UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended June 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

		For the transition period from to

Commission file number 000-31081

ETELOS, INC.

(Exact name of small business issuer as specified in its charter)

Delaware		77-0407364
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

1900 O’Farrell St., Suite 320, San Mateo, CA 94403

(Address of principal executive offices)

(425) 458-4510

(Issuer’s telephone number)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or For such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES o NO x

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

Large accelerated filer o		Accelerated Filer o

Non-accelerated filer o		Smaller reporting company x

(Do not check if a smaller reporting company)

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES o NO x

On June 30, 2008, the registrant had outstanding 23,052,624 shares of $0.01 par value common stock, its only class of common equity.

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PART I - FINANCIAL INFORMATION

ITEM 1. - FINANCIAL STATEMENTS (UNAUDITED)

ETELOS, INC.

CONDENSED BALANCE SHEETS

(in thousands, except share data)

(Unaudited)

	June 30, 2008			December 31, 2007

ASSETS
Current assets:
Cash and cash equivalents	$	1,796		$	928
Accounts receivable, net	5			—
Prepaid expenses and other current assets	62			20
Total current assets	1,863			948

Property and equipment, net	81			50
Other assets	308			41

Total assets	$	2,252		$	1,039

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	437		$	250
Accounts payable related parties	2			56
Accrued payroll and related expenses	588			514
Other accrued expenses	256			241
Deferred revenue	3			3
Deferred rent	4			—
Current portion notes payable, net of discounts	2,629			3,165
Current portion notes payable to related parties	150			187
Current portion capital leases	17			16
Warrant and derivative liability	10,521			—
Total current liabilities	14,607			4,432

Long-term notes payable, net of discounts, less current portion	2,871			889
Long-term notes payable to related parties, less currrent portion	561			629
Long-term deferred rent	1			—
Long-term capital leases	27			36

Total liabilities	18,067			5,986

Commitments and contingencies

Stockholders’ deficit:
Preferred stock, $0.01 par value: 50,000,000 shares authorized with liquidation preferences:
Series A: 4,166,667 shares authorized; issued and outstanding - no shares at June 30, 2008, and 22,167 at December 31, 2007	—			—
Series B: 7,500,000 shares authorized; issued and outstanding - no shares at June 30, 2008, and 40,000 at December 31, 2007	—			—
Series C: 20,000,000 shares authorized; issued and outstanding - no shares at June 30, 2008, and 1,482,604 at December 31, 2007	—			15
Common stock, $0.01 par value: 250,000,000 shares authorized; issued and outstanding - 23,052,624 at June 30, 2008, and 6,791,313 at December 31, 2007	231			68
Additional paid-in capital	18,192			5,404
Accumulated deficit	(34,238		)	(10,434		)
Total stockholders’ deficit	(15,815		)	(4,947		)

Total liabilities and stockholders’ deficit	$	2,252		$	1,039

The accompanying notes are an integral part of these condensed interim financial statements

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ETELOS, INC.

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2008			2007			2008			2007

Revenue	$	22		$	106		$	45		$	211
Cost of revenue	148			69			249			124
Gross profit (loss)	(126		)	37			(204		)	87

Operating expenses:
Research and development	1,283			292			2,476			554
Sales and marketing	508			149			801			221
General and administrative	630			110			1,100			155
Total operating expenses	2,421			551			4,377			930

Loss from operations	(2,547		)	(514		)	(4,581		)	(843		)

Other expense
Merger costs	13,444			—			13,444			—
Other expense	15			—			15			—
Total other expense	13,459			—			13,459			—

Interest expense, net	5,567			58			5,765			98
Loss before taxes	(21,573		)	(572		)	(23,805		)	(941		)

Provision for income taxes	—			—			—			—

Net loss	$	(21,573	)	$	(572	)	$	(23,805	)	$	(941	)

Basic and diluted net loss per share	$	(1.13	)	$	(0.16	)	$	(1.80	)	$	(0.27	)

Weighted average number of common shares used in computing basic and diluted net loss per share	19,046			3,507			13,198			3,504

The accompanying notes are an integral part of these condensed interim financial statements

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ETELOS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Six Months Ended
	June 30,
	2008			2007

Cash flows from operating activities:
Net loss	$	(23,805	)	$	(941	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	13			8
Amortization of notes discount	165			—
Amortization of financing fees	32			—
Stock based compensation	69			—
Interest expense paid in common stock	77			—
Beneficial conversion feature	991			—
Change in valuation of liability relating to embedded derivatives and warrants	4,377			—
Professional fees paid in common stock	—			30
Merger costs paid in common stock	13,177			—
Changes in operating assets and liabilities:
Accounts receivable, net	(5		)	(61		)
Prepaid expenses and other current assets	(41		)	(17		)
Other assets	(65		)	—
Accounts payable	153			129
Accounts payable related parties	(54		)	126
Accrued payroll and related expenses	73			59
Other accrued expenses	137			12
Deferred revenue	—			28
Deferred rent	5			—

Net cash used in operating activities	(4,701		)	(627		)

Cash flows from investing activity:
Purchases of property and equipment	(44		)	—

Net cash used in investing activities	(44		)	—

Cash flows from financing activity:
Proceeds from notes payable	5,500			600
Proceeds from issuance of common stock	460			—
Payment of fees on financing transactions	(234		)	—
Proceeds from (payments of) notes payable to related parties	(105		)	17
Payment of capital leases	(8		)	(7		)
Net change in line of credit	—			4

Net cash provided by financing activities	5,613			614

Net increase (decrease) in cash and cash equivalents	868			(13		)

Cash, and cash equivalents, beginning of period	928			15

Cash, and cash equivalents, end of period	$	1,796		$	2

Supplemental disclosure of cash flow information:
Cash paid for interest	$	126		$	33

Supplemental disclosure of non-cash financing activities:
Record warrants and embedded derivatives as liabilities	$	6,489		$	—
Issuance of common stock for convertible debt	$	2,463		$	—
Issuance of common stock for interest conversion	$	199		$	200
Issuance of detachable warrants	$	73		$	42
Discount on convertible notes	$	68		$	42
Issuance of common stock for anti-dilution	$	55		$	—
Repurchase of common stock	$	36		$	—
Conversion of preferred stock to common stock	$	15		$	—

The accompanying notes are an integral part of these condensed interim financial statements

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ETELOS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Organization

