137 * 8,137 (h) - - Brad Reifler 8,243 * 8,243 (v) - - Carlo W. Corzine (a) 4,820 (238) * 4,820 (h) (238) - - Claude Ware (a) 80,661 * 80,661 (h) - - Cliff Jensen (a) 5,561 * 5,561 (h) - - Daniel Pietro (a) 3,110 * 3,110 (h) - - David Evansen (a) 1,810 (239) * 1,810 (h) (239) - - Eric Singer 19,625 (240) * 19,625 (v) (240) - - Hilary Bergman 8,243 * 8,243 (v) - - John Green (a) 6,125 * 6,125 (h) - - Mark Ford (a) 32,864 * 32,864 (h) - - Robert Dombrowski (a) 5,322 * 5,322 (h) - - ROO, LLC (a) 5,322 (241) * 5,322 (h) (241) - - ViewTrade Financial (b) 10,645 (242) * 10,645 (v) (242) - - William Threewits (a) 7,240 * 7,240 (h) - - Richard Ames (a) 32,650 * 17,500 (k) 15,150 * Burton Bartlett (a) 17,250 * 17,250 (k) - - Patrick Hobert (a) 15,050 * 15,050 (k) - - Carl Keys (a) 48,750 (243) * 7,500 (k) (243) - - Cynthia Layne (a) 2,500 * 2,500 (k) - - John Means (a) 28,000 * 28,000 (k) - - Phil Rosenbaum (a) 2,500 * 2,500 (k) - - Eric Sjolund (a) 30,000 (244) * 3,750 (k) (244) - - Darrell Smith (a) 26,190 * 26,190 (k) - - Ronald Smith (a) 8,750 * 8,750 (k) - - Denis Wong (a) 68,750 (245) * 6,250 (k) (245) - - Warren Woon (a) 7,250 * 6,250 (k) 1,000 * Patrick McCabe 75,000 (246) * 75,000 (l) (246) - - Rutan & Tucker, LLP 150,000 (247) * 150,000 (m) (247) - - Strategic Growth International, Inc. 125,000 (248) * 125,000 (n) (248) - - Jamie Mieko Hamamoto (a) 26,670 (249) * 26,670 (y) (249) - - Generation Six (a) 120,282 (250) * 120,282 (250) - - - ------------------------ * Less than 1% 58 (a) This selling security holder, or one of the individuals who has power to vote or dispose of the securities held by the selling security holder, has represented to us that he is affiliated with a broker-dealer but that he is not acting as an underwriter in this offering, he acquired the shares he is offering under this prospectus in the ordinary course of business, and at the time of such acquisition, he had no agreements or understandings, directly or indirectly, with any person to distribute the shares. (b) This selling security holder has represented to us that it is a NASD-registered broker-dealer but that it is not acting as an underwriter in this offering, it acquired the shares it is offering under this prospectus in the ordinary course of business as transaction-based compensation for investment banking services, and at the time of such acquisition, it had no agreements or understandings, directly or indirectly, with any person to distribute the shares. (c) Brookstreet Securities Corporation has represented to us that it is a SEC-registered broker-dealer. With respect to 668,245 shares of common stock offered by Brookstreet Securities Corporation hereunder, it has represented to us that it is not acting as an underwriter in this offering, it acquired the shares in the ordinary course of business as transaction-based compensation for investment banking services, and at the time of such acquisition, it had no agreements or understandings, directly or indirectly, with any person to distribute the shares. With respect to 351,849 shares of common stock offered by Brookstreet Securities Corporation hereunder, it did not acquire such shares in the ordinary course of business as transaction-based compensation for investment banking services and, therefore, is deemed by the SEC to be acting as an underwriter with respect to these shares. (d) The shares of common stock offered hereunder, including shares of common stock that underlie Series D Warrants, were acquired from us in a June 2004 private placement transaction to accredited investors only under which we raised an aggregate of $1,750,000 at $1.80 per share and issued 972,223 shares of common stock, Series C Warrants to purchase an aggregate of 972,223 shares of common stock at an exercise price of $3.00 per share, and Series D Warrants to purchase an aggregate of 972,223 shares of common stock at an exercise price of $3.50 per share. In August 2004, we amended the terms of the Series C Warrants to reduce the exercise price to $1.25 per share. The Series C Warrants subsequently expired on August 15, 2006 and no such warrants were exercised prior to their expiration. In December 2005, we amended the terms of the Series D Warrants to reduce the exercise price to $0.50 per share. (e) The shares of common stock offered hereunder, including shares of common stock that underlie Series G Warrants, were acquired from us in a private placement transaction to accredited investors only that took place between April 2005 and November 2005, under which we sold "units" at a price per unit of $2.00, with each unit consisting of four shares of common stock and one Series G Warrant. We raised aggregate gross proceeds of approximately $7,130,000 under this private placement transaction and issued 14,256,750 shares of common stock and Series G Warrants to purchase an aggregate of 3,564,188 shares of common stock at an exercise price of $2.50 per share. (f) The shares of common stock offered hereunder, including shares of common stock that underlie warrants, were acquired from us in conjunction with a convertible bridge note private placement transaction to accredited investors only that took place between November 2004 and February 2005, and the subsequent conversion of such convertible bridge notes into shares of common stock and warrants to purchase common stock. We raised aggregate gross proceeds of $2,360,000 under this private placement transaction and, in addition to the convertible bridge notes, issued bridge note investors Series E Warrants to purchase an aggregate of 1,416,000 shares of common stock at an original exercise price of $0.60 per share. However, pursuant to the anti-dilution provisions of the Series E Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $0.51 per share as of April 7, 2008. In addition, due to the exercise of certain Series E Warrants, as of April 7, 2008 the outstanding Series E Warrants were exercisable into an aggregate of 141,000 shares of common stock. In August 2005, the total principal and accrued but unpaid interest under the convertible bridge notes automatically converted into an aggregate of 6,023,932 shares of common stock and Series G-BH Warrants to purchase an aggregate of 1,505,989 shares of common stock at an exercise price of $2.50 per share. 59 (g) The shares of common stock offered hereunder were acquired from us upon the automatic conversion of convertible bridge notes originally issued by us in a private placement transaction to accredited investors only that took place between February 2005 and April 2005. We raised aggregate gross proceeds of $600,000 under this private placement transaction and issued an aggregate of 1,540,244 shares of common stock upon the July 2005 automatic conversion of the total principal and accrued but unpaid interest under the convertible bridge notes. (h) The shares of common stock offered by the selling security holder hereunder underlie Series J placement agent warrants that Burnham Hill Partners, a division of Pali Capital, Inc. ("Burnham Hill Partners"), designated that we issue to the holder. Burnham Hill Partners acted as our placement agent in conjunction with the private placement transaction described in footnote (f) above. In conjunction with that private placement transaction, we entered into an agreement with Burnham Hill Partners for placement agent services. Under this agreement, we agreed to pay to Burnham Hill Partners a cash fee equal to 10% of gross proceeds raised by Burnham Hill Partners or its subagents in conjunction with the private placement transaction described in footnote (f), as well as issue to Burnham Hill Partners or its designees Series J placement agent warrants to purchase common stock in an amount equal to 10% of the common stock issued upon conversion of the convertible bridge notes issued in the private placement transaction. Pursuant to our agreement with Burnham Hill Partners, we paid Burnham Hill Partners a cash fee of $236,000 and issued Series J placement agent warrants to purchase an aggregate of 602,393 shares of common stock to designees of Burnham Hill Partners. The Series J placement agent warrants had an original exercise price of $0.50 per share of common stock. However, pursuant to the anti-dilution provisions of the Series J Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $0.47 per share as of April 7, 2008. In addition, due to the exercise of certain Series J Warrants, as of April 7, 2008 the outstanding Series J Warrants were exercisable into an aggregate of 16,255 shares of common stock. (i) The shares of common stock offered by the selling security holder hereunder underlie Series I Warrants that Burnham Hill Partners designated that we issue to the holder. In conjunction with financial advisory services provided to us by Burnham Hill Partners, we agreed to issue Series I Warrants to purchase an aggregate of 200,000 shares of common stock to Burnham Hill Partners or its designees. The Series I Warrants had an original exercise price of $0.60 per share of common stock. However, pursuant to the anti-dilution provisions of the Series I Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $0.51 per share as of April 7, 2008. In addition, due to the exercise of certain Series I Warrants, as of April 7, 2008 the outstanding Series I Warrants were exercisable into an aggregate of 10,000 shares of common stock. (j) The shares of common stock offered by the selling security holder hereunder underlie Series F placement agent warrants that Brookstreet Securities Corporation designated that we issue to the holder. Brookstreet Securities Corporation acted as our placement agent in conjunction with the private placement transaction described in footnote (g) above. In conjunction with that private placement transaction, we entered into an agreement with Brookstreet Securities Corporation for placement agent services. Under this agreement, we agreed to pay to Brookstreet Securities Corporation a cash fee equal to 12% of gross proceeds raised by Brookstreet Securities Corporation in conjunction with the private placement transaction described in footnote (g), as well as issue to Brookstreet Securities Corporation or its designees Series F placement agent warrants to purchase common stock in an amount equal to 15% of the common stock issued upon conversion of the convertible bridge notes issued in the private placement transaction. Pursuant to this agreement, we paid Brookstreet Securities Corporation a cash fee of $72,000 and issued Series F placement agent warrants to purchase an aggregate of 231,036 shares of common stock to Brookstreet Securities Corporation and its designees. However, due to the exercise of certain Series F Warrants, as of April 7, 2008 the outstanding Series F Warrants were exercisable into an aggregate of 14,385 shares of common stock. The Series F placement agent warrants have an exercise price of $0.40 per share of common stock. 60 (k) The shares of common stock offered by the selling security holder hereunder underlie Series H placement agent warrants that Brookstreet Securities Corporation designated that we issue to the holder. Brookstreet Securities Corporation acted as our placement agent in conjunction with the private placement transaction described in footnote (e) above. In conjunction with that private placement transaction, we entered into an agreement with Brookstreet Securities Corporation for placement agent services. Under this agreement, we agreed to pay to Brookstreet Securities Corporation a cash fee equal to 12% of gross proceeds raised by Brookstreet Securities Corporation in conjunction with the private placement transaction described in footnote (e), as well as issue to Brookstreet Securities Corporation or its designees Series H placement agent warrants to purchase common stock in an amount equal to 15% of the aggregate common stock issued in the private placement transaction. Pursuant to this agreement, we paid Brookstreet Securities Corporation a cash fee of $855,405 and issued Series H placement agent warrants to purchase an aggregate of 2,138,513 shares of common stock to Brookstreet Securities Corporation and its designees. The Series H placement agent warrants had an original exercise price of $0.50 per share of common stock, which was subsequently reduced to as low as $0.47 per share pursuant to the anti-dilution provisions of the warrants. All previously unexercised Series H Warrants expired in accordance with their terms on November 23, 2007. (l) The 75,000 shares of common stock offered by Patrick McCabe hereunder underlie warrants we issued to Patrick McCabe as compensation for services provided to us in connection with marketing research and introduction of our products to potential buyers. The warrants have an exercise price of $1.00 per share of common stock. (m) The 150,000 shares of common stock offered by Rutan & Tucker, LLP hereunder underlie warrants we issued to Rutan & Tucker, LLP as partial compensation for legal services rendered. The warrants have an exercise price of $2.00 per share of common stock. (n) The 125,000 shares of common stock offered by Strategic Growth International, Inc. hereunder underlie warrants we issued to Strategic Growth International, Inc. as compensation for investment relation support services rendered. The warrants have an exercise price of $3.50 per share of common stock. (o) The shares of common stock offered by the selling security holder hereunder include shares of common stock purchased from Edwin Hoffman, our Founder and Chief Solutions Architect, in a November 2005 private sale transaction whereby Mr. Hoffman sold an aggregate of 250,000 shares of our common stock at a price of $0.25 per share. (p) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (e) and (k) above. (q) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (f), (h) and (i) above. (r) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (f) and (h) above. (s) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (g), (j), (k) and (o) above. 61 (t) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (g), (j) and (k) above. (u) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (g) and (j) above. (v) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (h) and (i) above. (w) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (e), (g) and (k) above. (x) The shares of common stock offered by the selling security holder hereunder, including shares that underlie warrants, were acquired by the selling security holder pursuant to the transactions described in footnotes (g) and (k) above. (y) The shares of common stock offered by the selling security holder hereunder underlie warrants, or were issued upon the exercise of warrants, assigned from Brookstreet Securities Corporation, which acquired the warrants pursuant to the transactions described in footnotes (j) and (k) above. (1) Includes 138,889 shares underlying Series D Warrants held by DMK Investments, LLC. Power to vote or dispose of the shares is shared by Albert Wong and Lia Wong as Managers of DMK Investments, LLC. Albert Wong is one of our former directors. (2) Includes 555,556 shares underlying Series D Warrants held by Uptrend Investment, Inc. Power to vote or dispose of the shares is held by Catherine Lee Chin as President of Uptrend Investment, Inc. (3) Includes 277,778 shares of common stock and 277,778 shares underlying Series D Warrants held by Transglobal Investments, LLC. Power to vote or dispose of the shares is held by Andrew Su as Manager of Transglobal Investments, LLC. (4) Includes 10,000 shares underlying Series G Warrants. (5) Includes 37,500 shares underlying Series G Warrants. Shares and warrants offered hereunder are held in the name of Charles Schwab & Co., Inc., FBO: Bruce Charles Adams IRA. (6) Includes 12,500 shares underlying Series G Warrants. Shares and warrants offered hereunder are held in the name of Charles Schwab & Co., Inc., FBO: Linda Sue Adams IRA. (7) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of RBC Dain Rauscher Custodian, FBO: Carla Adams-Goldman IRA. (8) Includes 12,500 shares underlying Series G Warrants. (9) Includes 12,500 shares underlying Series G Warrants. (10) Includes 18,750 shares underlying Series G Warrants. (11) Includes 20,000 shares underlying Series G Warrants. Shares and warrants held in the name of First Trust Corporation, Custodian, FBO: Michael Bain. (12) Includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of Darryl Baker. Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: Darryl Baker IRA. (13) Includes 12,500 shares underlying Series G Warrants. (14) Includes 6,250 shares underlying Series G Warrants. (15) Includes 25,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Morgan L. Beatty and Winnie M. Huff as Trustees of the Beatty-Huff Family Trust. (16) Includes 10,000 shares underlying Series G Warrants. (17) Includes 16,250 shares underlying Series G Warrants. (18) Includes 25,000 shares underlying Series G Warrants. (19) Includes 12,500 shares underlying Series G Warrants. (20) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Mark Berman and Sharon Berman as Trustees of the 1999 Berman Family Trust dated 3-23-1999. 62 (21) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of Donald E. Betz. Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: Donald E. Betz A/C 079890. (22) Includes 12,500 shares underlying Series G Warrants. (23) Includes 5,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Robert D. Bjork MD as President of the Robert D. Bjork MDSC MPP & Trust #001 2002 Account. (24) Includes 12,500 shares underlying Series G Warrants. (25) Includes 12,500 shares underlying Series G Warrants. Shares and warrants held in the name of NFS, FMTC, FBO: Fred J. Boone SEP IRA 0JR-812420. (26) Includes 10,000 shares underlying Series G Warrants. (27) Includes 6,250 shares underlying Series G Warrants. (28) Includes 6,250 shares underlying Series G Warrants. (29) Includes 200,000 shares of common stock and 50,000 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: Stanley Clifton Brooks IRA 0JR-567469. Also includes 1,020,094 shares of common stock, 42,770 shares underlying Series H Warrants held by Brookstreet Securities Corporation, which shares are also being offered under this prospectus, the power to vote or dispose of which is held by Stanley C. Brooks as President and CEO of Brookstreet Securities Corporation. (30) Includes 50,000 shares underlying Series G Warrants. (31) Includes 6,250 shares underlying Series G Warrants. (32) Includes 25,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by John R. Harrington, Jr. as Managing Member of Channel Capital, LLC. In addition, 60,000 shares of common stock and 15,000 shares underlying Series G Warrants are held in the name of John R. Harrington, Jr., which shares are also being offered under this prospectus. (33) Includes 12,500 shares underlying Series G Warrants. (34) Includes 12,500 shares underlying Series G Warrants. (35) Includes 100,000 shares underlying Series G Warrants. (36) Includes 200,000 shares underlying Series G Warrants. (37) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of NFS, FMTC, FBO: Melvin Cohen IRA 0JR-812544. (38) Includes 12,500 shares underlying Series G Warrants. (39) Includes 6,250 shares underlying Series G Warrants. (40) Includes 7,500 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Harold Rex Combs A/C 83750. (41) Consists of 12,500 shares underlying Series G Warrants. (42) Includes 12,500 shares underlying Series G Warrants. (43) Includes 12,500 shares underlying Series G Warrants. (44) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of David R. Cravens. Also includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: David R. Cravens SEP IRA 0JR-702838. (45) Includes 12,500 shares underlying Series G Warrants. (46) Includes 25,000 shares underlying Series G Warrants. (47) Includes 6,250 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Mary Chin Dang, M.D., as Trustee of the Mary Chin Dang Revocable Trust u/a 10/16/1979. (48) Includes 12,500 shares underlying Series G Warrants. (49) Includes 50,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Delmar E. Demaree, Jr. as Trustee of the Delmar E. Demaree Jr. Revocable Trust. (50) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: Frank A. Dobrovich A/C 82479. Also includes 100,000 shares of common stock and 25,000 shares underlying Series G Warrants held jointly by Frank A. Dobrovich and Linda K. Dobrovich, which shares are also being offered under this prospectus. (51) Includes 100,000 shares of common stock and 25,000 shares underlying Series G Warrants held jointly by Frank A. Dobrovich and Linda K. Dobrovich. In addition, 50,000 shares of common stock and 12,500 shares underlying Series G Warrants are held in the name of Sterling Trust Company, Custodian, FBO: Frank A. Dobrovich A/C 82479, which shares are also being offered under this prospectus. (52) Includes 6,250 shares underlying Series G Warrants. 