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

On April 23, 2008, Tripath filed a Current Report on Form 8-K announcing, among other things, that Etelos-WA, merged with and into Tripath (the “Merger”), and that the surviving corporation changed its name to Etelos, Inc. and its fiscal year end to December 31. The effective date of the Merger was April 22, 2008, and Etelos, Inc., as the surviving corporation, will conduct the business and operations previously conducted by Etelos-WA. In connection with the Merger, all outstanding shares of Etelos-WA common stock were converted into shares of Etelos, Inc. common stock on a three for one ratio: one share of Etelos Inc. common stock for every three shares of common stock of Etelos-WA. Also in connection with the Merger, (i) all outstanding shares of preferred stock of Etelos-WA were converted in to shares of common stock of Etelos, Inc., (ii) Etelos, Inc. issued an aggregate of 5,010,000 shares of its common stock to the secured and unsecured creditors of Tripath and (iii) all the shares of Tripath Technology were cancelled. Also on April 23, 2008, Etelos, Inc., formerly Tripath, amended its articles of incorporation with the state of Delaware to change its total authorized shares of stock to 300,000,000 shares, of which 250,000,000 shares are designated “Common Stock” with a par value of $0.01 per share and 50,000,000 shares are designated “Preferred Stock” with a par value of $0.01 per share. The Preferred Stock may be issued from time to time in one or more series, each of such series to consist of such number of shares and to have such terms, rights, powers and preferences, and the qualifications and limitations with respect thereto, as stated in the resolutions providing for the issue of such series adopted by the board of directors.

Prior to the Merger, Tripath was a shell corporation and in accordance with the Plan of Reorganization had no assets or liabilities. While Tripath acquired all the outstanding preferred and common stock of Etelos-WA, for accounting purposes, the acquisition has been treated as a recapitalization of Etelos-WA with Etelos-WA as the acquirer (a reverse acquisition). The historical financial statements prior to April 22, 2008, are those of Etelos-WA and reflect the operations of Etelos-WA for the quarterly and six month period ended June 30, 2008 and 2007. Proforma financial information giving effect to the acquisition as if the acquisition took place on January 1, 2007, have not been presented because Etelos-WA acquired no tangible or intangible assets, liabilities or any of the business operations of Tripath prior to its emergence from bankruptcy and therefore, the historical operations of Tripath are not an indicator of the future operations of Etelos, Inc. The operations of Etelos, Inc. subsequent to the Merger include only those of Etelos-WA.

The 5,010,000 shares of Etelos, Inc. common stock were valued at $2.63 per share, the estimated fair value of the common stock on the date of the Merger, which resulted in a charge to operations of $13.2 million included in the caption Merger Related Costs in the accompanying Statement of Operations. Etelos, Inc. believes that these shares were issued primarily for past services provided to Etelos-WA by the secured creditors and the release of the secured and unsecured creditors claims against Tripath.

Information concerning number of shares outstanding for Etelos, Inc. including the conversion prices and number of shares issuable upon conversion of convertible securities and exercise prices of warrants and stock options and the number of shares issuable upon exercise of the options and warrants, has been adjusted to reflect this stock split as if it had occurred at the beginning of the quarterly and six month periods and as of December 31, 2007. Also, the Shareholders’ Deficit section of the accompanying Balance Sheet has been adjusted to reflect the legal capital structure of Tripath adjusted for the change in authorized shares of common and preferred stock.

2. The Company and Risks and Uncertainties

Etelos is a developer and distributor of software productivity solutions that assist business organizations to effectively use Web Applications. Etelos provides a revolutionary Software-as-a-Service (“SaaS”) ecosystem for building, distributing and using Web Applications, including the Etelos MarketplaceTM, which is a marketplace to deploy and support such Web Applications. The purpose of the Etelos Markeyplace is to give businesses choices in applications and hosting and support services to cost effectively accomplish their goals. Etelos offers subscriptions to its applications to end users including its Etelos Marketplace and provides software developed by Etelos to enable Marketplace partners to offer their products and services to end users as a service under a SaaS model.

We began operations in 1999 but we did not adopt the SaaS on-demand Web Applications delivery model until 2005. As such, we have a limited operating history in the SaaS industry, including licensing our software, from which to evaluate our business and prospects. We incurred a net loss of $4.0 million for the year ended December 31, 2007, and have an accumulated deficit of $10.4 million at December 31, 2007. During the six months ended June 30, 2008, revenue has been limited and revenue derived from SaaS has been minor. In addition, we have not generated any significant revenue from through the Etelos Marketplace from licensing or sale of subscriptions to our products or services or third-party products or services. We cannot assure you that our future planned operations will be implemented successfully or that we will ever have profits. Furthermore, we are experiencing the initial costs and uncertainties of a young operating company, including start-up expenditures, unforeseen costs and difficulties, complications, and delays, all of which must be resolved and/or paid without the benefit of a predictable revenue stream. We cannot be sure that we will be successful in meeting these challenges and addressing these risks and uncertainties. If we are unable to do so, then our business will not be successful.

We maintain the majority of cash balances and all of our short-term investments with one financial institution.

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As used herein, unless the context requires otherwise, the terms the “Company,” “we,” “us,” “our” or “Etelos” refers to Etelos, Inc., the corporation that survived the Merger.

3. Basis of Presentation

The accompanying condensed consolidated financial statements include our accounts as of June 30, 2008, and December 31, 2007, and for the three and six months ended June 30, 2008 and 2007. These condensed financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The December 31, 2007, consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. However, we believe that all disclosures are adequate to make the information presented not misleading. The accompanying unaudited condensed financial statements should be read in conjunction with the audited financial statements and the notes thereto, included on Form 8-K filed April 23, 2008, and Form 8-K/A filed April 25, 2008, by Tripath.

In the opinion of our management, all adjustments (which consist of normal recurring adjustments, except as disclosed herein) necessary to fairly present our financial position, results of operations and cash flows for the interim periods presented have been included. The results of operations for the three and six months ended June 30, 2008, are not necessarily indicative of the results to be expected for the full year or for any future periods.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods and such differences could be material.

4. Going Concern

The financial statements have been prepared by us with the assumption that we will continue as a going concern. We have experienced net losses of $23.8 million and $4.0 million for the six months ended June 30, 2008, and the year ended December 31, 2007, respectively, and have a total stockholders’ deficit of $15.8 million, as of June 30, 2008, all of which raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might arise should we be unable to continue as a going concern.

Management has supported current operations by raising additional operating cash through the private sale of convertible debentures and notes payable. This has provided us with the cash inflows to continue our business plan, but have not resulted in significant improvement in our financial position or results of operations. Alternatives we are pursuing to improve our cash flow used in operations include (1) raising additional working capital through additional sale of preferred stock, common stock and/or debt and (2) reducing cash operating expenses to levels that are in line with current revenues. The first alternative could result in substantial dilution to existing shareholders. There can be no assurance that our current financial position can be improved, that we can raise additional working capital, or that we can achieve positive cash flows from operations. Our long-term viability as a going concern is dependent upon our ability to (1) locate sources of debt or equity funding to meet current commitments and near-term future working capital requirements and (2) achieve profitability and ultimately generate sufficient cash flow from operations to sustain our continuing operations.

Our cash balance including proceeds from our recent debt financings may not be sufficient to fund our operations through September 2008. If cash reserves and our credit facility are not sufficient to sustain operations, then we plan to raise additional capital by selling shares of our capital stock or other securities. However, there are no commitments or arrangements for future financings in place at this time and we can give no assurance that such capital will be available on favorable terms, or at all. We may need additional financing thereafter until we can achieve profitability. If we cannot, then we will be forced to curtail our operations or possibly be forced to evaluate a sale or liquidation of our assets. Even if we are successful in raising additional funds, there is no assurance regarding the terms of any additional investment. Any future financing may involve substantial dilution to existing investors.

5. Research and Development and Software Development Costs

Research and development expenses consist primarily of salaries, payroll taxes, benefits, and related expenditures for technology, software development, project management, and support personnel. Costs related to the research and development of new products, services and enhancements to existing products are expensed as provided for by SFAS NO. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (SFAS 86). Under SFAS 86, costs incurred in the research and development of new software products are expensed as incurred until technological feasibility is established. Research and development costs are capitalized beginning when a product’s technological feasibility has been established and ending when the product is available for general release to customers. Technological feasibility is reached when the product reaches the working model stage. To date, products and enhancements have generally reached technological feasibility and have been released for sale at substantially the same time and all research and development costs have been expensed.

Statement of Position 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use” (SOP 98-1), which applies to Software as a Service (SaaS) business model, are met for the capitalization of software development cost. Under SOP 98-1, software development costs, including costs incurred to purchase third party software, are capitalized beginning when the Company has determined certain factors are present, including, among others, that technology exists to achieve the performance requirements, buy versus internal development decisions have been made, and the Company’s management has authorized the funding for the project. Capitalization of software development costs ceases when the software is substantially complete and is ready for its intended use. To date, no software development costs incurred have met the criteria set forth in SOP 98-1 for capitalization.

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6. Revenue Recognition

We distribute Web Applications as a subscription service using the Software-as-a-Service (SaaS) or software-on-demand business model and allow third parties to offer their products or services through storefronts in the Etelos Marketplace, and to advertise on our web site or in our annual magazine for a fee. We also license certain of our software products under perpetual and terms licenses. Revenues are recognized on these service and licensing transactions using the criteria in Securities and Exchange Commission Staff Accounting Bulletin 104, “ Revenue Recognition in Financial Statements” and SOP 97-2, “Software Revenue Recognition”, respectively, which both provide that revenue may be recognized when all of the following are met:

·		persuasive evidence of an arrangement exists,

·		the product or service has been delivered,

·		the fee is fixed or determinable, and

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

For the Software-as-a-Service (SaaS) business model, persuasive evidence is generally an acceptance by the customer of a binding agreement and authorization by the customer to charge a credit card; delivery generally occurs over the term of the subscription agreement related to the SaaS; and the fee is fixed and collection reasonably assured when the customer’s credit card is charged. Accordingly, revenue is recognized over the period the SaaS is provided.

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

Advertising on our web site is recognized as revenue over the period the add appears on our web site and advertising presented in our annual magazine is recognized upon publication of the magazine provided the other criteria for revenue recognition set forth above have been met.

Arrangements for which the fees are not deemed reasonably assured for collection are recognized upon cash collection.

7. Stock Based Compensation

The Company, under SFAS No. 123 (revised 2004), “Share-Based Payment” (FAS 123R), is applying the “modified prospective method” and used the Black-Scholes Merton model to value all new stock based compensation awards granted starting January 1, 2006, and for any modification, cancellation, or repurchase of awards granted prior to January 1, 2006. As a result, we have recorded compensation cost in the statement of operations based on the fair value of the award for the requisite service period. FAS 123(R) also requires us to estimate forfeitures in calculating the expense relating to share-based compensation as opposed to only recognizing these forfeitures and the corresponding reduction in expense as they occur. This resulted in $68.7 thousand and $0.0 of expense for the quarters ending June 30, 2008 and 2007 respectively and $68.8 and $0.0 of expense for the six months ending June 30, 2008 and 2007, respectively.

FAS 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows. Due to our loss position, there were no such tax benefits during the quarters and six month periods ended June 30, 2008 and 2007. Prior to the adoption of FAS 123(R), those benefits would have been reported as operating cash flows had we received any tax benefits related to stock option exercises.

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The weighted-average fair value of stock-based compensation is based on the single option valuation approach and is estimated on the date of grant using a Black-Scholes Merton based option valuation model. The fair value of forfeitures is an estimate and no dividends have been declared. The fair value of options granted during the three and six months ended June 30, 2008 and 2007, were calculated based on the following average assumptions:

	For the Three Months						For the Six Months
	Ended June 30						Ended June 30
	2008			2007			2008			2007
Estimate fair value	$	1.44		$	—		$	0.75		$	—
Expected lives in years	7			—			7			—
Volatlity	68.50		%	0.00		%	56.00		%	0.00		%
Risk free interst rate	3.46		%	0.00		%	3.13		%	0.00		%
Dividend yield	$	—		$	—		$	—		$	—

We used estimated volatility of comparable public companies to estimate the expected volatility used for the Black-Scholes Merton model. The risk-free interest rate assumption is based upon the US Treasury yield. We historically have not declared dividends and therefore the dividend yield was assumed to be zero in the model.

The following table summarizes stock option activity under the Company’s stock option plans:

Outstanding at December 31, 2007	4,097,083
Granted	693,167
Exercised	(3,750	)
Cancelled	(206,007	)
Outstanding at June 30, 2008	4,580,493

There was no cash received as a result of options exercised during the quarter ended June 30, 2008. There were no equity instruments granted under share-based payment arrangements and therefore there was no cash used to settle any equity instrument. We do not plan to repurchase any shares during the remainder of 2008.

8. Net Loss per Share

Basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of shares of common stock outstanding during the period, excluding any unvested restricted stock that is subject to repurchase. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of unvested restricted stock (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options and warrants (using the treasury stock method) and the conversion of the Company’s convertible notes and debentures (using the if-converted method). As their effect is antidilutive, 4,580,493 of common shares exercisable under outstanding employee stock options, 611,111 of common shares exercisable under outstanding warrants and 6,426,074 shares of common issuable upon conversion of the outstanding convertible notes payable and debentures have been excluded from this calculation. The average exercise price of outstanding employee stock options and warrants to purchase the Company’s common stock is $0.23 and $1.80, respectively, at June 30, 2008.