63 (53) Includes 12,500 shares underlying Series G Warrants. (54) Includes 12,500 shares underlying Series G Warrants. (55) Includes 12,500 shares underlying Series G Warrants. (56) Includes 6,250 shares underlying Series G Warrants. (57) Includes 3,750 shares underlying Series G Warrants. (58) Includes 12,500 shares underlying Series G Warrants. (59) Includes 75,000 shares underlying Series G Warrants. (60) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Darren E. Foster and Christy F. Foster. In addition, the following shares are also being offered under this prospectus, of which Christy F. Foster has either sole or shared power to vote or dispose as follows: (i) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Jeffrey W. Foster and Christy F. Foster, (ii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by the Farrell Family Trust - Trust B DTD 08/24/68 as restated 04/17/81, the power to vote or dispose of which is held by Christy F. Foster as Trustee, and (iii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by The Foster Family Trust DTD 2/3/87, the power to vote or dispose of which is shared by Steven W. Foster and Christy F. Foster as Trustees. (61) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Jeffrey W. Foster and Christy F. Foster. In addition, the following shares are also being offered under this prospectus, of which Christy F. Foster has either sole or shared power to vote or dispose as follows: (i) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Darren E. Foster and Christy F. Foster, (ii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by the Farrell Family Trust - Trust B DTD 08/24/68 as restated 04/17/81, the power to vote or dispose of which is held by Christy F. Foster as Trustee, and (iii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by The Foster Family Trust DTD 2/3/87, the power to vote or dispose of which is shared by Steven W. Foster and Christy F. Foster as Trustees. (62) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by the Farrell Family Trust - Trust B DTD 08/24/68 as restated 04/17/81, the power to vote or dispose of which is held by Christy F. Foster as Trustee. In addition, the following shares are also being offered under this prospectus, of which Christy F. Foster has shared power to vote or dispose as follows: (i) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Darren E. Foster and Christy F. Foster, (ii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Jeffrey W. Foster and Christy F. Foster, and (iii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by The Foster Family Trust DTD 2/3/87, the power to vote or dispose of which is shared by Steven W. Foster and Christy F. Foster as Trustees. (63) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by The Foster Family Trust DTD 2/3/87, the power to vote or dispose of which is shared by Steven W. Foster and Christy F. Foster as Trustees. In addition, the following shares are also being offered under this prospectus, of which Christy F. Foster has either sole or shared power to vote or dispose as follows: (i) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Darren E. Foster and Christy F. Foster, (ii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Jeffrey W. Foster and Christy F. Foster, and (iii) 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by the Farrell Family Trust - Trust B DTD 08/24/68 as restated 04/17/81, the power to vote or dispose of which is held by Christy F. Foster as Trustee. (64) Includes 25,000 shares underlying Series G Warrants. (65) Includes 57,500 shares of common stock 12,500 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: Robert Y. Fukunaga A/C 80368. (66) Includes 60,000 shares underlying Series G Warrants. (67) Includes 12,500 shares underlying Series G Warrants. (68) Includes 6,250 shares underlying Series G Warrants. (69) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Manny Gutsche A/C 74952. (70) Includes 12,500 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Jeff Halpin A/C 81839. (71) Includes 12,500 shares underlying Series G Warrants. 64 (72) Includes 60,000 shares of common stock and 15,000 shares underlying Series G Warrants held in the name of John R. Harrington, Jr. Also includes 100,000 shares of common stock and 25,000 shares underlying Series G Warrants held by Channel Capital, LLC, which shares are also being offered under this prospectus, the power to vote or dispose of which is held by John R. Harrington, Jr. as Managing Member of Channel Capital, LLC. (73) Includes 12,500 shares underlying Series G Warrants. (74) Includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: Joan E. Heiser. Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by James K. Heiser and Joan E. Heiser, which shares are also being offered under this prospectus. (75) Includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: J. Ken Heiser. Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by James K. Heiser (aka J. Ken Heiser) and Joan E. Heiser, which shares are also being offered under this prospectus. (76) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by James K. Heiser and Joan E. Heiser. In addition, 25,000 shares of common stock and 6,250 shares underlying Series G Warrants are held in the name of NFS, FMTC, FBO: Joan E. Heiser, which are also being offered under this prospectus; and 25,000 shares of common stock and 6,250 shares underlying Series G Warrants are held in the name of NFS, FMTC, FBO: J. Ken Heiser (aka James K. Heiser), which are also being offered under this prospectus. (77) Includes 6,250 shares underlying Series G Warrants. (78) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Howard F. Hill and Patricia A. Hill as Trustees of The Hill Family Trust. (79) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Don Ho as Trustee of the Don Ho Revocable Living Trust. (80) Includes 12,500 shares underlying Series G Warrants. (81) Includes 12,500 shares underlying Series G Warrants. (82) Includes 18,750 shares underlying Series G Warrants. (83) Includes 6,250 shares underlying Series G Warrants. (84) Includes 90,000 shares of common stock and 22,500 shares underlying Series G Warrants held in the name of Mark Porte Johnson and 40,000 shares of common stock and 10,000 shares underlying Series G Warrants held in the name of Charles Schwab & Co., Inc., FBO: Mark Porte Johnson IRA. Also includes 50,000 shares of common stock held in the name of Mark Porte Johnson, 23,600 shares of common stock held in the name of Charles Schwab & Co., Inc., FBO: Mark Porte Johnson IRA, and 18,400 shares of common stock held in the name of IRAs for the children of Mark Porte Johnson, the power to vote or dispose of which is held by Mark Porte Johnson, all of which shares were purchased on the OTC Bulletin Board and are not being offered under this prospectus and, accordingly, are shown as being beneficially owned after the offering. (85) Includes 5,000 shares underlying Series G Warrants. Shares and warrants held in the name of Charles Schwab & Co., Inc. Custodian, FBO: Jennifer M Johnson IRA. (86) Consists of 125,000 shares underlying Series G Warrants. (87) Includes 12,500 shares underlying Series G Warrants. (88) Includes 6,250 shares underlying Series G Warrants. In addition, 7,500 shares of common stock are held in the name of Carl Keys, which shares are also being offered under this prospectus. (89) Includes 12,500 shares underlying Series G Warrants. (90) Includes 12,500 shares underlying Series G Warrants. (91) Includes 12,500 shares underlying Series G Warrants. (92) Includes 17,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Bruce M. Krall and Elisa San Miguel Krall as Trustees of the BEK Living Trust 2004. (93) Includes 6,250 shares underlying Series G Warrants. (94) Includes 12,500 shares underlying Series G Warrants. (95) Includes 6,250 shares underlying Series G Warrants. (96) Includes 6,250 shares underlying Series G Warrants. (97) Includes 12,488 shares underlying Series G Warrants. (98) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of National Financial Services LLC/FMTC, FBO: William Madden, Acct. 0JR-766070. 65 (99) Includes 45,000 shares of common stock and 11,250 shares underlying Series G Warrants held in the name of J David Maddox. Also includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: J. David Maddox IRA. (100) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Susan C Maki A/C 72375. (101) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of NFS, FMTC, FBO: Beverly R. Marr. (102) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of NFS, FMTC, FBO: John L. Marr. (103) Includes 6,250 shares underlying Series G Warrants. (104) Includes 50,000 shares underlying Series G Warrants. (105) Includes 6,250 shares underlying Series G Warrants. (106) Includes 12,500 shares underlying Series G Warrants. (107) Includes 12,500 shares underlying Series G Warrants. (108) Includes 125,000 shares underlying Series G Warrants. (109) Includes 12,500 shares underlying Series G Warrants. (110) Includes 22,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: David Mowbray. Also includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: David Mowbray IRA. (111) Includes 50,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Thomas A. Murrell and Donna M. Murrell as Trustees of the Thomas A. Murrell Family Trust. (112) Includes 6,250 shares underlying Series G Warrants. (113) Includes 12,500 shares underlying Series G Warrants. (114) Includes 6,250 shares underlying Series G Warrants. (115) Includes 12,500 shares underlying Series G Warrants. (116) Includes 12,500 shares underlying Series G Warrants. Shares and warrants held in the name of NFS, FMTC, FBO: Barry Niswanger. (117) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Donald M. Norman and Cynthia S. Norman as Trustees of The Norman Living Trust. (118) Includes 17,500 shares underlying Series G Warrants. (119) Includes 43,450 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Sami J. Oweida as Trustee of the Oweida Orthopedic Association PA Emp PSP TR. (120) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Peter M. Pallotto A/C 72358. (121) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Ronald J. Pang, M.D., as Trustee of the Ronald J. Pang Revocable Living Trust u/a 6-12-1991. (122) Includes 23,750 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Carol Ann Pilger A/C 77544. (123) Includes 132,000 shares of common stock and 23,750 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: Nicholas J. Pilger A/C 77461. (124) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by James A. Gabriele as Managing Member of Pilot Capital Group, LLC. (125) Includes 10,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Ronald J. Piziali and Diane M. Piziali as Trustees of the R&D Piziali Family Living Trust DTD March 22, 2005. (126) Includes 6,250 shares underlying Series G Warrants. Shares and warrants held in the name of Sterling Trust Company, Custodian, FBO: Adriaan Pruyssers A/C 74404. (127) Includes 6,250 shares underlying Series G Warrants. (128) Includes 12,500 shares underlying Series G Warrants. (129) Includes 12,500 shares underlying Series G Warrants. (130) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: Gary W. Rodgers A/C 81984. Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Gary W. Rodgers and Sherrell Rodgers, which shares are also being offered under this prospectus. 66 (131) Includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held jointly by Gary W. Rodgers and Sherrell Rodgers. In addition, 50,000 shares of common stock and 12,500 shares underlying Series G Warrants are held in the name of Sterling Trust Company, Custodian, FBO: Gary W. Rodgers A/C 81984, which shares are also being offered under this prospectus. (132) Includes 50,000 shares underlying Series G Warrants. (133) Includes 47,500 shares underlying Series G Warrants. (134) Includes 7,500 shares underlying Series G Warrants. (135) Includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: David J. SaoMarcos A/C 72288 and 106,250 shares underlying Series H Warrants held in the name of David SaoMarcos. Also includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held jointly by David SaoMarcos and Shelly SaoMarcos, which shares are also being offered under this prospectus. (136) Includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held jointly by David SaoMarcos and Shelly SaoMarcos. In addition, 25,000 shares of common stock and 6,250 shares underlying Series G Warrants are held in the name of Sterling Trust Company, Custodian, FBO: David J. SaoMarcos A/C 72288 and 106,250 shares underlying Series H Warrants are held in the name of David SaoMarcos, which shares are also being offered under this prospectus. (137) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by James E. Sargeant Jr. and Pamela A. Sargeant as Trustees of the Sargeant Family Trust. (138) Includes 12,500 shares underlying Series G Warrants. (139) Includes 12,500 shares underlying Series G Warrants. (140) Includes 12,500 shares underlying Series G Warrants. (141) Includes 9,000 shares underlying Series G Warrants. (142) Includes 25,000 shares of common stock and 6,250 shares underlying Series G Warrants held in the name of James Gerard Schulze. Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: James Gerard Schulze. (143) Includes 25,000 shares underlying Series G Warrants. (144) Includes 12,500 shares underlying Series G Warrants. (145) Includes 6,250 shares underlying Series G Warrants. (146) Includes 12,500 shares underlying Series G Warrants. (147) Includes 12,500 shares underlying Series G Warrants. (148) Includes 12,500 shares underlying Series G Warrants. (149) Includes 6,250 shares underlying Series G Warrants. (150) Includes 6,250 shares underlying Series G Warrants. (151) Consists of 7,500 shares underlying Series G Warrants held jointly by David C. Singer and Patricia A. Singer. In addition, 13,250 shares of common stock and 5,000 shares underlying Series G Warrants held in the name of First Trust Corporation, Custodian, FBO: David C. Singer A/C 060000075597 and 5,000 shares underlying Series G Warrants held in the name of First Trust Corporation, Custodian, FBO: Patricia A. Singer A/C 060000075599, are also being offered under this prospectus. (152) Includes 13,250 shares of common stock and 5,000 shares underlying Series G Warrants held in the name of First Trust Corporation, Custodian, FBO: David C. Singer A/C 060000075597, which are being offered under this prospectus. Also includes 7,500 shares underlying Series G Warrants held jointly by David C. Singer and Patricia A. Singer, which shares are also being offered under this prospectus. (153) Includes 5,000 shares underlying Series G Warrants held in the name of First Trust Corporation, Custodian, FBO: Patricia A. Singer A/C 060000075599, which are being offered under this prospectus. Also includes 7,500 shares underlying Series G Warrants held jointly by David C. Singer and Patricia A. Singer, which shares are also being offered under this prospectus. (154) Includes 5,000 shares underlying Series G Warrants. (155) Includes 6,250 shares underlying Series G Warrants. In addition, 3,750 shares underlying Series H Warrants are held in the name of Eric Sjolund, which shares are also being offered under this prospectus. (156) Includes 351,250 shares underlying Series G Warrants. (157) Includes 12,500 shares underlying Series G Warrants. 67 (158) Includes 6,250 shares underlying Series G Warrants. (159) Includes 25,000 shares underlying Series G Warrants. (160) Includes 20,000 shares underlying Series G Warrants held in the name of NFS, FMTC, FBO: Steven M. Smith. (161) Includes 6,250 shares underlying Series G Warrants. (162) Includes 6,250 shares underlying Series G Warrants. (163) Includes 12,500 shares underlying Series G Warrants. (164) Includes 205,000 shares of common stock and 6,250 shares underlying Series G held in the name of James B. Stanley. Also includes 279,454 shares of common stock held in the name of Acceleron Capital, Ltd., which shares are also being offered under this prospectus, the power to vote or dispose of which is held by James B. Stanley as President and Sole Member of Acceleron Capital, Ltd. (165) Includes 9,000 shares underlying Series G Warrants. (166) Includes 6,500 shares underlying Series G Warrants. (167) Includes 6,250 shares underlying Series G Warrants. (168) Includes 50,000 shares underlying Series G Warrants. (169) Includes 15,000 shares underlying Series G Warrants. (170) Includes 6,250 shares underlying Series G Warrants. (171) Includes 7,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Joseph S. Taormino and Rosemary A. Taormino as Trustees of The Taormino Family Trust, dated 6/22/88. (172) Includes 25,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Walter D. Tearse and Jeanne K. Tearse as Trustees of the Walter D Tearse & Jeanne K Tearse Revocable Living Trust. (173) Includes 12,500 shares underlying Series G Warrants. (174) Includes 12,500 shares underlying Series G Warrants. (175) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by John F. Siegel as President of Tru-Pak Moving Systems, Inc. (176) Includes 10,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Barbara Vasquez as Trustee of the BV Family Trust. (177) Includes 6,250 shares underlying Series G Warrants. (178) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Joseph J. Victor and Carolyn S. Victor as Trustees of the Joseph and Carolyn Victor Living Trust dtd 11/7/00. (179) Includes 6,250 shares underlying Series G Warrants. (180) Includes 12,500 shares underlying Series G Warrants. Shares and warrants held in the name of NFS, FMTC, FBO: Gene T. Walker, MD. (181) Includes 25,000 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Quinten E. Ward and Marian L. Ward as Trustees of the Quinten & Marian Ward Trust. (182) Includes 12,500 shares underlying Series G Warrants. (183) Includes 6,250 shares underlying Series G Warrants. (184) Includes 25,000 shares underlying Series G Warrants held in the name of Sterling Trust Company, Custodian, FBO: Dennis G. Williamson A/C 79843. (185) Includes 12,500 shares underlying Series G Warrants. (186) Includes 37,500 shares underlying Series G Warrants. (187) Includes 6,250 shares underlying Series G Warrants. (188) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is held by Denis Y. Wong as Trustee of the Denis Y. Wong Rev Living Trust U/A 4/29/1983. In addition, 6,250 shares are held in the name of Denis Wong, which shares are also being offered under this prospectus. 68 (189) Includes 12,500 shares underlying Series G Warrants. Power to vote or dispose of the shares is shared by Henry R. Yamamoto and Jane S. Yamamoto as Trustees of the Henry & Jane Yamamoto 1987 Trust. (190) Includes 10,000 shares underlying Series G Warrants. (191) Includes 12,500 shares underlying Series G Warrants. (192) Includes 12,500 shares underlying Series G Warrants. (193) Includes 12,677 shares underlying Series G-BH Warrants. Power to vote or dispose of the shares is held by Allen Solomon as Trustee of the Allen Solomon Rev. Trust DTD 2/13/90. (194) Includes 9,451 shares underlying Series G-BH Warrants. (195) Includes 6,314 shares underlying Series G-BH Warrants. (196) Includes 9,417 shares underlying Series G-BH Warrants. Power to vote or dispose of the shares is held by Brad Baker as Trustee of the Bristol Edward Rudolf Trust. (197) Consists of 60,652 shares of common stock and 47,663 shares underlying Series G-BH Warrants originally issued to Charles Strogen and subsequently transferred to BACI Associates LLC in a private transaction. Power to vote or dispose of the shares is held by Charles Strogen as President of BACI Associates LLC. (198) Includes 21,000 shares underlying Series E Warrants and 22,099 shares underlying Series G-BH Warrants. (199) Includes 15,695 shares underlying Series G-BH Warrants. (200) Includes 9,508 shares underlying Series G-BH Warrants. Power to vote or dispose of the shares is shared by David P. Garmus and Caren M. Garmus as Trustees of the Garmus Living Trust. (201) Includes 15,732 shares underlying Series G-BH Warrants. (202) Includes 19,016 shares underlying Series G-BH Warrants. (203) Includes 15,000 shares underlying Series E Warrants and 15,847 shares underlying Series G-BH Warrants. (204) Includes 15,000 shares underlying Series E Warrants and 15,847 shares underlying Series G-BH Warrants. (205) Includes 30,000 shares underlying Series E Warrants and 31,775 shares underlying Series G-BH Warrants. (206) Includes 47,195 shares underlying Series G-BH Warrants. (207) Includes 31,463 shares underlying Series G-BH Warrants. (208) Includes 15,752 shares underlying Series G-BH Warrants. (209) Includes 15,000 shares underlying Series E Warrants and 15,695 shares underlying Series G-BH Warrants. Power to vote or dispose of the shares is held by Betty Henn as President of Joe-Net, Inc. (210) Includes 15,695 shares underlying Series G-BH Warrants. (211) Includes 9,451 shares underlying Series G-BH Warrants. (212) Includes 31,463 shares underlying Series G-BH Warrants. (213) Includes 15,785 shares underlying Series G-BH Warrants. (214) Includes 50,341 shares underlying Series G-BH Warrants. (215) Includes 12,628 shares underlying Series G-BH Warrants. (216) Includes 62,778 shares underlying Series G-BH Warrants. (217) Includes 15,888 shares underlying Series G-BH Warrants. (218) Includes 15,695 shares underlying Series G-BH Warrants. (219) Includes 15,888 shares underlying Series G-BH Warrants. (220) Includes 15,000 shares underlying Series E Warrants and 15,888 shares underlying Series G-BH Warrants. (221) Includes 6,278 shares underlying Series G-BH Warrants. (222) Includes 15,695 shares underlying Series G-BH Warrants. Power to vote or dispose of the shares is held by Robert Murray Chaikin as Trustee of the Revocable Trust DTD 7/9/93. (223) Includes 15,695 shares underlying Series G-BH Warrants. (224) Includes 62,778 shares underlying Series G-BH Warrants. 69 (225) Includes 18,833 shares underlying Series G-BH Warrants. (226) Includes 15,732 shares underlying Series G-BH Warrants. (227) Includes 648,164 shares underlying Series G-BH Warrants. Power to vote or dispose of the shares is held by Sam Eyde as Manager of SXJE, LLC. (228) Includes 30,000 shares underlying Series E Warrants and 31,775 shares underlying Series G-BH Warrants. (229) Includes 15,785 shares underlying Series G-BH Warrants. (230) Includes 9,508 shares underlying Series G-BH Warrants. (231) Includes 15,695 shares underlying Series G-BH Warrants. (232) Includes 15,732 shares underlying Series G-BH Warrants. (233) Includes 1,020,094 shares of common stock held by Brookstreet Securities Corporation, the power to vote or dispose of which is held by Stanley C. Brooks as President and CEO of Brookstreet Securities Corporation. In addition, 200,000 shares of common stock and 50,000 shares underlying Series G Warrants are held in the name of NFS, FMTC, FBO: Stanley Clifton Brooks IRA 0JR-567469, which shares are also being offered under this prospectus. (234) Power to vote or dispose of the shares is held by William H. Watson, III as President of WWIII Enterprises, LLC. (235) Includes 279,454 shares of common stock held in the name of Acceleron Capital, Ltd., the power to vote or dispose of which is held by James B. Stanley as President and Sole Member of Acceleron Capital, Ltd. In addition, 205,000 shares of common stock and 6,250 shares underlying Series G Warrants are held in the name of James B. Stanley, which shares are also being offered under this prospectus. (236) Includes 25,778 shares of common stock and 8,991 shares underlying Series F Warrants held in the name of AJ Sexton, V. Also includes 120,282 shares of common stock held in the name of Generation Six, which shares are also being offered under this prospectus, the power to vote or dispose of which is held by AJ Sexton, V. (237) Power to vote or dispose of the shares is held by David V. Ferrari as Trustee of the David V. Ferrari Exempt Trust 12/29/98. (238) Represents shares underlying Series J Warrants. (239) Represents shares underlying Series J Warrants. (240) Represents 10,000 shares underlying Series I Warrants and 9,625 shares underlying Series J Warrants. (241) Power to vote or dispose of the shares is held by James St. Clair as Managing Member of ROO, LLC. In addition, 10,645 shares of common stock are held by ViewTrade Financial, the power to vote or dispose of which is held by James St. Clair as President of ViewTrade Financial, which shares are also being offered under this prospectus. (242) Power to vote or dispose of the shares is held by James St. Clair as President of ViewTrade Financial. In addition, 5,322 shares of common stock are held by ROO, LLC, the power to vote or dispose of which is held by James St. Clair as Managing Member of ROO, LLC, which shares are also being offered under this prospectus. (243) Also includes 35,000 shares of common stock and 6,250 shares underlying Series G Warrants held jointly by Carl A. Keys, Jr. and Carol J. Keys, of which 31,250 shares are also being offered under this prospectus. 