The following table sets forth the computation of basic and diluted net loss per share for the periods presented (in thousands, except per share amounts):

	For the Three Months						For the Six Months
	Ended June 30						Ended June 30
	2008			2007			2008			2007

Numerator:
Net loss	$	(21,573	)	$	(572	)	$	(23,805	)	$	(941	)

Denominator:
Weighted average common stock	19,046			3,507			13,198			3,504

Net loss per share:
Basic and diluted	$	(1.13	)	$	(0.16	)	$	(1.80	)	$	(0.27	)

9. Recently Issued Accounting Standards

In February 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (FSP FAS 157-2), which delays the effective date of Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (SFAS 157) for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. We are currently evaluating the impact of adopting FSP FAS 157-2 for non-financial assets and non-financial liabilities on our consolidated financial position, cash flows, and results of operations.

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In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (FAS 141R), which requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. FAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Also, in December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (FAS 160), which clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. FAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our consolidated financial position, cash flows, and results of operations.

In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (FSP EITF 03-6-1), which requires entities to apply the two-class method of computing basic and diluted earnings per share for participating securities that include awards that accrue cash dividends (whether paid or unpaid) any time common shareholders receive dividends and those dividends do not need to be returned to the entity if the employee forfeits the award. FSP EITF 03-6-1 will be effective for the Company on January 1, 2009, and will require retroactive disclosure. The Company is currently evaluating the impact of adopting FSP EITF 03-6-1 on its consolidated financial position, cash flows, and results of operations.

10. Convertible Notes and Debentures and Embedded Derivative and Warrant Liability

Convertible notes and debentures comprise (in thousands):

	June 30, 2008			December 31, 2007
20% convertible notes	$	—		$	850
6% convertible notes	1,764			3,326
January 2008 Debentures	2,000			—
April 2008 Debentures	3,500			—
	7,264			4,176
Less discount on long term notes payable	(21		)	(16		)
Less amount classified as current	(4,431		)	(3,344		)
Long term	$	2,812		$	816

20% Convertible Notes

During the period October 2006 to June 2007, we issued 20 percent convertible notes with a face value of $850 thousand and detachable warrants to purchase shares of our common stock in exchange for $850 thousand. The notes mature on June 1, 2008, with interest due and payable on October 1, 2007, and the last day of each calendar quarter thereafter, through the maturity date. At our option, upon the closing of a Series D preferred stock offering having aggregate gross proceeds not less than $7.0 million, excluding the proceeds collected in connection with this financing, note holders may elect to convert the outstanding principal and the accrued and unpaid interest into Series D preferred stock at the purchase price per share of Series D preferred stock. In addition, a mandatory conversion provision would be triggered by the closing of a public offering at a conversion price equal to or greater than the note conversion price. There is a provision for a conversion price adjustment which would be triggered upon a stock split, reverse stock split, or issuance of stock dividends, whereby the conversion price would be adjusted to ensure that the holder would be receiving the same number of shares, as though the conversion right had been exercised prior to the triggering event. We are required to reserve, at all the times, the number of authorized unissued shares such that we have enough shares to issue in the event that the conversion right is exercised. As of June 30, 2008, $750 thousand of the 20% convertible notes have been converted into 1,000,000 shares of the Company’s common stock and the balance of $100 thousand have been paid in cash.

The detachable warrants allow the holders to purchase up to 283,333 shares of our common stock at an exercise price of $0.09 per share. As of June 30, 2008, all of the warrants had been exercised. The warrants were determined to have de minimus value at the issuance date.

6% Convertible Notes

During the period August 2007 to October 2007, we issued 6 percent convertible notes with a face value of $3,326.4 thousand at an original issue discount of 10 percent with detachable warrants to purchase shares of our common stock in exchange for $3,024 thousand. These notes mature on March 31, 2009, with interest due and payable on February 1, 2008, and on the last day of each calendar quarter thereafter. We are required to make payments on the outstanding principal balance beginning September 1, 2008,and on the 1^st day of each calendar quarter thereafter. The default interest rate is 8 percent. The notes and unpaid interest are convertible into shares of our common stock: (i) at our option upon the closing of a Preferred Series D round at $0.75 per share, and (ii) mandatorily upon; (a) closing of Series E Preferred Stock offering, no later than January 31, 2008, having aggregate gross proceeds to the Company of not less than $5.0 million at the price per share of the Series E preferred stock less a 10% discount, (b) closing of public offering at a conversion rate of $0.75 per preferred share, or (c) a change of 40 percent of the control, at a conversion rate of $0.75 per preferred share. As of June 30, 2008, $1,712 thousand of the face value of the 6% convertible notes have been converted to 2,283 thousand shares of the Company’s common stock and $1,764 thousand remain outstanding.

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In addition, the purchasers of the 6% Convertible Notes received warrants, which are fully exercisable, to purchase 1,080,000 shares of the Company’s common stock at an exercise price of $0.12. The warrants expire the earlier of August through October 2013 or are automatically terminated upon the Company’s, (i) public offering, (ii) sale of the Company, or (iii) change in control. At June 30, 2008, all of these warrants have been exercised or expired and none are outstanding.

January 2008 Debentures

On January 31, 2008, we issued convertible debentures (“the January 2008 Debentures”) with a principal amount of $2 million and detachable warrants to purchase 222,222 shares of our common stock in exchange for $1.9 million. The January 2008 Debentures are due on January 31, 2010, and bear interest at 6 percent per annum, which is payable semiannually on January 1 and July 1, commencing on July 1, 2008. Monthly principal payments equal to 1/18th of the principal amount begin on September 1, 2008. We have the right to pay interest and monthly principal payments in cash, or upon notice to the holders and compliance with certain equity conditions. We can pay all or a portion of any such payment in common stock valued at a price equal to the lesser of the then effective conversion price (currently $1.35) or 85 percent of the average of the volume weighted average price per share for our common stock for the 10 consecutive trading days immediately prior to the applicable payment date. The equity conditions that we must meet include having a currently effective registration statement covering the shares of common stock issuable upon conversion of the debenture, and having the daily dollar trading volume for our common stock exceed $250,000 for each of the 20 consecutive trading days before the date in question. The January 2008 Debentures and any accrued interest are convertible at anytime at the discretion of the holder at a conversion price per share of $1.35, subject to a cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion. The conversion price is adjusted upon a stock split, reverse stock split, or upon issuance of stock dividends, whereby the conversion price would be adjusted to ensure that the holder would be receiving the same number of shares, as though the conversion right had been exercised prior to the triggering event. Further, the conversion price is adjusted if common stock or equivalents are subsequently sold or re-priced at a price below the conversion price or rights, options or warrants are issued to holders of the Company’s common stock entitling them to purchase common stock at prices lower than the volume weighted average price on the date issued.

We have the option to redeem the January 2008 Debentures before their maturity by payment in cash of an amount equal to 120 percent of the then-outstanding principal amount, plus accrued interest and other charges, and the right to force conversion of the debentures if the average of the volume weighted average price of our common stock exceeds $3.39 for 20 trading days out of a consecutive 30 trading day period. This redemption option and forced conversion right are subject to the Company meeting certain equity conditions, including having the daily dollar trading volume for our common stock exceed $250 thousand for each of the 20 consecutive trading days before the date in question and having a currently effective registration statement covering the shares of common stock issuable upon conversion of the debentures and the forced conversion option, subject to the applicable cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion. The January 2008 Debentures are collateralized by substantially all the assets of the Company.

The January 2008 Debentures impose certain covenants on us, including restrictions against incurring additional indebtedness, creating any liens on our property, amending our certificate of incorporation or bylaws, redeeming or paying dividends on shares of our outstanding common stock, and entering into certain related party transactions. The January 2008 Debentures also define certain events of default, including, without limitation, failure to make a payment obligation, failure to observe other covenants of the debenture or related agreements (subject to applicable cure periods), breach of representation or warranty, bankruptcy, default under another significant contract or credit obligation, delisting of our common stock, a change in control, failure to secure and maintain an effective registration statement covering the resale of the common stock underlying the debentures and the warrants, or failure to deliver share certificates in a timely manner. In the event of default, the holders of the January 2008 Debentures have the right to accelerate all amounts outstanding under the debentures and demand payment of a mandatory default amount equal to 130 percent of the amount outstanding plus accrued interest and expenses.

Debt issuance costs of $85.2 thousand were incurred in conjunction with the issuance of the January 2008 Debentures, which have been capitalized as Other assets and are amortized using the effective interest method.

The detachable warrants, which are fully exercisable, to purchase 222,222 shares of our common stock, expire in January 2011 and are exercisable at a price of $1.80 per share, subject to adjustment, for the events described above, which adjust the conversion price of the January 2008 Debentures. As of June 30, 2008, none of these warrants had been exercised.

April 2008 Debentures

On April 22, 2008, we issued convertible debentures (“the April 2008 Debentures”) with a principal amount of $3,500.0 thousand and detachable warrants to purchase 388,889 shares of our common stock in exchange for $ 3,400.0 thousand. The April 2008 Debentures are due on April 30, 2010, and have the identical terms and conditions to the January 2008 Debentures described above.

Debt issuance costs of $149 thousand were incurred in conjunction with the issuance of the April 2008 Debentures, which have been capitalized as Other assets and are amortized using the effective interest method.

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The detachable warrants, which are fully exercisable, to purchase 388,889 shares of our common stock, expire in April 2011 and are exercisable at a price of $1.80 per share, subject to adjustment, for the events described above, which adjust the conversion price of the January 2008 Debentures. As of June 30, 2008, none of these warrants had been exercised.

In connection with the January 2008 Debentures and the April 2008 Debentures, we also entered into a registration rights agreement with the investors, pursuant to which we agreed to file a registration statement covering the resale of the shares of common stock that may be issued to such investors upon the conversion of the debentures, payment in kind, and the exercise of the related warrants. We agreed to maintain the effectiveness of the registration statement (subject to certain limitations) for a period of time until the holders can sell the underlying common stock without volume restrictions under Rule 144 of the Securities Act of 1933, or the Securities Act. If the registration statement is not declared effective by an agreed to date, or if we fail to maintain the effectiveness of the registration statement, then we are required to pay to each investor, as partial liquidated damages, cash equal to 1.0 percent of the aggregate purchase price paid by such investor for the securities purchased in the financing and then held by such investor, and must pay to such investor 1.0 percent for each subsequent 30-day period that the default remains uncured, up to a maximum aggregate liquidated damages amount of 10 percent of the aggregate purchase price paid by the holders of the debentures. We have determined that it is not probable that there will be any material damages and accordingly have not estimated any provision for default.

Our registration statement was effective July 31, 2008, which was 8 days after the deadline in the registration rights agreements. Accordingly, we may be liable for penalties in the amount of $14.7 thousand, which we have accrued in our liabilities.

Accounting for Convertible Notes and Debentures, Embedded Derivatives and Warrants

The Company has evaluated the embedded derivatives included in the 20% and 6% Convertible Notes (the Convertible Notes) and the January 2008 and April 2008 Debentures, which are not clearly and closely related to the Convertible Notes and January 2008 and April 2008 Debentures, consisting of the conversion features and certain put and call features described above, under the guidance in Statement of Financial Accounting Standard No. 133 “Accounting for Derivative Instruments and Hedging Activities” and its related guidance and interpretations (SFAS 133) on the issuance date of the Convertible Notes and January 2008 and April 2008 Debentures and on each subsequent reporting date. The purpose of the evaluation is to determine whether the embedded derivatives need to be bifurcated from the debt host and accounted for as a derivative at their estimated fair value as a liability at the date of issuance and thereafter, adjusted to market with a charge or credit to the Company’s statement of operations. SFAS 133 generally indicates that if the conversion features are (i) indexed to the Company’s capital stock and (ii) would be classified as equity if a freestanding derivative under the guidance in EITF 00-19,”Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (EITF 00-19), the embedded derivatives need not be bifurcated from the debt host. EITF 00-19 generally requires, among other factors, that (i) the Company can settle the derivative in cash or its own stock, at its option, (ii) settlement can be made in unregistered shares, and (iii) the Company has sufficient authorized shares to issue shares of its common stock for all equity instruments convertible to or which can be exercised for its capital stock. SFAS 133 also provides guidance on when put and call features included in a debt host agreement are not clearly and closely related to the debt host must be bifurcated and recorded as ability. Only the January 2008 and April 2008 Debentures include put and call features.

The Company concluded that the conversion features embedded in the 6% Convertible Notes met the criteria in SFAS 133 at issuance and through April 21, 2008, the day prior to the merger with Tripath, because the conversion to the Company’s common stock could only be settled in its capital stock, the capital stock could be unregistered and the sufficiency of the authorized shares was under the Company’s control as it could control the outcome of a shareholder vote to increase the authorized shares. However, on the date of the merger with Tripath, April 22, 2008, the Company concluded it no longer had control to ensure the sufficiency of its authorized shares of common stock and recorded the embedded conversion feature in the 6% Convertible Notes with an estimated fair value of $3,674 thousand and recorded the amount in the line entitled “Warrant and derivative liability” in the accompanying balance sheet. The fair value of the conversion feature was subsequently revalued to $7,554 thousand at June 30, 2008, with the related charge of $3,880 thousand included in the Company’s condensed statement of operations in interest expense for the quarter and six months ended June 30, 2008. The Company determined the estimated fair value of the conversion feature on April 22 and June 30, 2008, by using the Black-Scholes Merton valuation model and the following assumptions: fair value of the Company’s common stock of $2.91 and $4.00, respectively, per share; terms of .95 years and .75 years, respectively; risk free interest rates of 1.82% and 2.27%, respectively; and volatility of 47.16% and 56.13%, respectively. Probabilities were then applied to the outputs using the Matlab Monte Carlo Simulation of the Company’s stock prices to arrive at a value for the conversion options. Accretion charged to interest expense for the 6% Convertible Notes in the six months ended June 30, 2008, was $147 thousand. Also during the quarter and six months ended June 30, 2008, the Company recorded a beneficial conversion features related to accrued interest on the 6% Convertible notes, which were or could have been converted to the Company’s common stock, through the date the conversion features was recorded, as a liability of $58 thousand.