70 (244) Represents 3,750 shares of common stock. Also includes 20,000 shares of common stock and 6,250 shares underlying Series G Warrants held jointly by Eric Sjolund and Kathleen Sjolund, which shares are also being offered under this prospectus. (245) Also includes 50,000 shares of common stock and 12,500 shares underlying Series G Warrants held by the Denis Y. Wong Rev Living Trust U/A 4/29/1983, which shares are also being offered under this prospectus, the power to vote or dispose of which is held by Denis Y. Wong as Trustee. (246) Represents shares underlying warrants. (247) Represents shares underlying warrants. Power to vote or dispose of the shares is held by the managing member of Rutan & Tucker, LLP. Rutan & Tucker, LLP acts as our legal counsel in various matters. (248) Represents shares underlying warrants. Power to vote or dispose of the shares is held by Richard Cooper as Chairman of Strategic Growth International, Inc. (249) Includes 5,394 shares underlying Series F Warrants (250) Power to vote or dispose of the shares is held by AJ Sexton, V. In addition, 25,778 shares of common stock and 8,991 shares underlying Series F Warrants are held in the name of AJ Sexton, V, which shares are also being offered under this prospectus. PRIVATE PLACEMENTS THROUGH WHICH THE SELLING SECURITY HOLDERS OBTAINED BENEFICIAL OWNERSHIP OF THE OFFERED SHARES All of the shares of common stock being offered under this prospectus were issued, or are issuable upon exercise of warrants that were issued, in the below-described private placement transactions. The descriptions of the agreements discussed below are qualified by reference to the complete text of those agreements. However, the representations, warranties, covenants and other provisions of those agreements are not intended as documents for investors and the public to obtain factual information about our current state of affairs. Rather, investors and the public should look to other disclosures contained in our reports under the Exchange Act. JUNE 2004 PRIVATE PLACEMENT OF COMMON STOCK AND WARRANTS In June 2004, we issued to DMK Investments, LLC, Uptrend Investment, Inc., and Transglobal Investments, LLC, an aggregate of 972,223 shares of our common stock, 972,223 Series C Warrants to purchase common stock and 972,223 Series D Warrants to purchase common stock, at a price per share of common stock of $1.80, for an aggregate purchase price of $1,750,000. The Series C Warrants were issued with an original exercise price of $3.00 per share. In August 2004, we amended the terms of the Series C Warrants to reduce the exercise price to $1.25 per share. The Series C Warrants subsequently expired on August 15, 2006 and no such warrants were exercised prior to their expiration. The Series D Warrants expire on June 1, 2009 and had an original exercise price of $3.50 per share. In December 2005, we amended the terms of the Series D Warrants to reduce the exercise price to $0.50 per share. We entered into a registration rights agreement with the investors in this transaction. As amended in December 2005, the registration rights agreement requires us to register for resale the shares of common stock issued to the investors and the shares of common stock issuable upon exercise of the Series D Warrants (collectively, the "June 2004 Registrable Securities"). The registration rights agreement contains cross-indemnification provisions between us and the investors and requires, among other things, that we cause the registration statement to remain effective for a maximum of two years after the filing date. 71 The Series D Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. In addition, the Series D Warrants contain a cashless exercise feature that will permit the warrants to be exercised for a net number of shares using the spread between the warrant exercise price and the average of the last closing price of our common stock for the ten trading days immediately preceding the exercise of the warrant as payment for a reduced number of common shares. Use of this cashless exercise feature by the warrantholder is limited to times when a valid resale prospectus is not then available for use by the warrantholder. The Series D Warrants also contain provisions limiting the exercise of the warrants to the extent necessary to ensure that, following the exercise, the total number of shares beneficially owned by the warrantholder and its affiliates and others whose beneficial ownership would be aggregated with the warrantholders for purposes of Section 13(d) of the Exchange Act does not exceed 4.99% of the total number of then issued and outstanding shares of our common stock (including for such purpose the shares of common stock issuable upon such exercise). The beneficial ownership limitation does not preclude the warrantholder from exercising a warrant in stages over time where each such stage does not cause the holder and its affiliates to beneficially own shares in excess of the 4.99% limitation amount. The 4.99% beneficial ownership limitation may be waived by the warrantholder upon providing us 60-days' prior written notice. Albert Wong, one of our former directors, is a manager and controlling shareholder of DMK Investments, LLC. 10% CONVERTIBLE BRIDGE NOTE FINANCING During the period between November 2004 and February 2005, we issued convertible notes (the "10% Notes") to forty-one accredited investors in the aggregate principal amount of $2,360,000 in exchange for $2,360,000 in cash. Our net proceeds were $2,124,000, after the payment of a 10% placement agent fee to Burnham Hill Partners, a division of Pali Capital, Inc. (a NASD-registered broker-dealer) who acted as placement agent for the financing. The 10% Notes bore interest at a rate of 10% per annum. Pursuant to the terms of the 10% Notes, the outstanding principal amount of these notes, together with all accrued but unpaid interest thereunder, would automatically convert into shares issued in an equity-based financing with gross proceeds of at least $4,000,000, if any, of the sale of our common stock or other equity based equivalent, and at a price per share not to exceed $0.50 per share (a "10% Note Qualified Financing"). However, for the purpose of determining the number of shares and warrants to be received by the holders upon conversion following a 10% Note Qualified Financing, the holders would be deemed to have tendered 120% of the outstanding balance of the 10% Notes. As of the August 25, 2005 closing of our 2005 Private Placement, we had raised total gross proceeds of $3,558,500 through the 2005 Private Placement. In addition, between February 2005 and April 2005, we secured additional private debt financing in the original aggregate principal amount of $600,000 through the issuance of 8% Convertible Bridge Notes. After adding this $600,000 in convertible debt financing to the gross proceeds of the 2005 Private Placement, our aggregate gross proceeds were $4,158,500. As a result, we achieved a 10% Note Qualified Financing and, accordingly, the $4,000,000 automatic conversion event of the 10% Notes was triggered upon the August 25, 2005 closing of the 2005 Private Placement. 72 As of August 25, 2005, the total principal and accrued interest under the 10% Notes was $2,509,971. After taking into account the provision of the 10% Notes which provided that the holders would be deemed to have tendered 120% of the outstanding balance of the 10% Notes, the holders of the 10% Notes were deemed to have tendered $3,011,965 for the purpose of determining the number of shares and warrants to be received by the holders upon such conversion. Based on the offering terms of our 2005 Private Placement, the holders were issued an aggregate of 6,023,932 shares of our common stock (based on a $0.50 price per share of common stock included within the units offered to investors in the 2005 Private Placement) and 1,505,989 Series G-BH Warrants to purchase our common stock. The Series G-BH Warrants have an exercise price of $2.50 per share of common stock and expire August 25, 2010. So long as certain other conditions set forth in the Series G-BH Warrants are met, the Series G-BH warrants are callable by us the first day after the 30-trading-day average price of our common stock exceeds $3.50 per share. Pursuant to a provision in the 10% Notes that entitled the holders to 600 Series E Warrants for every $1,000 of investment, the 10% Note holders were also issued Series E Warrants to purchase up to 1,416,000 shares of our common stock at an original exercise price of $0.60 per share. However, pursuant to the anti-dilution provisions of the Series E Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $0.51 per share as of April 7, 2008. In addition, due to the exercise of certain Series E Warrants, as of April 7, 2008 the outstanding Series E Warrants were exercisable into an aggregate of 141,000 shares of common stock. The term of the Series E Warrants is five years from the respective noteholder's 10% Note issuance date. If the closing bid price of our common stock exceeds $2.50 per share and certain other conditions set forth in the Series E Warrants are met, 50% of the Series E Warrants are callable by us during the first two years after the date of issuance of the Series E Warrants, and 100% of the Series E Warrants are callable by us thereafter. The Series E Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. The Series E Warrants are also subject to anti-dilution adjustments in conjunction with future issuances of our common stock or securities that are exercisable for or convertible into shares of our common stock at a price per share below the then exercise price of the Series E Warrants. In addition, the Series E Warrants contain a cashless exercise feature that will permit the warrants to be exercised for a net number of shares using the spread between the warrant exercise price and the closing bid price of our common stock on the date of the exercise of the warrant as payment for a reduced number of common shares. Use of this cashless exercise feature by the warrantholder is limited to times when a valid resale prospectus is not then available for use by the warrantholder. In addition, the Series E Warrants contain provisions limiting the exercise of the warrants to the extent necessary to ensure that, following the exercise, the total number of shares beneficially owned by the warrantholder and its affiliates and others whose beneficial ownership would be aggregated with the warrantholders for purposes of Section 13(d) of the Exchange Act does not exceed 4.9% of the total number of then issued and outstanding shares of our common stock (including for such purpose the shares of common stock issuable upon such exercise). The beneficial ownership limitation does not preclude the warrantholder from exercising a warrant in stages over time where each such stage does not cause the holder and its affiliates to beneficially own shares in excess of the 4.9% limitation amount. The 4.9% beneficial ownership limitation may be waived by the warrantholder upon providing us 61-days' prior written notice. 73 The Series G-BH Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. In addition, the Series G-BH Warrants contain provisions affording the holders piggyback registration rights. These rights entitle the holders who so elect to be included in registration statements to be filed by us with respect to other registrations of equity securities. The holders are limited to the exercise of one such piggyback registration. In conjunction with these piggyback registration rights, the holders of the Series G-BH Warrants agreed to certain indemnification provisions. We also issued 602,393 Series J placement agent warrants to designees of Burnham Hill Partners, a division of Pali Capital, Inc., for placement agent services provided in conjunction with the 10% Note financing. The Series J Warrants had an original exercise price of $0.50 per shares of common stock and expire August 25, 2010. However, pursuant to the anti-dilution provisions of the Series J Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $0.47 per share as of April 7, 2008. In addition, due to the exercise of certain Series J Warrants, as of April 7, 2008 the outstanding Series J Warrants were exercisable into an aggregate of 16,255 shares of common stock. The Series J Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. The Series J Warrants are also subject to anti-dilution adjustments in conjunction with future issuances of our common stock or securities that are exercisable for or convertible into shares of our common stock at a price per share below the then exercise price of the Series J Warrants. In addition, the Series J Warrants contain a cashless exercise feature that will permit the warrants to be exercised for a net number of shares using the spread between the warrant exercise price and the closing bid price of our common stock on the date of the exercise of the warrant as payment for a reduced number of common shares. Use of this cashless exercise feature by the warrantholder is limited to times when a valid resale prospectus is not then available for use by the warrantholder. In addition, the Series J Warrants contain provisions limiting the exercise of the warrants to the extent necessary to ensure that, following the exercise, the total number of shares beneficially owned by the warrantholder and its affiliates and others whose beneficial ownership would be aggregated with the warrantholders for purposes of Section 13(d) of the Exchange Act does not exceed 4.9% of the total number of then issued and outstanding shares of our common stock (including for such purpose the shares of common stock issuable upon such exercise). The beneficial ownership limitation does not preclude the warrantholder from exercising a warrant in stages over time where each such stage does not cause the holder and its affiliates to beneficially own shares in excess of the 4.9% limitation amount. The 4.9% beneficial ownership limitation may be waived by the warrantholder upon providing us 61-days' prior written notice. Certain registered representatives of Burnham Hill Partners participated in the 10% Note financing. In addition, designees of Burnham Hill Partners received Series J Warrants issued pursuant to the above described transactions. Other than these issuances related to Burnham Hill Partners, there were no material relationships between us and any of the investors who invested in the 10% Note financing. 74 8% CONVERTIBLE BRIDGE NOTE FINANCING During the period between February 2005 and April 2005, we secured private debt financing from ten accredited investors in the original aggregate principal amount of $600,000. Our net proceeds were $528,000 after the payment of a 12% placement fee to the placement agent. The debt was evidenced by thirteen Convertible Bridge Notes (the "8% Notes"), which bore interest at a rate of 8% per annum. The 8% Notes contained a conversion provision whereby the entire principal and accrued interest of the 8% Notes would automatically convert into shares of our common stock if we raised at least $3,000,000 in a private equity financing after the issuance of the 8% Notes (an "8% Note Qualified Financing"). For purposes of such conversion, the conversion price would reflect a 20% discount from the per share purchase price in the 8% Note Qualified Financing. In addition, the $600,000 in 8% Notes was to be added to the proceeds from the 8% Note Qualified Financing for purposes of calculating the $3,000,000 amount, which triggered the automatic conversion. As of the July 15, 2005 closing of our 2005 Private Placement, we had raised total gross proceeds of $2,416,000 through the 2005 Private Placement. After adding the $600,000 in 8% Notes to these gross proceeds as required by the conversion provisions of the 8% Notes, the aggregate gross proceeds from the 2005 Private Placement and 8% Notes was $3,016,000. As a result, we achieved an 8% Note Qualified Financing and, accordingly, the $3,000,000 automatic conversion event of the 8% Notes was triggered upon the July 15, 2005 closing of the 2005 Private Placement. As of July 15, 2005, the total principal and accrued interest under the 8% Notes was $616,097. Pursuant to the 20% discount in conversion price discussed above, the conversion price of the 8% Notes was $0.40 per share of our common stock (based on a $0.50 price per share of common stock included within the units offered to investors in the 8% Note Qualified Financing). Based on this $0.40 per share conversion price, the holders of the 8% Notes were entitled to an aggregate of 1,540,244 shares of our common stock. The conversion of the 8% Notes did not entitle their holders to any warrants to purchase common stock. In conjunction with the 8% Note financing, we entered into a subscription agreement with the investors in the 8% Notes that contains cross-indemnification provisions between us and the investors. We also issued 231,036 Series F placement agent warrants to Brookstreet Securities Corporation and its designees for placement agent services provided in conjunction with the 8% Note financing. However, due to the exercise of certain Series F Warrants, as of April 7, 2008 the outstanding Series F Warrants were exercisable into an aggregate of 14,385 shares of common stock. The Series F Warrants have an exercise price of $0.40 per share of common stock and expire on the earlier of April 23, 2010 or upon a merger, acquisition, consolidation, sale of voting control or sale of substantially all of our assets in which our shareholders do not own a majority of the outstanding shares of the surviving corporation. The Series F Warrants contain provisions affording the holders registration rights that require us to register the common stock underlying the warrants in the same registration statement covering the securities issued in our 2005 Private Placement. The Series F Warrants contain cross-indemnification provisions between us and the holders in conjunction with the registration of the shares underlying the warrants. 75 The Series F Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. The Series F Warrants are also subject to anti-dilution adjustments in conjunction with future issuances of our common stock or securities that are exercisable for or convertible into shares of our common stock at a price per share below $0.50. The Series F Warrants contain cashless exercise features that permit the warrants to be exercised either in exchange for shares of our common stock held by the holder as payment of the exercise price or pursuant to a cashless exchange through a broker. Brookstreet Securities Corporation and certain of its registered representatives participated in the 8% Note financing. In addition, designees of Brookstreet Securities Corporation received Series F Warrants issued pursuant to the above described transactions. Other than these issuances related to Brookstreet Securities Corporation, there were no material relationships between us and any of the investors who invested in the 8% Note financing. 2005 PRIVATE PLACEMENT OF COMMON STOCK AND WARRANTS During the period between April 2005 and November 2005, we sold a combination of common stock and warrants in a private placement transaction to 189 accredited investors (the "2005 Private Placement"). The common stock and warrants were sold as "units," with each unit consisting of four shares of common stock and one Series G Warrant to purchase common stock. The price per unit was $2.00. We raised aggregate gross proceeds of $7,128,375 under this private placement transaction and issued 14,256,750 shares of common stock and Series G Warrants to purchase an aggregate of 3,564,188 shares of common stock. Our net proceeds were $6,272,970 after the payment of $855,405 in placement agent fees to Brookstreet Securities Corporation, who acted as placement agent for the transaction. We entered into an Investors' Rights Agreement with the investors that requires us to register for resale the shares of common stock issued to the investors and the shares of common stock issuable upon exercise of the Series G Warrants. The agreement contains cross-indemnification provisions between us and the investors and requires that we cause the registration statement to become and remain effective for at least two years or until the offering described in the registration statement has been completed, whichever is shorter. The Series G Warrants have an exercise price of $2.50 per share of common stock and expire five years from their respective date of issuance. So long as certain other conditions set forth in the Series G Warrants are met, the Series G Warrants are callable by us the first day after the 30-trading-day average price of our common stock exceeds $3.50 per share. The Series G Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. In addition, we issued Series H placement agent warrants to acquire up to 2,138,513 shares of common stock to Brookstreet Securities Corporation and its designees for placement agent services rendered in conjunction with the 2005 Private Placement. The Series H Warrants had an original exercise price of $0.50 per share of common stock, which was subsequently reduced to as low as $0.47 per share pursuant to the anti-dilution provisions of the warrants. All previously unexercised Series H Warrants expired in accordance with their terms on November 23, 2007. 76 Certain registered representatives of Brookstreet Securities Corporation participated in the 2005 Private Placement. In addition, designees of Brookstreet Securities Corporation received Series H Warrants issued pursuant to the above described transactions. Other than these issuances related to Brookstreet Securities Corporation, there were no material relationships between us and any of the investors who invested in the 2005 Private Placement. CERTAIN OTHER TRANSACTIONS BURNHAM HILL ADVISORY WARRANTS In July 2005 we issued Series I Warrants to purchase 200,000 shares of our common stock to designees of Burnham Hill Partners as compensation for financial advisory services. The Series I Warrants had an original exercise price of $0.60 per share of common stock and expire on February 11, 2010. However, pursuant to the anti-dilution provisions of the Series I Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $0.51 per share as of April 7, 2008. In addition, due to the exercise of certain Series I Warrants, as of April 7, 2008 the outstanding Series I Warrants were exercisable into an aggregate of 10,000 shares of common stock. The Series I Warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. The Series I Warrants are also subject to anti-dilution adjustments in conjunction with future issuances of our common stock or securities that are exercisable for or convertible into shares of our common stock at a price per share below the then exercise price of the Series I Warrants. In addition, the Series I Warrants contain a cashless exercise feature that will permit the warrants to be exercised for a net number of shares using the spread between the warrant exercise price and the closing bid price of our common stock on the date of the exercise of the warrant as payment for a reduced number of common shares. Use of this cashless exercise feature by the warrantholder is limited to times when a valid resale prospectus is not then available for use by the warrantholder. In addition, the Series I Warrants contain provisions limiting the exercise of the warrants to the extent necessary to ensure that, following the exercise, the total number of shares beneficially owned by the warrantholder and its affiliates and others whose beneficial ownership would be aggregated with the warrantholders for purposes of Section 13(d) of the Exchange Act, as amended, does not exceed 4.9% of the total number of then issued and outstanding shares of our common stock (including for such purpose the shares of common stock issuable upon such exercise). The beneficial ownership limitation does not preclude the warrantholder from exercising a warrant in stages over time where each such stage does not cause the holder and its affiliates to beneficially own shares in excess of the 4.9% limitation amount. The 4.9% beneficial ownership limitation may be waived by the warrantholder upon providing us 61-days' prior written notice. PATRICK MCCABE Of the shares of our common stock underlying warrants covered by this prospectus, 75,000 shares underlie warrants we issued to Patrick McCabe in October 2004 as compensation for services provided to us in connection with marketing research and introduction of our products to potential buyers. The warrants have an exercise price of $1.00 per share of common stock and expire on October 1, 2009. The warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. 77 RUTAN & TUCKER, LLP Of the shares of our common stock underlying warrants covered by this prospectus, 150,000 shares underlie warrants we issued to Rutan & Tucker, LLP in June 2004 as partial compensation for legal services rendered. The warrants have an exercise price of $2.00 per share of common stock and expire on June 21, 2009. The warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. The warrants contain provisions affording the holder piggyback registration rights. These rights entitle the holder to be included in registration statements to be filed by us with respect to other registrations of equity securities. The holder is entitled to unlimited piggyback registration rights. The warrant contains cross-indemnification provisions between us and the holder in conjunction with such piggyback registration rights. In addition, the warrants contain a cashless exercise feature that will permit the warrants to be exercised for a net number of shares using the spread between the warrant exercise price and the average of the closing ask price of our common stock for the 30-trading-day period ending five business days prior to the date of exercise of the warrant as payment for a reduced number of common shares. Use of this cashless exercise feature by the warrantholder is limited to times when a valid resale prospectus is not then available for use by the warrantholder. Rutan & Tucker, LLP acts as our legal counsel in various matters. STRATEGIC GROWTH INTERNATIONAL, INC. Of the shares of our common stock underlying warrants covered by this prospectus, 125,000 shares underlie warrants we issued to Strategic Growth International, Inc. in April 2004 as compensation for investment relation support services rendered. The warrants have an exercise price of $3.50 per share of common stock and expire on April 22, 2009. The warrants contain customary anti-dilution provisions for stock splits, stock dividends and the like. The warrants contain provisions affording the holder both piggyback and demand registration rights. The piggyback registration rights entitle the holder to be included in registration statements to be filed by us with respect to other registrations of equity securities. The demand registration rights entitle the holder to require us to register the common stock underlying the warrants if a registration statement has not previous been filed pursuant to the piggyback registration rights. The holder is limited to an aggregate of one registration pursuant these piggyback and demand registration rights. In addition, the warrants contain a cashless exercise feature that will permit the warrants to be exercised for a net number of shares using the spread between the warrant exercise price and the average of the closing ask price of our common stock for the 30-trading-day period ending five business days prior to the date of exercise of the warrant as payment for a reduced number of common shares. Use of this cashless exercise feature by the warrantholder is limited to times when a valid resale prospectus is not then available for use by the warrantholder. PRIVATE SALE OF COMMON STOCK BY OUR FOUNDER AND CHIEF SOLUTIONS ARCHITECT Of the shares of common stock covered by this prospectus, 250,000 shares were acquired in a November 2005 private sale transaction whereby Edwin Hoffman, our Founder and Chief Solutions Architect, sold an aggregate of 250,000 shares. The shares sold by Mr. Hoffman were originally acquired by him in exchange for an equal number of shares of Raptor Networks Technology, Inc., a California corporation ("Raptor"), as part of our October 2003 share-for-share exchange whereby Raptor became our wholly-owned subsidiary. Brookstreet Securities Corporation and Acceleron Capital, Ltd. each purchased 125,000 shares from Mr. Hoffman at a price per share of $0.25. 78 PLAN OF DISTRIBUTION The selling security holders and any of their donees, pledgees, assignees and other successors-in-interest may, from time to time, sell any or all of their shares of common stock being offered under this prospectus on any stock exchange, automated inter-dealer quotation system, market or trading facility on which the shares are traded, in the over-the-counter market, or private transactions. These sales, which may include block transactions, may be at fixed or negotiated prices. The selling security holders may use any one or more of the following methods when disposing of shares: o ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; o block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; o purchases by a broker-dealer as principal and resales by the broker-dealer for its own account; o an exchange distribution in accordance with the rules of the applicable exchange; o privately negotiated transactions; o short sales, which are contracts for the sale of shares of stock that the seller does not own, or certificates for which are not within the seller's control, so as to be available for delivery at the time when, under applicable rules, delivery must be made; o transactions to cover short sales; o through the distribution of the shares by any selling security holder to its partners, members or stockholders; o broker-dealers may agree with the selling security holders to sell a specified number of shares at a stipulated price per share; o one or more underwritten offerings on a firm commitment or best efforts basis; o a combination of any of these methods of sale; or o any other method permitted by applicable law. The sale price to the public may be: o the market price prevailing at the time of sale; o a price related to the prevailing market price; o at negotiated prices; or o a price the selling security holder determines from time to time. 79 The shares may also be sold under Rule 144 under the Securities Act, if available, rather than under this prospectus. The selling security holders have the sole and absolute discretion not to accept any purchase offer or make any sale of shares if they deem the purchase price to be unsatisfactory at any particular time. The selling security holders may also engage in short sales against the box, which are sales where the selling security holder owns enough shares to cover the borrowed shares, if necessary, puts and calls and other transactions in our securities or derivatives of our securities and may sell or deliver shares in connection with these trades. The selling security holders may pledge their shares to their brokers under the margin provisions of customer agreements. If a selling security holder defaults on a margin loan, the broker may, from time to time, offer and sell the pledged shares. Notwithstanding the terms of this plan of distribution, the selling security holders may not use shares offered under this prospectus to cover short sales or short sales against the box that are made before the registration statement of which this prospectus is a part becomes effective. Broker-dealers engaged by the selling security holders may arrange for other broker-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the selling security holders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated, which commissions as to a particular broker or dealer may be in excess of customary commissions to the extent permitted by applicable law. If sales of shares offered under this prospectus are made to broker-dealers as principals, we would be required to file a post-effective amendment to the registration statement of which this prospectus is a part. In the post-effective amendment, we would be required to disclose the names of any participating broker-dealers and the compensation arrangements relating to such sales. The selling security holders and any broker-dealers or agents that are involved in selling the shares offered under this prospectus may be deemed to be "underwriters" within the meaning of the Securities Act in connection with these sales. Commissions received by these broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Any broker-dealers or agents that are deemed to be underwriters may not sell shares offered under this prospectus unless and until we set forth the names of the underwriters and the material details of their underwriting arrangements in a supplement to this prospectus or, if required, in a replacement prospectus included in a post-effective amendment to the registration statement of which this prospectus is a part. The selling security holders may sell all or any part of the shares offered under this prospectus through an underwriter. To our knowledge, no selling security holder has entered into any agreement with a prospective underwriter, and we cannot assure you as to whether any such agreement will be entered into. If a selling security holder informs us that it has entered into such an agreement or agreements, any material details will be set forth in a supplement to this prospectus or, if required, in a replacement prospectus included in a post-effective amendment to the registration statement of which this prospectus is a part. The selling security holders and any other persons participating in the sale or distribution of the shares offered under this prospectus will be subject to applicable provisions of the Exchange Act and the rules and regulations under that act, including Regulation M. These provisions may restrict activities of, and limit the timing of purchases and sales of any of the shares by, the selling security holders or any other person. Furthermore, under Regulation M, persons engaged in a distribution of securities are prohibited from simultaneously 80 engaging in market making and other activities with respect to those securities for a specified period of time prior to the commencement of such distributions, subject to specified exceptions or exemptions. All of these limitations may affect the marketability of the shares. This prospectus does not cover the sale or other transfer of any of the derivative securities whose underlying shares of common stock are being offered for sale pursuant to this prospectus. If a selling security holder transfers those derivative securities prior to conversion or exercise, then the transferee of those derivative securities may not sell the underlying shares of common stock under this prospectus unless we amend or supplement this prospectus to cover such sales. In addition, if any of the shares of common stock offered for sale pursuant to this prospectus are transferred other than pursuant to a sale under this prospectus, then subsequent holders could not use this prospectus until a post-effective amendment or prospectus supplement is filed, naming such holders. We offer no assurance as to whether any of the selling security holders will sell all or any portion of the shares offered under this prospectus. For the period a selling security holder holds a derivative security whose underlying shares of common stock are being offered for sale pursuant to this prospectus, the selling security holder has the opportunity to profit from a rise in the market price of our common stock without assuming the risk of ownership of the underlying shares of common stock. The terms on which we could obtain additional capital during the period in which those derivative securities remain outstanding may be adversely affected. The holders of derivative securities are most likely to voluntarily convert or exercise their derivative securities when the conversion or exercise price is less than the market price for our common stock. However, we offer no assurance as to whether any of those derivative securities will be converted or exercised. We have agreed to pay all fees and expenses incident to the registration of the shares being offered under this prospectus. However, each selling security holder and purchaser is responsible for paying any discounts, concessions and similar selling expenses they incur. We have agreed with some of the selling security holders to prepare and file all amendments and supplements to the registration statement of which this prospectus is a part as may be necessary under the rules and regulations of the Securities Act to keep it effective for an aggregate of two years from the date it first becomes effective, excluding any periods in which sales cannot be made under the registration statement. We and certain of the selling security holders have agreed to indemnify one another against certain losses, claims, damages and liabilities arising in connection with this prospectus, including liabilities under the Securities Act. We will not receive any of the proceeds from the sale of the shares of common stock offered by the selling security holders. 81 DESCRIPTION OF CAPITAL STOCK General ------- Our Articles of Incorporation, as amended, authorize the issuance of up to 200,000,000 shares of common stock, $0.001 par value per share, and 5,000,000 shares of preferred stock, no par value per share. As of April 7, 2008, there were 68,167,374 shares of common stock issued and outstanding, no shares of preferred stock issued and outstanding, and no series or rights, powers or preferences of our preferred stock have been established. Common Stock ------------ The holders of our common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders, including the election of directors, and do not have cumulative voting rights. Accordingly, the holders of a majority of the shares of common stock entitled to vote in any election of directors can elect all of the directors standing for election, if they so choose. Subject to preferences that may be applicable to any then outstanding preferred stock, holders of common stock are entitled to receive ratably those dividends, if any, as may be declared by our Board of Directors out of legally available funds. Upon our liquidation, dissolution or winding up, the holders of our common stock will be entitled to share ratably in the net assets legally available for distribution to stockholders after the payment of all of our debts and our other liabilities, subject to the prior rights of any preferred stock then outstanding. Holders of our common stock have no preemptive or conversion rights or other subscription rights and there are no redemption or sinking funds provisions applicable to our common stock. All outstanding shares of our common stock are fully paid and nonassessable. Preferred Stock --------------- The affirmative vote of the holders of a majority of our common stock is required to designate one or more series of preferred stock and to fix the number of shares, designations, preferences, powers, and relative, participating, optional or other special rights and the qualifications or restrictions thereof. Thereafter, our Board of Directors has the authority to issue the preferred stock from time to time without any further action by our stockholders. The preferences, powers, rights and restrictions of different series of preferred stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions, and purchase funds and other matters. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of our common stock or adversely affect the rights and powers, including voting rights, of the holders of our common stock, and may have the effect of delaying, deferring or preventing a change in control of our Company. The existence of authorized but unissued preferred stock may enable our Board of Directors to render more difficult or to discourage an attempt to obtain control of our Company by means of a merger, tender offer, proxy contest or otherwise. For example, if in the due exercise of its fiduciary obligations, our Board of Directors were to determine that a takeover proposal is not in our best interests, our Board of Directors could cause shares of preferred stock of a series previously approved by our stockholders to be issued without further stockholder approval in one or more private offerings or other transactions that might dilute the voting or other rights of the proposed acquirer or insurgent stockholder or stockholder group. Transfer Agent and Registrar ---------------------------- The transfer agent and registrar for our common stock is First American Stock Transfer. Its telephone number is (602) 485-1346. 82 LEGAL MATTERS The validity of the shares of common stock offered under this prospectus will be passed upon by Hart & Trinen, L.L.P., Denver, Colorado. EXPERTS The consolidated financial statements of Raptor Networks Technology, Inc., as of and for the year ended December 31, 2006 (restated), included in this prospectus and in the registration statement of which this prospectus is a part, have been audited by Comiskey & Company, P.C., independent certified public accountants, to the extent and for the periods set forth in their report thereon appearing elsewhere in this prospectus, and are included in reliance upon such report, given on the authority of Comiskey & Company, P.C., as experts in auditing and accounting. The consolidated financial statements of Raptor Networks Technology, Inc., as of and for the year ended December 31, 2007, included in this prospectus and in the registration statement of which this prospectus is a part, have been audited by Mendoza Berger & Company, LLP, independent certified public accountants, to the extent and for the periods set forth in their report thereon appearing elsewhere in this prospectus, and are included in reliance upon such report, given on the authority of Mendoza Berger & Company, LLP, as experts in auditing and accounting. CHANGE IN CERTIFYING ACCOUNTANTS On July 6, 2007, we notified Comiskey & Company, P.C. ("Comiskey"), the independent registered public accounting firm that was engaged as our principal accountant to audit our consolidated financial statements, that we intended to engage new certifying accountants and thereby were dismissing Comiskey. The reason for the change was to allow us to engage a larger firm with offices in our local area that we believe has greater resources to provide us with the auditing and tax services we require. The audit report dated March 17, 2007, except for paragraph 7 of Note 1, which is dated August 14, 2007, of Comiskey on our consolidated financial statements and consolidated financial statement schedules as of and for the years ended December 31, 2006 and 2005 did not contain any adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope, or accounting principles, except that the audit report contained a separate paragraph stating: The accompanying financial statements are presented assuming the Company will continue as a going concern. As more fully described in Note 1 to the financial statements, the Company has sustained accumulated losses from operations totaling more than $60,700,000 at December 31, 2006. This condition, and the fact that the Company has had no significant sales of its products to date, raise substantial doubt about its ability to continue as a going concern. Management's plans to address these conditions are also set forth in Note 1 to the financial statements. The accompanying financial statements do not include any adjustments which might be necessary if the Company in unable to continue. During the years ended December 31, 2006 and 2005 and the subsequent interim period through July 6, 2007, there were no disagreements with Comiskey on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures which disagreements, if not resolved to Comiskey's satisfaction, would have caused Comiskey to make reference to the subject matter of the disagreement in connection with its report. Also on July 6, 2007, we engaged Stonefield Josephson, Inc. ("Stonefield") as our new independent auditors. 