The Company concluded that the conversion features embedded in the January 2008 Debentures met the criteria in SFAS 133 at issuance and through March 31, 2008, and therefore, were not bifurcated from the debt host because the conversion to the Company’s common stock could only be settled in its common stock, the common stock could be unregistered and the sufficiency of the authorized shares was under the Company’s control as it could control the outcome of a shareholder vote to increase the authorized shares. While we concluded that the put and call embedded in the January 2008 Debentures was not clearly and closely related to the debt host, the estimated fair value of the put and call was determined to be de minimus and therefore was not bifurcated from the debt host. However, on the date of the merger with Tripath, April 22, 2008, the Company concluded it no longer had control to ensure the

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sufficiency of its authorized shares of common stock nor could it settle the conversion feature in unregistered shares and therefore, recorded the embedded conversion feature and put and call in the January 2008 Debentures with an estimated value fair value of $896 thousand and recorded the amount in the line entitled “Warrant and derivative liability” in the accompanying balance sheet. The fair value of the conversion feature was subsequently revalued to $578 thousand at June 30, 2008, with the related credit of $318 thousand included in the Company’s consolidated statement of operations for the quarter and six months ended June 30, 2008. The Company determined the estimated fair value of the conversion options on April 22 and June 30, 2008, using the Black-Scholes Merton valuation model and the following assumptions: fair value of the Company’s common stock of 2.91 and $4.00, respectively, per share; terms of 1 year and 1.75 years and 1.2 years and 1.5 years, respectively; risk free interest rates of 1.84% and 2.14% and 2.41% and 2.50%, respectively; and volatility of 47.16% and 48.48% and 49.08% and 49.97%, respectively. Probabilities were than applied to the outputs using the Matlab Monte Carlo Simulation of the Company’s stock prices to arrive at a value for the conversion options. Accretion charged to interest expense for the January 2008 Debentures in the six months ended June 30, 2008, was $20 thousand.

The Company concluded that the embedded conversion features in the April 2008 Debentures should be bifurcated from the debt host and recorded as liabilities because the conversion features must be settled in registered shares and that due to the Merger with Tripath, we no longer had control over a shareholder vote to ensure the sufficiency of our authorized shares of common stock. We also concluded that the put and call in the April 2008 Debentures were embedded derivatives and were not clearly and closely related to the debt host and therefore should be bifurcated from the debt host along with the conversion features and recorded as a liability at their estimated fair value at issuance and June 30, 2008. The estimated fair value of the embedded conversion features and put and call was $1,057 thousand $950 thousand at April 23, 2008, and June 30, 2008, respectively, and recorded in the line entitled “Warrant and derivative liability” in the accompanying Balance Sheet. The adjustments to revalue the estimated fair value of the conversion features and put and calls at June 30, 2008, of $557 thousand was credited to in the Company’s consolidated statement of operations for the quarter and six months ended June 30, 2008. The resulting discount on the April 2008 Debentures of $2,097 thousand, which included the estimated fair values of the related detachable warrants described below, is accreted from April 2008, the date of issuance, to April 30, 2010, the maturity date of the April 2008 Debentures, using the interest method with the relating charge to interest expense in the Company’s statement of operations. Accretion charged to interest expense for the April 2008 Debentures in the quarter and six months ended June 30, 2008, was $345 thousand. The Company determined the estimated fair value of the conversion options on April 22 and June 30, 2008, using the Black-Scholes Merton valuation model and the following assumptions: fair value of the Company’s common stock of 2.91 and $4.00, respectively, per share; terms of 1 year and 2 years and 1.4 years and 1.8 years, respectively; risk free interest rates of 1.87% and 2.24% and 2.47% and 2.58%, respectively; and volatility of 45.76% and 49.00% and 50.29% and 49.64%, respectively. Probabilities were then applied to the outputs using the Matlab Monte Carlo Simulation of the Company’s stock prices to arrive at a value for the conversion options.

The Company evaluated the terms and conditions of the detachable warrants issued with the January 2008 and April 2008 Debentures under the guidance in EITF 00-19 to determine whether the detachable warrants should be accounted for as equity or a liability and thereafter adjusted to their respective estimated fair value at each reporting date.

The Company concluded that the detachable warrants issued with the January 2008 Debentures met the criteria in SFAS 133 at issuance and through March 31, 2008, and therefore, were accounted for as equity because the warrants could only be settled by issuance of the Company’s common stock, the common stock could be unregistered, and the sufficiency of the authorized shares was under the Company’s control as it could control the outcome of a shareholder vote to increase the authorized shares. However, on the date of the merger with Tripath, April 22, 2008, the Company concluded it no longer had control to ensure the sufficiency of its authorized shares of common stock nor could it settle the warrants in unregistered shares and therefore, recorded the estimated value fair value of the warrants of $320 thousand in the line entitled “Warrant and embedded derivative liability” in the accompanying Balance Sheet. The fair value of the warrants was revalued to $544 thousand at June 30, 2008, with the related charge of $244 thousand included in the Company’s consolidated statement of operations for the quarter and six months ended June 30, 2008. The Company determined the estimated fair value of the warrants on April 22 and June 30, 2008, by using the Black Scholes Merton valuation model and the following assumptions: fair value of the Company’s common stock of $2.91 and $4.00, respectively, per share; terms of 2.5 years and 2.5 years, respectively; risk free interest rates of 2.54% and 2.77%, respectively; and volatility of 47.81% and 49.53%, respectively.

The Company concluded that the detachable warrants issued with the April Debentures did not meet the criteria in SFAS 133 at issuance because it no longer had control to ensure the sufficiency of its authorized shares of common stock nor could it settle the warrants in unregistered shares and therefore, recorded the estimated value fair value of the warrants of $590 thousand in the line entitled “Warrant and embedded derivative liability” in the accompanying Balance Sheet. The fair value of the warrants was revalued to $980 thousand at June 30, 2008, with the related charge included in the Company’s consolidated statement of operations for the quarter and six months ended June 30, 2008. The Company determined the estimated fair value of the warrants on April 22 and June 30, 2008, by using the Black Scholes Merton valuation model and the following assumptions: fair value of the Company’s common stock of $2.91 and $4.00, respectively, per share; terms of 3 years and 3 years, respectively; risk free intererst rates of 2.43% and 2.91%, respectively; and volatility of 49.17% and 49.80%, respectively.