83 On October 1, 2007, we notified Stonefield Josephson, Inc. ("Stonefield"), the independent registered public accounting firm that was engaged as our principal accountant to audit our consolidated financial statements for the fiscal year ending December 31, 2007, that we intended to engage new certifying accountants and therefore were dismissing Stonefield. Our decision to change accountants was approved by our audit committee and board of directors, based on our desire to engage an alternative firm that we believe has similar resources to provide us with the auditing and tax services we require on a basis that we believe is more cost-effective for an entity with our financial profile. During the interim period from July 6, 2007 through October 1, 2007, there were no disagreements with Stonefield on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures which disagreements, if not resolved to Stonefield's satisfaction, would have caused Stonefield to make reference to the subject matter of the disagreement in connection with the report that we would have requested Stonefield to render in the future on our financial statements for the year ending December 31, 2007. Also on October 1, 2007, we engaged Mendoza Berger & Company, L.L.P. ("Mendoza") as our new independent auditors. We have not consulted with Mendoza during the two most recent fiscal years and through October 1, 2007 regarding the application of accounting principles to a specific completed or contemplated transaction, or the type of audit opinion that might be rendered on our consolidated financial statements or as to any disagreement or event as described in Item 304 (a) (1) (iv) of Regulation S-B under the Securities Act of 1933, as amended. 84 WHERE YOU CAN FIND MORE INFORMATION We have filed with the Securities and Exchange Commission a registration statement on Form SB-2 under the Securities Act, and the rules and regulations promulgated under the Securities Act, with respect to the common stock offered under this prospectus. This prospectus, which constitutes a part of the registration statement, does not contain all of the information contained in the registration statement and the exhibits and schedules to the registration statement. Many of the contracts and documents described in this prospectus are filed as exhibits to the registration statements and you may review the full text of such contracts and documents by referring to such exhibits. For further information with respect to us and the common stock offered under this prospectus, reference is made to the registration statement and its exhibits and schedules. The registration statement, including its exhibits and schedules, may be inspected without charge at the Public Reference Room maintained by the Securities and Exchange Commission at 100 F Street N.E., Washington, D.C. 20549. Copies of such documents may be obtained from the Securities and Exchange Commission upon the payment of the charges prescribed by the Securities and Exchange Commission. The public may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers, such as us, that file electronically with the Securities and Exchange Commission. The Securities and Exchange Commission's website address is http://www.sec.gov. Our website address is http://www.raptor-networks.com. All trademarks or trade names referred to in this prospectus are the property of their respective owners. 85 RAPTOR NETWORKS TECHNOLOGY, INC. INDEX TO FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm .....................F-2 Report of Independent Registered Public Accounting Firm .....................F-3 Financial Statements Consolidated Balance Sheets.............................................F-4 Consolidated Statements of Operations...................................F-5 Consolidated Statements of Stockholders' Equity (Deficit)...............F-6 Consolidated Statements of Cash Flows...................................F-7 Notes to Consolidated Financial Statements..............................F-8 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders' of Raptor Networks Technology, Inc. and Subsidiary We have audited the accompanying consolidated balance sheet of Raptor Networks Technology, Inc. (a Colorado corporation) as of December 31, 2007, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of Raptor Networks Technology, Inc. for the year ended December 31 2006, were audited by other auditors whose report dated March 17, 2007, except paragraph 7 of Note 1, which is August 14, 2007, expressed an unqualified opinion on those statements (the March 17, 2007, except paragraph 7 of Note 1, which is August 14, 2007, report was modified related to the uncertainty of the Company's ability as a going concern), have been furnished to us. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Raptor Networks Technology, Inc. as of December 31, 2007, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements are presented assuming the company will continue as a going concern. As more fully described in Note 1 to the consolidated financial statements, the Company has sustained accumulated losses from operations totaling more than $70,200,000 at December 31, 2007. This condition, and the fact that the Company has had no significant sales of its products to date, raise substantial doubt about its ability to continue as a going concern. Management's plans to address these conditions are also set forth in Note 1 to the consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments which might be necessary if the Company is unable to continue. /s/ MENDOZA BERGER & COMPANY, LLP Irvine, California March 26, 2008 F-2 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors Raptor Networks Technology, Inc. We have audited the consolidated balance sheets of Raptor Networks Technology, Inc. as of December 31, 2005 (not presented) and 2006, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the years ended December 31, 2005 and 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (U.S.). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As more fully described in paragraph 7 of Note 1 to the financial statements, the Company has restated its 2006 financial statements to account for a change in its method of accounting for value assigned to a beneficial conversion feature of senior convertible notes and warrants. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Raptor Networks Technology, Inc. as of December 31, 2005 and 2006, and the consolidated results of its operations, changes in stockholders' equity (deficit) and cash flows for the years ended December 31, 2005 and 2006 in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements are presented assuming the company will continue as a going concern. As more fully described in Note 1 to the financial statements, the Company has sustained accumulated losses from operations totaling more than $60,700,000 at December 31, 2006. This condition, and the fact that the Company has had no significant sales of its products to date, raise substantial doubt about its ability to continue as a going concern. Management's plans to address these conditions are also set forth in Note 1 to the financial statements. The accompanying financial statements do not include any adjustments which might be necessary if the Company is unable to continue. Denver, Colorado March 17, 2007, except paragraph 7 of Note 1 which is August 14, 2007 /S/ COMISKEY & COMPANY PROFESSIONAL CORPORATION F-3 RAPTOR NETWORKS TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, DECEMBER 31, 2006 2007 (AS RESTATED) ------------ ------------ ASSETS CURRENT ASSETS Cash and cash equivalents $ 952,828 $ 821,388 Accounts Receivable (net of allowance for doubtful accounts of $30,075 and 0 at December 31, 2007 and December 31, 2006, respectively) 462,555 319,764 Inventory, net 940,988 951,618 License fees - current 226,690 297,520 Prepaid expenses and other current assets 232,346 240,826 ------------ ------------ Total current assets 2,815,407 2,631,116 PROPERTY AND EQUIPMENT, NET 153,541 282,560 OTHER ASSETS Debt issue cost 126,171 97,176 Deposits 48,996 102,362 ------------ ------------ TOTAL ASSETS $ 3,144,115 $ 3,113,214 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES Accounts payable $ 184,757 $ 87,488 Deferred revenues 12,980 36,376 Accrued liabilities 498,761 205,619 Warrant liability 8,911,086 9,773,967 Conversion option liability 4,079,890 6,806,620 Senior convertible notes payable 3,251,947 1,041,666 Short-term convertible notes - 1,214,290 Accrued interest payable 34,717 265,055 ------------ ------------ Total current liabilities 16,974,138 19,431,081 STOCKHOLDERS' DEFICIT Preferred stock, no par value; 5,000,000 shares authorized - - Common stock, $.001 par; 200,000,000 and 110,000,000 Shares authorized 65,042,374 and 54,360,096 shares issued and outstanding at December 31, 2007 and December 31, 2006, respectively 65,043 54,360 Additional paid-in capital 56,303,256 44,316,848 Accumulated deficit (70,198,322) (60,689,075) ------------ ------------ Total stockholders' deficit (13,830,023) (16,317,867) ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 3,144,115 $ 3,113,214 ============ ============ The accompanying notes are an integral part of these consolidated financial statements F-4 RAPTOR NETWORKS TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS DECEMBER 31, DECEMBER 31, 2006 2007 (AS RESTATED) ------------ ------------ REVENUE, NET $ 1,035,108 $ 849,285 COST OF SALES 385,111 320,073 ------------ ------------ GROSS PROFIT 649,997 529,212 ------------ ------------ OPERATING EXPENSES Salary expense and salary related costs 2,596,537 2,099,946 Marketing 97,237 229,381 Research and development 1,356,326 1,336,518 Selling, general and administrative 2,998,641 2,975,251 ------------ ------------ Total operating expenses 7,048,741 6,641,096 ------------ ------------ Loss from operations (6,398,744) (6,111,884) ------------ ------------ OTHER INCOME (EXPENSE) Interest income 23,298 1,609 Change in fair value of warrant liability and convertible debt 18,956,186 (9,080,794) Senior convertible note restructuring charges (2,089,284) - Extinguishment of debt 11,571,860 - Cost of financing senior convertible note (24,557,055) (2,499,794) Debt financing amortization - warrant liability and conversion feature (6,073,669) (1,041,666) Interest expense (941,839) (346,049) ------------ ------------ Total other income (loss) (3,110,503) (12,966,694) ------------ ------------ Loss before income taxes (9,509,247) (19,078,578) ------------ ------------ Provision for income taxes - - NET LOSS $ (9,509,247) $(19,078,578) ============ ============ Basic and diluted net loss per share $ (0.16) $ (0.35) ============ ============ Basic and diluted weighted average number of shares outstanding 60,096,402 54,213,443 ============ ============ The accompanying notes are an integral part of these consolidated financial statements F-5 RAPTOR NETWORKS TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) Common Stock Total ------------------------- Additional Additional stockholders' Number of Paid-in Paid-in Capital- Accumulated equity shares Amount Capital Warrants Deficit (deficit) ----------- ------------- --------------- ----------------- --------------- ----------------- Balance, December 31, 2005 54,204,367 $ 54,204 $ 37,766,670 $ 6,204,994 $(41,610,497) $ 2,415,371 ----------- ------------- --------------- ----------------- --------------- ----------------- Common stock issued upon cashless exercise of Warrants 46,979 47 23,442 (23,489) - - Common stock issued for cash upon exercise of Warrants 108,750 109 54,266 - - 54,375 Stock Based Compensation - - 168,214 - - 168,214 Beneficial Conversion Privilege - - 122,751 - - 122,751 Net loss for the year ended December 31, 2006 - - - - (19,078,578) (19,078,578) ----------- ------------- --------------- ----------------- --------------- ----------------- Balance, December 31, 2006 54,360,096 54,360 38,135,343 6,181,505 (60,689,075) (16,317,867) ----------- ------------- --------------- ----------------- --------------- ----------------- Common stock issued upon cashless 1,643,760 1,644 1,651,919 (1,653,563) - - exercise of Warrants Common stock issued for cash upon exercise of Warrants 2,332,647 2,333 1,089,302 - - 1,091,635 Stock Based Compensation - - 360,058 - - 360,058 Common stock issued upon conversion of February 2005 note 397,748 398 1,391,722 - - 1,392,120 Common stock issued upon conversions of senior convertible notes 6,208,123 6,208 8,801,580 - - 8,807,788 Common stock issued upon conversion of common stock options 100,000 100 99,900 - - 100,000 Beneficial Conversion Feature - - - 78,930 - 78,930 Valuation conversion related to issuance of warrants - - - 166,560 - 166,560 Net loss for the year ended December 31, 2007 - - - - (9,509,247) (9,509,247) ----------- ------------- --------------- ----------------- --------------- ----------------- Balance, December 31, 2007 65,042,374 $ 65,043 $ 51,529,824 $ 4,773,432 $(70,198,322) $(13,830,023) ----------- ------------- --------------- ----------------- --------------- ----------------- The accompanying notes are an integral part of the consolidated financial statements. F-6 RAPTOR NETWORKS TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS DECEMBER 31, DECEMBER 31, 2006 2007 (RESTATED) ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (9,509,247) $(19,078,578) Adjustments to reconcile net loss to net cash flows from operating activities: Depreciation 174,179 311,563 Amortization 6,192,910 1,080,077 Change in fair value of warrants and conversion option liability (18,956,185) 9,080,794 Gain on extinguishment of debt (11,571,859) - Senior convertible note restructuring charges 2,204,909 - Stock based compensation expense 360,058 168,214 Warrants Issued 166,560 - Cost of financing senior convertible note 24,557,054 2,499,794 Change in inventory reserve 101,468 - Changes in assets and liabilities: Accounts receivable (142,791) (141,124) Prepaid expenses and Other current assets 8,480 (20,320) License fees 70,830 7,800 Debt issuance costs (69,307) - Deposits 53,366 - Inventory (90,838) 180,704 Accounts payable 390,411 (67,924) Accrued interest payable (31,637) 212,591 Other accrued liabilities - 61,380 Deferred Revenue (23,396) 36,376 ------------ ------------ Net cash flows used for operating activities (6,115,035) (5,668,653) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Property and equipment purchases (45,160) (6,464) ------------ ------------ Net cash flows used for investing activities (45,160) (6,464) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock 1,091,635 54,375 Proceeds from issuance of convertible note payable 5,100,000 5,000,000 Payments on short-term debt - (689,410) Proceeds from convertible Debt - 689,410 Issuance of common stock for the exercise of stock options 100,000 - ------------ ------------ Net cash flows provided by financing activities 6,291,635 5,054,375 ------------ ------------ NET INCREASE IN CASH AND CASH EQUIVALENTS 131,440 (620,742) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 821,388 1,442,130 ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 952,828 $ 821,388 ============ ============ SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES - --------------------------------------------------------------------- Conversion of debt to equity 10,199,908 - Warrants issued for financing services 166,560 - Fair market value change of the beneficial conversion feature 6,079,443 - Warrants issue for convertible debt 78,929 - Issuance of common stock from cashless exercise of warrants 1,653,563 - Interest paid - 95,043 The accompanying notes are an integral part of the consolidated financial statements. F-7 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION - ----------- The Company is a provider of integrated high-speed Ethernet switching systems which enable new emerging high bandwidth critical applications. The data network market areas that the Company is targeting include video, storage, Internet Protocol telephony, and technology refresh. The Company is currently focusing on the United States market. Principal operations have commenced, although minimal revenues have been recognized to date. The Company was incorporated under the laws of the state of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. ("Pacific"). The principal office of the corporation is 1241 E. Dyer Rd., Suite 150, Santa Ana, California 92705. On October 17, 2003, Pacific completed a business combination transaction with Raptor Networks Technology, Inc. ("Raptor"), a closely-held California corporation, through acquisition of all of the issued and outstanding common stock of Raptor in exchange for authorized but previously unissued restricted Common Stock of Pacific. Immediately prior to completion of the acquisition transaction, Pacific had a total of 4,034,000 shares of its Common Stock issued and outstanding comprised of 1,034,000 registered shares held by approximately 25 stockholders and 3,000,000 shares of restricted stock held by Pacific's founder and sole officer and director. As a material aspect of the acquisition, Pacific re-acquired and cancelled the 3,000,000 restricted shares as consideration for transfer of its remaining assets consisting of cash and office equipment to the officer and director, leaving only the registered common stock, 1,034,000 shares, as all of its issued and outstanding capital stock prior to completion of the Raptor acquisition. Pursuant to terms of the acquisition agreement, all of the issued and outstanding common stock of Raptor, 19,161,256 shares, was acquired by Pacific, share-for-share, in exchange for its authorized but previously unissued common stock. Upon completion of the acquisition, Raptor became a wholly owned subsidiary of Pacific and the Raptor shareholders became shareholders of Pacific. Unless otherwise indicated, all references in these financial statements to "the Company" include Pacific and its wholly owned subsidiary, Raptor. All intercompany transactions have been eliminated. On December 3, 2003, Pacific changed its name to Raptor Networks Technology, Inc. The acquisition transaction has been treated as a reverse merger, with Raptor considered the accounting acquirer. The Company's reporting year end was subsequently changed from August 31 to December 31. RESTATEMENT OF PRIOR PERIODS - ---------------------------- Restatement of December 2006 - ---------------------------- The Company has restated its prior period financial results because of an error in our interpretation of accounting treatment for derivatives issued in the private placement transactions in July 2006 and January 2007. These restatements are included in the year to date numbers of this 10-KSB. The restatements were required because the Company capitalized as deferred debt costs the fair value of the conversion features and warrants in excess of the face value of the debt host instrument whereas this cost of financing should have been expensed at the time of closing the financing. F-8 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 The effect of the restatement on debt discount cost, debt financing amortization expense, cost of financing, other expense, net loss and basic and diluted earnings per share as of December 31, 2006 are as follows: AS ORIGINALLY RESTATEMENT REPORTED ADJUSTMENTS AS RESTATED ------------- ----------- ------------- Balance Sheet - ------------- Debt discount cost $ 1,979,004 $(1,979,004) $ 0 ============= =========== ============= Statement of Operations - ----------------------- Debt financing amortization $ 1,562,456 $ (520,790) $ 1,041,666 ============= =========== ============= Cost of financing senior convertible note $ 0 $ 2,499,794 $ 2,499,794 ============= =========== ============= Other expense $ 10,987,690 $ 1,979,004 $ 12,966,694 ============= =========== ============= Net Loss $ (17,099,574) $(1,979,004) $ (19,078,578) ============= =========== ============= Basic and diluted net loss per share $ (0.32) $ (0.03) $ (0.35) ============= =========== ============= Third quarter 2007 Restatement - ------------------------------------ On July 30, 2007, we effected a mandatory conversion in the amount of $2,707,475 entitling the holders to 4,387,798 shares of Raptor common stock. The amount of the conversion carried a corresponding conversion feature, valued at $3,607,648. This amount was recognized in our statement of operations as a gain to "other income/loss". As this transaction related to a conversion of a portion of the senior convertible note, the valuation amount of $3,607,648 should have instead been properly accounted for as an increase to our "Additional paid-in capital" (APIC) account on our balance sheet. As such, our September 30, 2007 Net income/loss and Additional paid-in capital were understated by $3,607,648. This accounting restatement was addressed in the fourth quarter of 2007 and appropriate corrections were made such that the financial data for the 2007 fiscal year as included in this 10-KSB are consistent with our restatement. The adjustments are cash neutral and did not affect the Company's cash position. The affect of the restatement to Additional paid-in capital, Change in fair value of warrant liability and convertible liability, Net loss and Basic and diluted earnings per share for the nine months ended September 30, 2007, are as follows: AS ORIGINALLY RESTATEMENT AS REPORTED ADJUSTMENTS RESTATED ------------- ----------- ------------- Balance Sheet - ------------- Additional paid-in capital $ (52,015,168) $(3,607,648) $ (55,622,816) ============= =========== ============= Statement of Operations Other Income/(Loss) - -------------------------------------------- Change in fair value of warrant liability and convertible debt $ (5,198,576) $(3,607,648) $ (8,806,224) ============= =========== ============= Net Income/(Loss) $ (30,241,246) $(3,607,648) $ (33,848,894) ============= =========== ============= Basic and diluted net (loss) per share $ (0.52) $ (0.06) $ (0.58) ============= =========== ============= The affect of the restatement to Additional paid-in capital, Change in fair value of warrant liability and convertible liability, Net loss and Basic and diluted earnings per share for the three months ended September 30, 2007, are as follows: F-9 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 AS ORIGINALLY RESTATEMENT AS REPORTED ADJUSTMENTS RESTATED ------------- ----------- ------------- Balance Sheet - ------------- Additional paid-in capital $ (52,015,168) $(3,607,648) $ (55,622,816) ============= =========== ============= Statement of Operations Other Income/(Loss) - -------------------------------------------- Change in fair value of warrant liability and convertible debt $ 19,127,702 $ (3,607,648) $ 15,520,054 ============= =========== ============= Net Income/(Loss) $ 9,485,164 $ (3,607,648) $ 5,877,516 ============= =========== ============= Basic and diluted net income/(loss) per share $ 0.15 $ (0.06) $ 0.09 ============= =========== ============= REVENUE RECOGNITION - ------------------- The Company records revenues when the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred; (iii) the price to the customer is fixed or determinable; and (iv) collection of the sales price is reasonably assured. Delivery occurs when goods are shipped and title and risk of loss have passed to the customer. Revenue is deferred in all instances where the earnings process is incomplete. The Company recognizes revenue from distribution sales when all contingencies are satisfied and upon persuasive evidence of a sale to end users until such time that historical sell through ratios have been developed. CASH AND CASH EQUIVALENTS - ------------------------- The Company considers all short-term marketable securities with a maturity of three months or less to be cash equivalents. ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS - ------------------------------------------------------- Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the Company's existing accounts receivable. The Company establishes provisions for losses on accounts receivable when it is probable that all or part of the outstanding balance will not be collected. The Company regularly reviews collectability and establishes or adjusts the allowance as necessary using the specific identification method. INVENTORY - --------- Inventory is recorded at the lower of average cost or market. When required, a provision is made to reduce excess and obsolete inventory to estimated net realizable value. Inventory at December 31, 2007 consists of raw materials, work in process and finished goods. LICENSE FEES - ------------ The Company capitalizes software license fees of third party software which is included in its systems. These costs will be amortized and charged to cost of sales over the projected number of systems expected to be sold incorporating the capitalized software. Amortization of the license fees included in cost of sales for the years ended December 31, 2007 and 2006 totaled $20,824 and $7,800 respectively. PREPAID EXPENSES - ---------------- Prepaid expenses represent amounts paid in advance for contracts extending past the period end date. PROPERTY AND EQUIPMENT - ---------------------- Property and equipment are recorded at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the assets' estimated useful lives as follows: computer equipment, furniture and fixtures and testing equipment are depreciated over three years, office equipment is depreciated over seven years and leasehold improvements are depreciated over the term of the lease. F-10 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 DEBT ISSUANCE COSTS - -------------------- Debt issuance costs reflect fees incurred to obtain financing. Debt issuance costs are amortized (included in interest expense using the straight-line method over the life of the related debt. Amortization expense for the years ended December 31, 2007 and 2006 was $119,240 and $38,413 respectively. DEPOSITS - -------- Deposits represent amounts paid under the Company's office space lease and various other arrangements with state agencies. REPAIRS AND MAINTENANCE - ----------------------- Repairs and maintenance of a routine nature are charged as incurred, while those which extend or improve the life of existing assets are capitalized. MARKETING COSTS - --------------- Marketing costs are expensed as incurred. For the years ended December 31, 2007 and 2006, marketing costs were $97,237 and $229,381 respectively. RESEARCH AND DEVELOPMENT COSTS - ------------------------------ Research and development (R&D) costs, which are expensed as incurred, are comprised of the following costs incurred in performing R&D activities: labor, product design cost including rental of design tools, consumables, and costs of prototypes. COMPENSATED ABSENCES - -------------------- The Company maintains a personal time off policy. Employees of the Company are entitled to compensated absences depending on their length of service to a maximum of 25 days. For the years ended December 31, 2007 and 2006 the balance owed for compensated absences was $120,108 and $108,752 respectively. IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS - ------------------------------------------- The Company reviews its long-lived assets and certain related intangibles for impairment periodically, and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. When necessary, impaired assets are written down to estimated fair value based on the best information available. Estimated fair value is generally based on either appraised value or measured by discounting estimated future cash flows. Considerable management judgment is necessary to estimate discounted future cash flows. Accordingly, actual results could vary significantly from such estimates. No assets were considered impaired for the years ended December 31, 2007 and 2006. USE OF ESTIMATES - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INCOME TAXES - ------------ The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted federal, state, and local income tax rates and laws that are expected to be in effect when the differences reverse. During the year ended December 31, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48), which supplements SFAS No. 109, "Accounting for Income Taxes," by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. The Interpretation requires that the tax effects of a position be recognized only if it is "more-likely-than-not" to be sustained based solely on its technical merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by management that a company is entitled to the economic benefits of a tax position, If a tax position is not considered F-11 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 more-likely-than-not to be sustained based solely on its technical merits. No benefits of the tax position are to be recognized. Moreover, the more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. With the adoption of FIN 48, companies are required to adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained. Any necessary adjustment would be recorded directly to retained earnings and reported as a change in accounting principle. FAIR VALUE OF FINANCIAL INSTRUMENTS - ----------------------------------- Unless otherwise indicated, the fair value of all reported assets and liabilities which represent financial instruments (none of which are held for trading purposes) approximate the carrying values of such instruments. RECLASSIFICATIONS - ----------------- Certain previous year amounts have been reclassified to conform to the current year presentation. These reclassifications had no impact on net earnings, financial position or cash flows. STOCK-BASED COMPENSATION - ------------------------ The Company accounts for stock-based compensation using the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Shared Based Payment" ("SFAS No. 123(R)") using the Black-Scholes Option pricing model. Under SFAS No. 123(R), all 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. For the year ended December 31, 2007 and December 31, 2006, the Company recognized $360,058 and $168,214 respectively, in stock based compensation costs related to the issuance of options to employees. These costs were calculated in accordance with SFAS No. 123(R) and are reflected in operating expenses. The total stock options for the 2005 Plan and non-plan options in the amounts of 626,000 and 1,175,000, respectively, results in a total of 1,801,000 options outstanding at December 31, 2007. 2005 Stock Plan - --------------- The Company's 2005 Stock Plan was approved by the Company's Board of Directors on April 7, 2005, approved by the Company's shareholders on June 9, 2005, and amended and restated as the First Amended and Restated 2005 Stock Plan ("2005 Plan") by the Company's Board of Directors on June, 29, 2007. The Company filed a registration statement on Form S-8 with the Securities and Exchange Commission ("SEC") in May 2007 to cover the issuance of up to 3,000,000 shares of common stock underlying options and stock purchase rights authorized for issuance under the 2005 Plan and qualified for issuance the underlying securities with the California Department of Corporations in July, 2007. Prior to that time, the Company issued only non-plan stock options. The 2005 Plan is now the Company's only formal plan for providing stock-based incentive compensation to the Company's eligible employees, non-employee directors and certain consultants. The Board of Directors or committee of the Board of Directors administering the 2005 Plan has discretion to set vesting, expiration and other terms of awards under the 2005 Plan. As of December 31, 2007, the 2005 Plan had a total of 626,000 options outstanding and 2,374,000 shares reserved for future grants. Non-Plan Options - ---------------- Prior to approval of our 2005 Plan, the Company granted stock options out-of-plan. These non-plan options provided for the periodic issuance of stock options to our employees and non-employee board of directors. The vesting period for the non-plan stock options is three equal annual installments 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 December 31, 2007, there were 1,175,000 non-plan options outstanding. F-12 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 Information with respect to stock option activity is as follows: Weighted Weighted Average Average Remaining Contract Aggregate Options Shares Exercise Price Term Intrinsic Value - ------- ------ -------------- ---- --------------- Outstanding, December 31, 2006 1,645,500 $ 1.00 Granted 661,500 1.03 Forfeited / Expired (406,000) 1.00 Exercised (100,000) 1.00 --------- -------------- Outstanding, December 31, 2007 1,801,000 $ 1.01 5.41 - ========= ============== ==== ==== Exercisable, December 31, 2007 1,181,833 $ 1.00 4.51 - ========= ============== ==== ==== A summary of the status of the Company's unvested shares as of December 31, 2007 is presented below: Weighted Average Number of Shares Grant-Date Fair Value ---------------- --------------------- Non-vested at January 1, 2007 663,836 Granted 661,500 0.66 Vested (316,836) 1.08 Non-vested shares forfeited (389,333) $ 0.66 ---------- --------------------- Non-vested at December 31, 2007 619,167 $ 0.66 December 31, 2007 ----------------- Dividend Yield...................... 0.0% Risk-Free Interest Rate............. 4.49% Expected Life....................... 3.00 years Expected Volatility................. 114.82% As of December 31, 2007 total unrecognized stock-based compensation cost related to unvested stock options was approximately $119,817 which is expected to be recognized over a weighted average period of approximately 2.12 years. CONSIDERATION OF OTHER COMPREHENSIVE INCOME ITEMS - ------------------------------------------------- The Financial Accounting Standards Board has issued "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires companies to present comprehensive income (consisting primarily of net income plus other direct equity changes and credits) and its components as part of the basic financial statements. For the year ended December 31, 2007 and the year ended December 31, 2006, the Company's financial statements do not contain any changes in equity that are required to be reported separately in comprehensive income. CONCENTRATION OF RISK - --------------------- From time-to-time, the Company maintains cash balances in excess of FDIC insured limits. The amount of such excess at December 31, 2007 was approximately $834,600. LOSS PER SHARE - -------------- Loss per share was computed using the weighted average number of shares of common stock and common stock equivalents outstanding during the period. F-13 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 RECENT ACCOUNTING PRONOUNCEMENTS - -------------------------------- In September 2006, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 108 ("SAB 108"), FINANCIAL STATEMENTS - CONSIDERING THE EFFECTS OF PRIOR YEAR MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS." SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year's financial statements are materially misstated. SAB 108 provides that once a current year misstatement has been quantified, the guidance in SAB No. 99, FINANCIAL STATEMENTS - MATERIALITY, should be applied to determine whether the misstatement is material and should result in an adjustment to the financial statements. Under certain circumstances, prior year financial statements will not have to be restated and the effects of initially applying SAB 108 on prior years will be recorded as a cumulative effect adjustment to beginning Retained Earnings on January 1, 2006, with disclosure of the items included in the cumulative effect. The Company applied the provisions of SAB 108 with the preparation of the Company's annual financial statements for the calendar year ended December 31, 2006. The application of the provisions of SAB 108 did not have a material impact on the Company's financial statements for the year ended December 31, 2007. In November 2006, the FASB ratified EITF Issue No. 06-7, "Issuer's Accounting for a Previously Bifurcated Conversion Option in a Convertible Debt Instrument When the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities" ("EITF No. 06-7"). At the time of issuance, an embedded conversion option in a convertible debt instrument may be required to be bifurcated from the debt instrument and accounted for separately by the issuer as a derivative under SFAS No. 133, based on the application of EITF No. 00-19. Subsequent to the issuance of the convertible debt, facts may change and cause the embedded conversion option to no longer meet the conditions for separate accounting as a derivative instrument, such as when the bifurcated instrument meets the conditions of EITF No. 00-19 to be classified in stockholders' equity. Under EITF No. 06-7, when an embedded conversion option previously accounted for as a derivative under Statement of Financial Accounting Standards ("SFAS") No. 133 no longer meets the bifurcation criteria under that standard, an issuer shall disclose a description of the principal changes causing the embedded conversion option to no longer require bifurcation under SFAS No. 133 and the amount of the liability for the conversion option reclassified to stockholders' equity. EITF No. 06-7 should be applied to all previously bifurcated conversion options in convertible debt instruments that no longer meet the bifurcation criteria in SFAS No. 133 in interim or annual periods beginning after December 15, 2006, regardless of whether the debt instrument was entered into prior or subsequent to the effective date of EITF No. 06-7. The adoption of EITF 06-7 did not have a material impact on our financial position, results of operations or cash flows. In November 2006, the FASB ratified EITF Issue No. 06-6, Application of EITF Issue No. 05-7, `Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues ' ("EITF 06-6"). EITF 06-6 addresses the modification of a convertible debt instrument that changes the fair value of an embedded conversion option and the subsequent recognition of interest expense for the associated debt instrument when the modification does not result in a debt extinguishment pursuant to EITF 96-19. The Company does not expect the adoption of EITF 06-6 to have a material impact on its consolidated financial position, results of operations or cash flows. In December 2006, FASB Staff Position No. EITF 00-19-2 was issued. This FASB Staff Position (FSP) addresses an issuer's accounting for registration payment arrangements. This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies. The guidance in this FSP amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, and FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, to include scope exceptions for registration payment arrangements. This FSP further clarifies that a financial instrument subject to a registration payment arrangement should be accounted for in accordance with other applicable generally accepted accounting principles (GAAP) without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement. The Company follows the guidance in FSP 00-19-2 in assessing its liabilities related to the liquidated damages arising from the Company's default position on the convertible financing arrangements. F-14 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 In February 2007, the FASB issued Statement No. 159 ("FAS 159") which expanded FAS No. 157, "FAIR VALUE MEASUREMENTS ," which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. FAS 159 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. FAS 159 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company is currently evaluating the impact of FAS 159, but does not expect the adoption of FAS 159 to have a material impact on our financial statements. In June 2007, the FASB ratified the consensus on Emerging Issues Task Force (EITF) Issue No. 06-11, "Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards" ("EITF 06-11"). EITF 06-11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for non-vested equity-classified employee share-based payment awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. While the Company is currently evaluating the provisions of EITF 06-11, the adoption is not expected to have any significant effect on the Company's consolidated financial position or results of operations. In July 2006, the FASB issued Interpretation No. 48, " ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES, AN INTERPRETATION OF FAS 109 "("FIN 48") which clarifies the accounting for uncertainty in income taxes recognized in accordance with FAS 109, " ACCOUNTING FOR INCOME TAXES." FIN 48 is a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. If an income tax position exceeds a more likely than not (greater than 50%) probability of success upon tax audit, the company will recognize an income tax benefit in its financial statements. Additionally, companies are required to accrue interest and related penalties, if applicable, on all tax exposures consistent with jurisdictional tax laws. This interpretation is effective as of January 1, 2007. The adoption of this statement does not have a material impact on our financial statements. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "FAIR VALUE MEASUREMENTS" ("SFAS No. 157"). SFAS No. 157 provides guidance for using fair value to measure assets and liabilities. This standard also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years; therefore, the Company expects to adopt SFAS No. 157 at the beginning of fiscal 2008. The Company is currently evaluating the impact of this standard. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities--Including an amendment of FASB Statement No. 115". SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the FASB's long-term measurement objectives for accounting for financial instruments. SFAS No. 