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11. Notes Payable to Related Parties

We previously entered into a series of unsecured loan transactions with relatives of our executive chairman and chief technology officer. On December 30, 2007, in connection with settlement of the loans, we entered into three unsecured promissory notes with an aggregate original principal amount of $815,827, each of which will become collateralized by certain presently unidentified assets of the Company if and when Daniel J.A. Kolke is no longer an employee nor a member of our board of directors. Such security interest, if granted, would be subordinated to any and all bank debt or convertible corporate debt. These three notes are outstanding in an aggregate balance of $711 thousand as of June 30, 2008. Future payments of principal and interest under the terms of the notes are the following for the twelve months ending June 30:

2009	$	199
2010	78
2011	78
2012	78
2013	78
2014 and later	482
Total minimum loan payments	993
Less: amount representing interest	(282		)
Present value of minimum loan payments	711
Less: current portion of loan obligations	(150		)
Long-term loan obligations	$	561

12. Credit Facility

In October 2007, we entered into a one year credit facility with Bridge Bank which provides for borrowing of up to $250 thousand at an annual interest rate equal to the bank’s prime rate plus 2.5 percent. The credit facility is collateralized by substantially all of our assets and expires in October 2008. The credit facility contains financial and reporting covenants that require us to maintain certain financial ratios only when we have an outstanding balance. The facility has monthly repayment terms of both interest and principal amortized over an imputed twelve month period. We issued warrants to Bridge Bank to purchase up to 10,417 shares of our common stock at an exercise price of $1.20 per share in connection with this facility. The Bank elected not to exercise its warrants as of the Reverse Merger Date and the warrants are no longer outstanding and exercisable. There was no borrowing under this facility during the six months ending June 30, 2008.

13. Contingency

During June 2008, the Company paid federal and state payroll withholding taxes, including its portion of such payroll taxes and interest and penalty totaling $572 thousand, relating to 2007. These amounts were accrued as of December 31, 2006 and 2007 and at March 31, 2008. In June 2008, calendar and fiscal year the Company also became aware that it had not made certain payroll tax filings and had not filed its federal and state income tax returns for calendar and fiscal years 2004, 2005 and 2006. During June 2008, the Company made these filings. However, the Internal Revenue Services has notified the Company that certain payroll tax and income tax filings other than these also have not been filled in prior years. The Company is in the process of determining whether these payroll and income tax returns were filed and if not will either refile the returns or prepare such returns and make appropriate filings with the Internal Revenue Service. The Company believes it owes no more state or federal payroll taxes applicable to prior years and that it owes no federal or state income taxes because it had annual losses in each year of operations since its inception in 1999. However, because of the uncertainties related to both the amount and range of loss of this matter, management is unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, the Company will assess its potential liability and revise its estimates.

14. Subsequent Events

In July 2008, Kaufman Bros. L.P. filed suit against us in the United States District Court for the Southern District of New York (Case No. 80 CV 5716). The complaint arises our of an advisory services agreement, pursuant to which Kaufman Bros. was to provide us with advisory services in connection with financings and strategic transactions. We notified Kaufman Bros. that we believed it had failed to provide the required services under the agreement, and that we were therefore entitled to terminate the agreement for cause. In the suit, Kaufman Bros. was seeking (i) monetary damages of $400,000 for anticipatory breach of the agreement; (ii) $73,800 in fees allegedly owed in connection with a previously closed financing transaction; (iii) and injunction prohibiting us from cancelling any shares issued to Kaufman Bros. as compensation, (iv) a declaration from the court that we are not entitled to a refund of any fees previously paid to Kaufman Bros., and (v) a declaration that we are obligated to pay Kaufman Bros. a commission on any financing or transaction that we enter into within 18 months following the termination of the agreement. On July 15, 2008, Kaufman Bros. voluntarily filed a notice of dismissal without prejudice. Settlement discussions were unsuccessful and Kaufman Bros. has re-filed substantially the same claims in the Supreme Court of New York - County of New York (Index No. 08-602239). The Company has been served and is developing its defense plan. However, because of the uncertainties related to both the amount and range of loss of this matter, management is unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, the Company will assess its potential liability and revise its estimates.

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support the English Application Scripting Engine (EASETM), a simple-to-use open standards-based scripting language developed by us. In order to support broader adoption of our products, EASE and other components of the EDE are made available to developers at market appropriate pricing. This is done to support the development of new Web Applications and the migration of existing Web Applications into the Etelos ecosystem where there are tools and other support mechanisms for the marketing, distribution, and support of these applications. We generally receive a transaction fee or subscription fee for transactions that occur within the Etelos ecosystem via the Etelos Marketplace and, under Storefront Operating Agreements, share that revenue with Marketplace partners, calculated as a percentage of gross revenues from the sale of subscriptions to Marketplace partner products and service in the Etelos Marketplace.

The Etelos Marketplace supports and encourages communities of developers, distributors, and consumers to expand their offerings, collaborate on new ideas and improvements, and provide scalable solutions using Web Applications available to others.

Recent Financings

January 2008 Debentures.

On January 31, 2008, we entered into a securities purchase agreement with three unaffiliated institutional investors for the sale of 6 percent secured convertible debentures and common stock purchase warrants. We refer to these debentures as our January 2008 Debentures. In this transaction we issued an aggregate of $2.0 million principal amount of debentures and warrants to purchase an aggregate of 222,222 shares of our common stock. This transaction resulted in net proceeds to us of $1.9 million.

The warrants are three year warrants to purchase shares of our common stock at a price of $1.80 per share, subject to adjustment, including full-ratchet anti-dilution protection. As of June 30, 2008, none of these warrants had been exercised.

For a more detailed discussion of our January 2008 Debentures, please see the section entitled “January 2008 Debentures” under “Note 10. Convertible Notes and Debentures and Embedded Derivative and Warrant Liability” to our financial statements contained in “Item 1. Financial Statements,” of this report.

April 2008 Debentures

On April 22, 2008, we entered into a securities purchase agreement with two unaffiliated institutional investors for the sale of original issue discount 6 percent convertible debentures and common stock purchase warrants. We refer to these debentures as our April 2008 Debentures. In this transaction we issued an aggregate of $3.5 million principal amount of debentures and warrants to purchase an aggregate of up to 388,889 shares of our common stock. The warrants have a term of five years and an exercise price of $1.80 per share, subject to adjustment, including full-ratchet anti-dilution protection. This transaction resulted in net proceeds to us of $3.4 million.