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of this standard. PRESENTATION AS A GOING CONCERN - ------------------------------- The accompanying condensed 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 sustained net losses of $9,509,247 and $19,078,578 for the years ended December 31, 2007 and December 31, 2006, respectively. Net cash used in operations for the year ended December 31, 2007 was $6,115,035. The Company also has an accumulated deficit of $70,198,322 and a working capital deficit of $14,158,731 at December 31, 2007, of which $12,990,976 relates to the fair value of derivative financial instruments. F-15 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 The items discussed above raise substantial doubts about the Company's ability to continue as a going concern. If the Company's financial resources are insufficient, the Company may require additional financing in order to execute its operating plan and continue as a going concern. The Company cannot predict whether this additional financing will be in the form of equity, debt, or another form. The Company may not be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all. In any of these events, the Company may be unable to implement its current plans for expansion, repay its debt obligations as they become due or respond to competitive pressures, any of which circumstances would have a material adverse effect on its business, prospects, financial condition and results of operations. The financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or amounts and reclassification of liabilities that might be necessary, should the Company be unable to continue as a going concern. Should financing sources fail to materialize, management would seek alternate funding sources such as the sale of common and/or preferred stock, the issuance of debt, or other means. The Company plans to attempt to address its working capital deficiency by increasing its sales, maintaining strict expense controls and seeking strategic alliances. In the event that these financing sources do not materialize, or the Company is unsuccessful in increasing its revenues and profits, the Company will be forced to further reduce its costs, may be unable to repay its debt obligations as they become due, or respond to competitive pressures, any of which circumstances would have a material adverse effect on its business, prospects, financial condition and results of operations. Additionally, if these funding sources or increased revenues and profits do not materialize, and the Company is unable to secure additional financing, the Company could be forced to reduce or curtail its business operations unless it is able to engage in a merger or other corporate finance transaction with a better capitalized entity. 2. PROPERTY AND EQUIPMENT Property and equipment consisted of the following: December 31, December 31, 2007 2006 ------------ ------------ Furniture and Office equipment $ 203,280 $ 194,944 Computer equipment 214,773 193,701 Testing equipment 620,445 606,738 Leasehold Improvements 113,317 113,317 ------------ ------------ 1,151,815 1,108,700 Less: Accumulated depreciation (998,274) (826,140) ------------ ------------ $ 153,541 $ 282,560 ============ ============ Depreciation and amortization expense related to property and equipment for the years ended December 31, 2007 and 2006 was $174,079 and $311,563, respectively. 3. INVENTORY December 31, December 31, 2007 2006 ------------ ------------ Raw materials $ 628,386 $ 706,381 Work In Process 59,522 - Finished goods 457,838 348,527 ------------ ------------ 1,145,746 1,054,908 Less: Allowance for obsolescence (204,758) (103,290) ------------ ------------ Inventory, net $ 940,988 $ 951,618 ============ ============ F-16 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 4. SHORT-TERM CONVERTIBLE NOTES During the period from December 2003 to April 2004, the Company issued convertible notes for a total amount of $1,214,290. Interest on these loans accrues at an annual rate of 8%. Pursuant to the terms of the notes, upon the third anniversary of the issuance of the notes, the total outstanding principal balance in the amount of $1,214,290 and all accrued and unpaid interest in the amount of $177,827 converted into 397,748 shares of our common stock on April 15, 2007, based on a conversion price of $3.50 per share. 5. SENIOR CONVERTIBLE NOTE PAYABLE Senior convertible notes consisting of $5 million notes issued on July 31, 2006 and a January 18, 2007 restructuring resulting in notes of $8,804,909 Senior Detachable Conversion Convertible Note payable Warrants Option note payable Debt Discount Liability Liability ------------ ------------- ------------- ------------- Balance at December 31, 2005 $ - $ - $ - $ - ============ ============= ============= ============= July 31, 2006 Senior convertible notes (5,000,000) 5,000,000 (4,431,011) (3,068,783) Change in fair value of warrants - - (5,342,956) - Change in fair value of conversion feature - - - (3,737,837) Amortization of debt discount - (1,041,666) - - ------------ ------------- ------------- ------------- Balance at December 31, 2006 as restated $ (5,000,000) $ 3,958,334 $ (9,773,967) $ (6,806,620) ============ ============= ============= ============= Amortization and change in fair values from January 1 to January 18, 2007 (114,247) 524,400 640,241 To record gain on extinguishment of debt - (3,844,087) 9,249,567 6,166,379 January 18 Senior convertible notes amended (3,804,909) - - - Detachable L Warrant and Conversion feature January 18, 2007 - 8,804,909 (16,279,237) (10,858,880) Recognition of detachable M warrant feature, July 30, 2007 - - (4,144,328) - Reduction upon conversion of note 2,707,475 - - 6,079,443 Change in fair value of L Warrants - - 9,752,888 - Change in fair value of M Warrants - - 1,974,487 - Change in fair value of conversion feature - - - 849,975 Amortization of debt discount - (5,473,312) - - ------------ ------------- ------------- ------------- Balance at December 31, 2007 $ (6,097,434) $ 3,331,597 $ (8,696,190) $ (3,929,462) ============ ============= ============= ============= On July 30, 2006, the Company entered into a Securities Purchase Agreement with three institutional investors in connection with a private placement transaction providing for, among other things, our issuance of senior convertible notes in the aggregate principal amount of $5 million, Series L-1 Warrants to purchase up to an aggregate of 17,065,623 shares of our common stock and Series M-1 Warrants to purchase up to an aggregate of 7,395,103 shares of our common stock. The Series L-1 Warrants are immediately exercisable. The Series M-1 Warrants become exercisable only upon a mandatory conversion of the notes at the option of the Company. The Company received aggregate gross proceeds of $5 million from the investors for our issuance of these notes and warrants. F-17 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 In November 2006, the Company determined that it would not be able to obtain an effective registration statement by the contractually required date of December 1, 2006 and the Company and investors agreed to restructure the financing. In connection with the restructuring the Company entered into Amendment and Exchange Agreements, dated January 18, 2007 and amended and restated on January 22, 2007, with the investors from the July 30, 2006 private placement providing for certain amendments to the senior convertible notes, Series L-1 Warrants, Series M-1 Warrants and registration rights agreement. These amendments include, but are 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 July 30, 2006 agreements, an increase in the principal amount of the notes from an aggregate of $5 million to an aggregate of approximately $7.2 million, a 5,688,540 increase in 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, on January 18, 2007, the Company entered into a Securities Purchase Agreement with one of the existing institutional investors in connection with a private placement transaction providing for, among other things, our issuance of senior convertible notes in the aggregate principal amount of $1.6 million, Series L-2 Warrants to purchase up to an aggregate of 7,281,332 shares of our common stock and Series M-2 Warrants to purchase up to an aggregate of 2,366,433 shares of our common stock. The Series L-2 Warrants are immediately exercisable. The Series M-2 warrants become exercisable only upon a mandatory conversion of the notes at the option of the Company. The Company received aggregate gross proceeds of $1.6 million from the investors for our issuance of these notes and warrants. Both the Series L-2 Warrants and Series M-2 Warrants have an initial exercise price of $0.43948 per share and expire on July 31, 2011. The Company may elect to make monthly installment payments in cash or in shares of the Company's common stock. All notes mature on July 31, 2008 (the "Maturity Date"), subject to the right of the investors to extend the date for the payment of any installment of principal (as described below). The notes bear interest at the rate of 9.25% per annum, which rate may be adjusted to 7.0% per annum at the beginning of each calendar quarter if certain conditions are satisfied. The interest rate is increased to 15% upon the occurrence of an event of default. Pursuant to the terms of the convertible note private placement agreements, the Company is required to file a registration statement with the SEC registering for resale certain shares of common stock underlying all of the convertible notes, Series L-1 and L-2 Warrants (together the "Series L Warrants") and Series M-1 and M-2 Warrants (together the "Series M Warrants"). Some important events of default follow: o The failure of any registration statement required by the Amended Registration Rights Agreement to be declared effective by the SEC within 60 days after the date required by the Amended 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). F-18 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 o 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. o The failure to issue shares upon conversion of a Note 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. If there is an event of default, then 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. Subject to certain conditions, the Company may require the investors to convert up to 50%, of the notes after the SEC has declared effective the initial registration statement at any time when the shares of the Company's Common Stock are trading at or above 150% of the initial Conversion Price or convert up to 100%, of the notes after the SEC has declared effective the initial registration statement at any time when the shares of the Company's Common Stock are trading at or above 175% of the initial Conversion Price. The notes contain certain limitations on optional and mandatory conversion. For example, they provide that no conversion may be made if, after giving effect to the conversion, the investor would own in excess of 4.99% of the Company's outstanding shares of Common Stock. This percentage may, however, be increased up to 9.99% at the option of the investor upon 61-days prior notice to the Company. The terms of the Amendment and Exchange Agreement, dated January 18, 2007 and amended and restated on January 22, 2007, with the investors from the July 30, 2006 private placement including the financing of $1.6 million result in the following accounting treatment: The restructuring of our July 30, 2006 debt which took place in January 2007 constitutes, as per SFAS No. 15, non-troubled debt and therefore is subject to the accounting treatment as provided in Emerging Issues Task Force ("EITF") 96-19. In SFAS No. 15 it is stated "a debt constitutes a troubled debt restructuring if the creditor grants a concession to the debtor". As no concessions were granted in our January 2007 debt restructuring, troubled debt accounting rules do not apply. In accordance with EITF 96-19 we determined that the amended agreements differ substantially from the original July 31, 2006 financing agreements and therefore the restructuring of our original senior convertible notes should be accounted for as an extinguishment of debt. This treatment resulted in the recognition, on January 18, 2007, of an $11,571,860 gain after eliminating all liabilities related to the July 31, 2006 financing. The terms of the amended convertible notes include certain conversion features that represent derivative financial instruments under paragraph 12 of SFAS No. 133. These conversion features could result in a required number of shares to be issued upon conversion that is greater than the currently authorized number of shares and therefore the convertible note does not qualify as conventional convertible debt as defined by EITF 05-02. As such, in accordance with paragraph 4 of EITF 00-19, the Company has classified the conversion feature as a liability on its balance sheet measured at fair value using the Black-Scholes option pricing model. The initial amount of this conversion liability on January 18, 2007 was valued at $10,858,880. SFAS No. 133 and EITF 00-19 further require the Company to account for the conversion feature using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded against earnings. The fair market value of the conversion feature at December 31, 2007 after applying the Black-Scholes option pricing model was determined to be $3,929,462 and was recognized by recording a gain of $849,975 to Other Expenses for the year ended December 31, 2007. During the year ended December 31, 2007, the carrying value of the conversion feature was also decreased by $6,079,443. This amount represents the fair value associated with the reduction of 6,160,638 shares in connection with the conversion of a portion of the notes totaling $2,707,475. In connection with this conversion the Company also issued a total of 13,665 shares of common stock as payment for accrued interest due on the converted amounts. The Note holders have elected to make certain deferrals for their June 1, 2007 through December 1, 2007 standard conversions. F-19 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 The key assumptions used in applying the Black-Scholes option pricing model to determine the fair value at December 31, 2007 are as follows: Stock price of $0.67 Exercise price of $0.44 Volatility of 79.2 % Expected life 0.60 years Interest rate of 3.46% The combined fair value of the conversion feature and the detachable L warrants at January 18, 2007 was $27,138,117. The face value of the related senior convertible note was $8,804,909. Therefore, the Company has recognized the excess of $18,333,208 as a charge to the Cost of Financing in January 2007. Amortization of the $8,804,909 debt discount liability equals $5,473,312 for the year ended December 31, 2007. With respect to the Series L Warrants and the Series M Warrants, it is noted that the conversion feature as mentioned before could result in a required number of shares to be issued upon conversion that is greater than the currently authorized number of shares. This condition, which is outside of the Company's control, could impact the Company's ability to maintain the appropriate level of reserved shares in place required for the Series L Warrants and the Series M Warrants. This could result in the need for the Company to obtain approval from its shareholders to increase its authorized share capital to accommodate appropriate reserves for shares issuable upon exercise of the Series L Warrants and Series M Warrants. Since shareholder approval for this increase of authorized share capital cannot be guaranteed, the Series L Warrants and Series M Warrants, in accordance with EITF 00-19, need to be classified as a liability on the Company balance sheet, measured at fair value using the Black-Scholes option pricing model. The initial amount of the detachable L Warrants on January 18, 2007 was valued at $16,279,237. SFAS No. 133 and EITF 00-19, further require the Company to account for the detachable warrant conversion feature using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded against earnings. The fair market value of the detachable L warrants at December 31, 2007 after applying the Black-Scholes option pricing model was determined to be $6,526,349 and was recognized by recording a $9,752,888 gain to Other Expenses during the year ended December 31, 2007. The key assumptions used in applying the Black-Scholes option pricing model to determine the fair value are as follows: Stock price of $0.67 Exercise price of $0.44 Volatility of 79.2 % Expected life 0.60 years Interest rate of 3.46% F-20 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 The holders' right to exercise the 9,761,536 Series M Warrants was contingent on a mandatory conversion of the notes at the option of the Company. A mandatory conversion for a portion of the notes took place on July 30, 2007 entitling investors to exercise up to 7,646,361 M warrant shares. The fair value of these 7,646,361 Series M warrant shares, measured at January 18, 2007 using the Black-Scholes option pricing model is $4,144,328. As prescribed by paragraph 13 of EITF 98-5, this $4,144,328 has been recognized as a charge to the Cost of Financing in the third quarter of 2007. SFAS No. 133 and EITF 00-19, further requires the Company to account for the now exercisable 7,646,361 Series M warrant shares using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded against earnings. The fair market value at December 31, 2007 of the M Warrants after applying the Black-Scholes option pricing model was determined to be $2,169,841 and was recognized by recording a $1,974,487 gain to Other Expenses during the year ended December 31, 2007. At December 31, 2007, an amount of 2,115,175 Series M Warrants remain contingent until there is a further mandatory conversion of the notes. The value of these remaining warrants measured at fair value on January 18, 2007 using the Black-Scholes option pricing model is $1,146,425 and will be recognized upon a mandatory conversion at the option of the Company, if any. In connection with the $8,804,909 private placement, the Company issued to the placement agent warrants with a term of five years to purchase 600,710 shares of the Company's common stock. These placement agent warrants are immediately exercisable and have an exercise price of $0.43948 per share. The placement agent warrants were measured at fair value using the Black-Scholes option pricing model. The resulting net debt issuance cost at December 31, 2007 was $66,490. During the year ended December 31, 2007, the Company amortized $109,615 to interest expense. These senior convertible notes are classified as short-term because investors have the right to accelerate conversion of their notes 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. In addition, the Company has the right to call a forced conversion under certain conditions. Therefore, the Company believes the conversion of the notes will take place within a year. This accelerated conversion also applies to the deferred conversions by the note holders. $3,500,000 July 2007 Senior Secured Convertible Note Financing - -------------------------------------------------------------- Senior Detachable Conversion Convertible Note payable Warrants Option note payable Debt Discount Liability Liability ------------ ------------- ------------- ------------- Balance at December 31, 2006 $ - $ - $ - $ - July 2007 Senior convertible notes (3,500,000) - - - Detachable warrant and Conversion feature July 2007 - 3,500,000 (3,282,069) (2,297,449) Change in fair value of warrants - - 3,067,173 - Change in fair value of conversion feature - - - 2,147,021 Amortization of debt discount to other expense - (486,110) - - ------------ ------------- ------------- ------------- Balance at December 31, 2007 $ (3,500,000) $ 3,013,890 $ (214,896) $ (150,428) ============ ============= ============= ============= On July 31, 2007, we entered into a securities purchase agreement with our investors involved in the July 2006 and January 2007 transactions for total gross proceeds of $3.5 million, which agreement provides for the issuance on August 1, 2007 of Senior Secured Convertible Notes in the aggregate principal amount of $3.5 million ("Secured Notes"), Series N Warrants, Series O Warrants and Series P Warrants in a private placement transaction. The agreement also requires the Company to enter into a security agreement granting the investors a first priority perfected security interest in all of the Company's assets and requires the Company's subsidiary to guaranty the Company's obligations under the Secured Notes. The Secured Notes and accompanying warrants are or may become convertible into or exercisable for the following number of shares of the Company's common stock: F-21 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 Notes: 2,909,636 N Warrants: 2,909,636 O Warrants: 1,891,263 P Warrants: 1,246,987 ---------------------------------------------------- Total: 8,957,522 The Secured Notes carry an interest rate of 9.25% per annum, which rate may be increased to 15% upon the occurrence of an event of default, and mature on August 1, 2010. This date may be extended, at the option of the investors, by up to two years. Interest will be payable quarterly, starting October 1, 2007. The Secured Notes are immediately convertible at a conversion price of $1.2029 per share. The entire outstanding principal balance and any outstanding fees or interest shall be due and payable in full on the maturity date. Under certain conditions, the Company may require investors to convert up to either 50% or 100% of the outstanding balances of the Secured Notes at any time the Company shares are trading at or above $1.80435 or $2.105075, respectively. The N Warrants carry a strike price of $1.2029 for each share and are immediately exercisable. The N warrants expire on the earlier of August 1, 2016 or seven years after the date all of the shares issuable upon conversion of the Secured Notes have been included on an effective registration statement. The O Warrants also carry a strike price of $1.2029 for each share. The O Warrants will only become exercisable by an investor if the Company conducts mandatory conversions, and then only to the extent of 65% of the number of shares issued to such investor upon each mandatory conversion. The O Warrants expire on the earlier of August 1, 2016 or seven years after the date all of the shares issuable upon conversion of the Secured Notes have been included on an effective registration statement. The P Warrants carry a strike price of $1.2029 for each share and are immediately exercisable. The P Warrants expire on the earlier of the maturity date of the Secured Notes of August 1, 2010, which date may be extended by up to two years at the option of the investors, and the date the Company has satisfied its payment obligations under the warrant holder's Secured Note. In the event of a default or upon the occurrence of certain fundamental transactions as defined in the Secured Notes, the investors will have the right to require the Company to redeem the Secured Notes at a premium. In addition, at any time on or after August 1, 2010, the investors may accelerate the partial payment of the Secured 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. The conversion price of the Secured Notes and the exercise price of the N Warrants, O Warrants and P 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. The Secured Notes and the N Warrants, O Warrants and P Warrants contain certain limitations on conversion or exercise, including that a holders 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 or decrease, upon at least 61-days' notice, by the investor to the Company, of up to 9.99%). The Company has agreed to register the shares of common stock underlying the Secured Notes, N Warrants, O Warrants and P Warrants, If the Company fails to meet the filing or effectiveness requirements, subject to certain grace periods, the Company may be required to pay liquidated damages of $70,000 on the date of such failure and on every 30th day thereafter until such failure is cured. The total liquidated damages payable by the Company for failure to meet the filing and effectiveness requirements are capped at $437,500. F-22 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 The terms of the Secured Notes include certain conversion features that represent derivative financial instruments under paragraph 12 of SFAS No. 133. These conversion features could result in a variable number of shares to be issued upon conversion and therefore the Secured Notes do not qualify as conventional convertible debt as defined by EITF 05-02. As such, in accordance with paragraph 4 of EITF 00-19, the Company has classified the conversion feature as a liability on its balance sheet measured at fair value using the Black-Scholes option pricing model. The initial amount of this conversion liability on July 30, 2007 was valued at $2,297,449. SFAS No. 133 and EITF 00-19 further require the Company to account for the conversion feature using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded against earnings. The fair market value of the conversion feature at December 31, 2007 after applying the Black-Scholes option pricing model was determined to be $150,428 and was recognized by recording a gain of $2,147,021 to Other Expenses for the year ended December 31, 2007. The key assumptions used in applying the Black-Scholes option pricing model to determine the fair value at December 31, 2007 are as follows: Stock price of $0.67 Exercise price of $1.2029 Volatility of 79.2% Expected life 0.60 years Interest rate of 3.46% The combined fair value of the conversion feature and the detachable N warrants and P warrant at July 30, 2007 was $5,579,518. The face value of the related Secured Notes was $3,500,000. Therefore, the Company has recognized the excess of $2,079,518 as a charge to the Cost of Financing in July 2007. Amortization of the $3,500,000 debt discount liability equals $486,110 for the year ended December 31, 2007. With respect to the Series N Warrants and the Series P Warrants, it is noted that the conversion feature could result in a variable number of shares to be issued upon conversion. This condition, which is outside of the Company's control, could impact the Company's ability to maintain the appropriate level of reserved shares in place required for the Series N Warrants and the Series P Warrants. This could result in the need for the Company to obtain approval from its shareholders to increase its authorized share capital to accommodate appropriate reserves for shares issuable upon exercise of the Series N Warrants and Series P Warrants. Since shareholder approval for this increase of authorized share capital cannot be guaranteed, the Series N Warrants and Series P Warrants, in accordance with EITF 00-19, need to be classified as a liability on the Company balance sheet, measured at fair value using the Black-Scholes option pricing model. On July 30, 2007 the initial amount of the detachable N Warrants and P Warrants combined was valued at $3,282,069. SFAS No. 133 and EITF 00-19, further require the Company to account for the detachable warrant conversion feature using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded against earnings. The fair market value of the detachable warrant at December 31, 2007 after applying the Black-Scholes option pricing model was determined to be $214,896 and was recognized by recording a $3,067,173 gain to Other Expenses during the year ended December 31, 2007. The key assumptions used in applying the Black-Scholes option pricing model to determine the fair value are as follows: Stock price of $0.67 Exercise price of $1.2029 Volatility of 79.2% Expected life 0.60 years Interest rate of 3.46% Since conversion of the Series O Warrants is contingent on a mandatory conversion of the Secured Notes at the option of the Company the total charge was measured as per the date of issuance of these warrants; however, this charge will not be recognized until the mandatory conversion "contingency" has been removed as allowed under paragraph 13 of EITF 98-5. The value of the Series O Warrants measured at fair value on July 30, 2007 using the Black-Scholes option pricing model is $1,493,341. F-23 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 6. STOCKHOLDERS' EQUITY The Company's authorized capital consisted of 200,000,000 and 110,000,000 shares of common stock, par value $0.001 per share at December 31, 2007 and December 31, 2006, respectively, and 5,000,000 shares of preferred stock, no par value per share as of both dates. The additional 90,000,000 authorized shares issued in 2007 were approved by the Shareholders on April 30, 2007 during the Company's Annual Meeting of Shareholders. During 2005, the Company issued 975,000 shares and 262,500 shares, respectively, in connection with the settlement of two lawsuits as more fully described in the Company's Current Reports on Form 8-K filed with the SEC on January 24, 2005 and February 22, 2005, respectively. The Company also issued 300,000 shares for services During 2006, the Company issued a total of 155,729 shares of which 46,979 shares related to the cashless exercise of Series J warrants and 108,750 shares related to the cash exercise of Series H warrants issued at $0.50 per share for total proceeds of $54,375. During 2007, in connection with the Company's senior convertible notes, the Company issued 6,208,123 shares upon conversions of $2,707,475 in notes by the investors. During 2007, the Company issued a total of 3,976,428 shares of which 1,643,760 shares related to the exercise of warrants utilizing a cashless feature and the remaining 2,332,668 shares related to the cash exercise of warrants issued for total proceeds to the Company of $1,091,635. In July of 2007, the Company issued 100,000 shares upon the exercise of employee stock options for total proceeds of $100,000. A total of 397,748 shares were issued on April 15, 2007 upon the conversion of the $1,214,290 short term convertible notes as discussed in Note 4 above. F-24 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 7. WARRANTS Warrants granted to investors, brokers and other service providers are summarized as follows: Weighted Average Shares Exercise Price -------------- ------------------- Outstanding at December 31, 2005 16,255,087 $ 2.01 Granted 24,915,810 0.51 Cancelled/Forfeited (972,223) 1.25 Exercised (205,800) .50 -------------- ------------------- Outstanding at December 31, 2006 39,992,874 $ .98 Granted 21,729,817 0.65 Cancelled/Forfeited (34,500) 0.47 Exercised (6,083,747) 0.84 -------------- ------------------- Outstanding at December 31, 2007 55,604,444 $ 0.76 ============== =================== The following tables summarize warrants outstanding at December 31, 2007: Range Number Wtd. Ave. Life Wtd. Ave. Price Exercisable ----- ------ -------------- --------------- ----------- $.40-2.50 55,604,444 1.81 $0.76 53,713,181 OUTSTANDING AT EXERCISED/ OUTSTANDING AT EXERCISED/ OUTSTANDING SERIES ISSUE DATE 12/31/05 FORFEITED GRANTED 12/31/06 FORFEITED GRANTED AT 12/31/07 - ---------- ---------- -------------- ------------ ------------- ----------------- ------------ ------------ --------------- A April 2004 - - - - - - B April 2004 3,200,000 - - 3,200,000 (1,249,999) - 1,950,001 C June, 2004 972,223 (972,223) - - - - - D June, 2004 972,223 - - 972,223 - - 972,223 E 2004-2005 1,416,000 - - 1,416,000 (1,275,000) - 141,000 F April 2005 231,036 - - 231,036 (216,651) - 14,385 G April 2005 3,564,188 - - 3,564,188 - - 3,564,188 G-BH April 2005 1,505,989 - - 1,505,989 - - 1,505,989 H April 2005 2,138,513 (108,750) - 2,029,763 (2,029,763) - - February I 2005 200,000 - - 200,000 (190,000) - 10,000 J August 2005 602,393 (97,050) - 505,343 (489,088) - 16,255 K Not Used - - - - - - - July 2006 & January L-1 2007 - - 17,065,623 17,065,623 - 5,688,540 22,754,163 January L-2 2007 - - - - - 7,281,332 7,281,332 M-1 July 2006 - - 7,395,103 7,395,103 - - 7,395,103 January M-2 2007 - - - - - 2,366,433 2,366,433 N July 2007 - - - - - 2,909,636 2,909,636 O July 2007 - - - - - 1,891,263 1,891,263 P July 2007 - - - - - 1,246,987 1,246,987 MISC 2003-2007 1,452,522 - 455,084 1,907,606 (667,746) 345,626 1,585,486 -------------- ------------ ------------- ----------------- ------------ ------------ --------------- TOTAL 16,255,087 (1,178,023) 24,915,810 39,992,874 (6,118,247) 21,729,817 55,604,444 ============== ============ ============= ================= ============ ============ =============== F-25 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 2007 Warrants - ------------- In connection with securing the January 2007 Senior Convertible Notes (as described in Note 5 above), the three convertible note investors were entitled to Series L-1 Warrants to purchase up to an aggregate of 5,688,540 shares of the Company's common stock Series L-2 Warrants to purchase up to an aggregate of 7,281,332 shares of the Company's common stock and Series M-2 Warrants to purchase up to an aggregate of 2,366,433 shares of the Company's common stock. Both the Series L-1 Warrants and Series M-2 Warrants have an original exercise price of $.43948 per share and expire by August 1, 2016. The Series L-1 Warrants are immediately exercisable. The Series M-2 Warrants become exercisable only upon a "mandatory conversion" of the notes, which is callable by the Company. In connection with securing the July 2007 $3,500,000 Senior Convertible Note (as described in Note 5 above), the investor was entitled to Series N Warrants to purchase up to an aggregate of 2,909,636 shares of the Company's common stock, Series P Warrants to purchase up to an aggregate of 1,246,987 shares of the Company's common stock and Series O Warrants to purchase up to an aggregate of 1,891,263 shares of the Company's common stock. These series of N, O, and P warrants have an original exercise price of $1.2029 per share and expire by August 1, 2016. The Series N and P Warrants are immediately exercisable. The Series O Warrants become exercisable only upon a "mandatory conversion" of the notes, which is callable by the Company. During the second quarter of 2007, the Company issued warrants to a non-related service provider for providing investment related services for the Company. The warrants totaling 200,000 were issued in two separate transactions of 100,000 warrants each and have an exercise price of $0.50 and $1.00 per share of the Company's common stock and expire during the second quarter of 2010. Investment related costs of $166,500 were recognized for these warrants issued in 2007. 2006 Warrants - ------------- In connection with securing the Senior Convertible Notes (as described in Note 5 above), the three convertible note investors were entitled to Series L Warrants to purchase up to an aggregate of 17,065,623 shares of the Company's common stock and Series M Warrants to purchase up to an aggregate of 7,395,103 shares of the Company's common stock. Both the Series L Warrants and Series M Warrants had an original exercise price of $0.5054 per share and expire on July 31, 2011. The Series L Warrants are immediately exercisable. The Series M Warrants become exercisable only upon a "mandatory conversion" of the notes, which is callable by the Company. Because the Company was unable to register the number of shares agreed upon in the Senior Convertible Note financing, the registration statement filed with the SEC was withdrawn and an amended financing was agreed upon on January 22, 2007. In connection with the $5,000,000 private placement, the Company issued to the placement agent, warrants with a term of five-years, to purchase 455,084 shares of the Company's common stock. These placement agent warrants are immediately exercisable and have an exercise price of $0.43948 per share. During the fourth quarter of 2006, 205,800 warrants were exercised of which 97,050 warrants related to the cashless exercise of Series J warrants and 108,750 warrants related to the cash exercise of Series H warrants issued at $0.50 per share for total proceeds of $54,375. In addition, during the third quarter of 2006 all of the Company's outstanding Series C Warrants to purchase an aggregate of 972,223 shares of the Company's common stock expired. None of the Series C Warrants were exercised prior to their expiration. F-26 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 2005 Warrants - ------------- As further consideration for securing the 8% Notes (as described in Note 4 above), our placement agent was entitled to warrants to purchase shares of the Company's common stock in an amount equal to 15% of the 1,540,243 shares issued upon conversion of the 8% Notes on July 15, 2005. Based on the 1,540,243 shares of common stock issuable the placement agent and its designees were issued an aggregate of 231,036 Series F Warrants. The Series F Warrants shall have an exercise price of $0.40 per share and shall expire on the earlier of April 23, 2010 or a change of control of the Company. An additional expense of financing of $146,349 was recognized during the year 2005. On July 12, 2005, the Company issued a total of 200,000 Series I Warrants to seven non-affiliate private-parties for providing financial advisory services to the Company. The Series I Warrants have an exercise price of $0.60 per share of the Company's common stock and expire on February 11, 2010. Compensation costs of $86,000 were recorded for these warrants in 2005. As further consideration to the placement agent that secured the 10% Note financing (as described in Note 4 above), upon the August 25, 2005 conversion of the 10% Notes, the Company became obligated to issue to the placement agent 602,393 Series J Warrants to purchase common stock. The Series J Warrants have an original exercise price of $0.50 per share of common stock and expire on August 25, 2010. An additional expense of financing of $240,957 has been recognized during the year 2005. On September 20, 2005, the Company amended the terms of its 972,223 previously issued Series D Warrants to reduce the original exercise price of $3.50 per share to an amended exercise price of $0.50 per share. Pursuant to the terms of the 2005 Private Placement, the Company issued 3,564,188 Series G Warrants in 2005 to investors in conjunction with the $7,128,375 in gross proceeds raised from the 2005 Private Placement. The Series G Warrants have an exercise price of $2.50 per share of common stock, expire five years from issuance date and are callable by the Company the first day after the 30-trading-day average price of the Company's common stock exceeds $3.50 per share. An additional expense of financing of $1,106,349 has been recognized during the year 2005. In addition, as further consideration for securing the $7,128,375 in gross proceed through the Company's 2005 Private Placement, the placement agent was entitled to warrants to purchase shares of the Company's common stock in an amount equal to 15% of the number of shares of common stock issued in the 2005 Private Placement. Based upon the issuance of 14,256,750 shares of common stock as of the final closing of the 2005 Private Placement on November 22, 2005, the Company issued 2,138,513 Series H Warrants to the placement agent and its designees. The Series H Warrants have an exercise price of $0.50 per share of common stock and expire on the earlier of November 23, 2007 or a change in control of the Company. An additional expense of financing of $906,023 has been recognized during the year 2005. 2004 Warrants - ------------- In April 2004, we closed an equity based financing for gross proceeds of $5,600,000. The financing involved the purchase of 3,200,000 shares of our common stock, 3,200,000 Series A Warrants and 3,200,000 Series B Warrants. The Series A Warrants expired on September 30, 2004 and no such warrants were exercised prior to their expiration. The Series B Warrants expire on April 1, 2009 and had an original exercise price of $3.50 per share. However, pursuant to the anti-dilution provisions of the Series B Warrants, our subsequent issuances of securities have resulted in a reduced exercise price of $1.22 per share as of January 18, 2007. In June 2004, we closed an equity based financing for gross proceeds of $1,750,000. The financing involved the purchase of 972,223 shares of our common stock, 972,223 Series C Warrants to purchase common stock and 972,223 Series D Warrants to purchase common stock. The Series C Warrants were issued with an original exercise price of $3.00 per share. In August 2004, we amended the terms of the Series C Warrants to reduce the exercise price to $1.25 per share. The Series C Warrants subsequently expired on August 15, 2006 and no such warrants were exercised prior to their expiration. The Series D Warrants expire on June 1, 2009 and had an original exercise price of $3.50 per share. In December 2005, we amended the terms of the Series D Warrants to reduce the exercise price to $0.50 per share. F-27 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 8. COMMITMENTS AND LEASES As of December 31, 2007, the Company leases for its use office space and workstations under a non-cancelable operating lease expiring in 2009. In addition, the Company leases a copier through 2008 and has agreements related to inventory purchase commitments requiring future payments through 2008. Future minimum payments for commitments over the next three years are as follows: For the year ended December 31, Amount ------------ ------ 2008 $ 291,039 2009 168,882 2010 - ---------- Total $ 459,921 ========== Rent expense for the years ended December 31, 2007 and 2006 was $246,800 and $209,574, respectively. In addition, at December 31, 2007, the Company has $203,697 in purchase order commitments. 9. INCOME TAXES The Company computes and records taxes payable based upon determination of taxable income which is different from pre-tax financial statement income. Such differences arise from the reporting of financial statement amounts in different periods for tax purposes. The timing differences are a result of different accounting methods being used for financial and tax reporting. The Company's total deferred tax assets and deferred tax liabilities at December 31, 2007 and 2006 are as follows: December 31, December 31, 2007 2006 ------------ ------------ Deferred tax assets Non-cash compensation $ 158,000 $ 44,000 Non-benefited tax losses and credits 21,897,000 14,831,000 ------------ ------------ Total deferred tax assets 22,055,000 14,875,000 Deferred tax liabilities Net book value of assets (45,000) (5,000) ------------ ------------ Total deferred tax liabilities (45,000) (5,000) ------------ ------------ Total net deferred tax assets 22,010,000 14,870,000 Valuation allowance (22,010,000) (14,870,000) ------------ ------------ Net deferred tax assets $ - $ - ============ ============ A valuation allowance has been established against the realization of the deferred tax assets since the Company has determined that the operating loss carryforwards may not be realized. The Company has federal and state net operating loss carryforwards of approximately $54,000,000 expiring between 2023 and 2027. Upon adoption of FIN 48 as of January 1, 2007, the Company had no gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. At December 31, 2007 the amount of gross unrecognized tax benefits before valuation allowances and the amount that would favorably affect the effective income tax rate in future periods after valuation allowances were zero. These amounts consider the guidance in FIN 48-1, "Definition of Settlement in FASB Interpretation No. 48". The Company has not accrued any additional interest or penalties as a result of the adoption of FIN 48. F-28 RAPTOR NETWORKS TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 and 2007 10. SUBSEQUENT EVENTS OPTIONS ISSUED - -------------- Subsequent to December 31, 2007, the Company awarded a total of 727,000 common stock purchase options, to certain employees which vest at the rate of 33 1/3% on each of the first, second and third anniversaries of the date of grant, expire on the eight-year anniversary of the date of grant, and have an exercise price of $0.67 per share of the Company's common stock. These 727,000 options to purchase common stock have been approved to by the Company's Board, subject to the 2005 Plan. Also, subsequent to December 31, 2007, the Company cancelled 32,500 options granted in previous years. NEW LEASE AGREEMENT - ------------------- On February 15, 2008, the Company entered into an agreement with an agency to occupy certain space in their facilities located in the Washington D.C. area for the purpose of conducting sales activities. The agreement is for a period of one year and requires the Company to pay monthly occupancy fees of $750. F-29 RAPTOR NETWORKS TECHNOLOGY, INC. PROSPECTUS MAY 22, 2008 WE HAVE NOT AUTHORIZED ANY DEALER, SALESMAN OR OTHER PERSON TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND ANY ACCOMPANYING SUPPLEMENT TO THIS PROSPECTUS. YOU MUST NOT RELY UPON ANY INFORMATION OR REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS OR ANY ACCOMPANYING PROSPECTUS SUPPLEMENT. THIS PROSPECTUS AND ANY ACCOMPANYING SUPPLEMENT TO THIS PROSPECTUS DO NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH THEY RELATE, NOR DO THIS PROSPECTUS AND ANY ACCOMPANYING SUPPLEMENT TO THIS PROSPECTUS CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SECURITIES IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. THE INFORMATION CONTAINED IN THIS PROSPECTUS AND ANY ACCOMPANYING SUPPLEMENT TO THIS PROSPECTUS IS ACCURATE AS OF THE DATES ON THEIR COVERS. WHEN WE DELIVER THIS PROSPECTUS OR A SUPPLEMENT OR MAKE A SALE PURSUANT TO THIS PROSPECTUS OR A SUPPLEMENT, WE ARE NOT IMPLYING THAT THE INFORMATION IS CURRENT AS OF THE DATE OF THE DELIVERY OR SALE.