For a more detailed discussion of our April 2008 Debentures, please see the section entitled “April 2008 Debentures” under “Note 10. Convertible Notes and Debentures and Embedded Derivative and Warrant Liability” to our financial statements contained in “Item 1. Financial Statements,” of this report.

As further discussed under “Liquidity and Capital Resources,” below, we believe our cash balance at June 30, 2008, is sufficient to fund our operations through at least September 2008. If cash reserves are not sufficient to sustain operations, then we plan to raise additional capital by selling shares of capital stock or other debt or equity securities. However, there are no commitments or arrangements for future financings in place at this time, and there can be no assurance that such capital will be available on favorable terms to us or at all.

Critical Accounting Policies Involving Management Estimates and Assumptions

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

Allowance for Doubtful Accounts

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

Revenue Recognition

We provide Web Applications as a subscription service using the Software-as-a-Service (SaaS) or software-on-demand business model and allow third parties to offer their products and service through Storefronts in the Etelos Marketplace, and to advertise on our web site or in our annual magazine for a fee. We also license our software under perpetual and term licenses. Revenues are recognized on these service and licensing transactions using the criteria in Securities and Exchange Commission Staff Accounting Bulletin 104, “ Revenue Recognition in Financial Statements “ (SAB 104) and SOP 97-2, “Software Revenue Recognition”, (SOP 97-2) respectively, which both provide that revenue may be recognized when all of the following criteria are met:

	·	persuasive evidence of an arrangement exists,

	·	the product or service has been delivered,

	·	the fee is fixed or determinable, and

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

We must first determine whether SAB 104 or SOP 97-2 applies to our revenue transactions. We than determine if the criteria above have been met by assessing the SAB 104 and SOP 97-2 and their various interpretations in view of the agreements and other documentation related to the revenue transactions. The interpretation of the agreements often requires considerable judgment as well as determining what accounting literature is appropriate and how that literature should be applied. If our standard agreements are used to establish evidence of the arrangement, then our revenue is generally recognized as follows:

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

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

	·	Advertising on our web site is recognized as revenue over the period the advertisements appears on our web site and advertising presented in our annual magazine is recognized upon publication of the magazine provided all the other criteria set forth above for revenue

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

Internal Use Software

Under SFAS NO. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (SFAS 86), costs incurred in the research and development of new software products are expensed as incurred until technological feasibility is established. Alternatively, Statement of Position 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use” (SOP 98-1), applies to software development costs that are not related to software to be sold, licensed, leased or otherwise marketed as a separate product or as part of a product or process and are within the scope of SFAS 86. Under SOP 98-1, software development costs incurred for software that is only used internally, including costs incurred to purchase third party software, are capitalized beginning when the Company has determined certain factors are present, including among others, that technology exists to achieve the performance requirements, buy versus internal development decisions have been made, and the Company’s management has authorized the funding for the project. We must determine whether SFAS 86 or SOP 98-1 is applicable to our software development costs. We must than determine when software capitalization should begin and cease and what costs under the applicable standard can be capitalized. Both of these tasks involves considerable judgment and can result in material different amounts of software being capitalized and have a significant impact on our reported results of operations. To date, because we plan to license all our software products, we have determined that the provisions of SFAS 86 should be applied to the cost of our product development. As products and enhancements have generally reached technological feasibility and have been released for sale at substantially the same time, all research and development costs have been expensed.

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Operating Expenses

Research and Development. Research and development expenses include primarily employee and employee related expenses. Research and development expenses were $1,283 thousand and $292 thousand for the quarters ending June 30, 2008 and 2007, respectively. Stated as a percentage of revenues, research and development expense for the corresponding periods was 5,831.8 percent and 275.5 percent, respectively. Research and development expenses increased by $991 thousand or by 339.4 percent, in the first quarter of 2008 compared to the same period in 2007. This increase was primarily due to additional hiring of engineers for research and development.

Sales and Marketing Expenses. Sales and marketing expenses include payroll, employee benefits, and other headcount-related costs associated with sales and marketing personnel and travel, advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses were $508 thousand and $149 thousand for the quarters ending June 30, 2008 and 2007, respectively. The $359 thousand, or 240.9 percent, increase in sales and marketing expense was due to increased hiring of sales and marketing personnel and increased focus on sales and marketing activities. Stated as a percentage of revenues, sales and marketing expense for the corresponding periods was 2,309.1 percent and 140.6 percent, respectively.

General and Administrative. General and administrative expenses include payroll and related employee benefits, and other headcount-related costs associated with finance, facilities, legal and other administrative expenses. General and administrative expenses were $630 thousand and $110 thousand for the quarters ending June 30, 2008 and 2007, respectively. The $520 thousand, or 472.7 percent, increase in general and administrative expense was primarily attributable to increased hiring of accounting, administrative, legal and compliance personnel and greater use of consultants and temporary personnel as we worked to complete the reverse merger and prepare our infrastructure to support being a public company. Stated as a percentage of revenues, general and administrative expense for the corresponding periods was 2,863.6 percent and 103.8 percent, respectively.

Other Income (Expense)

Net other expense of $13,459 thousand for the quarter ending June 30, 2008, $13.4 million is related to the costs associated with completing the Merger with Tripath. The costs include the value of 5,010,000 shares of Etelos common stock paid to Tripath creditors, which were valued on April 22, 2008, at $2.63 per share for a total cost of $13.2 million. The remaining expense consists of legal, according and other professional fees paid in cost to complete the Merger. There were no similiar costs in 2007.

Interest Expense

Net interest expense was $5,567 thousand for the quarter ending June 30, 2008, compared to $58 thousand for the comparable period of 2007. Included in interest expense are noncash charges of $960 thousand related to accretion of notes and debentures payable, $77 thousand related to the payment of interest in common stock, $991 thousand related to the recognition of beneficial conversion features on accrued interest on notes payable, which can be converted to common stock, and $3,417 thousand related to the change in the warrant and derivative liability, all of which total $5,445 thousand. The increase in interest expense was primarily due to multiple rounds of convertible debt financing completed during 2007 and the first half of 2008.

Net Loss

Our net loss was $21.6 million and $572 thousand for the quarters ending June 30, 2008 and 2007, respectively, an increase of $21.0 million, or 3,671.5, percent. The increase in net loss from 2007 to 2008 was primarily due to decreased revenue and increased salaries and other employee-related costs incurred during a period of transition in which we were deeply involved in preparations for completing the reverse merger process, in addition to the Merger and interest charges explained above.

Six Months Ended June 30, 2008, Compared with Six Months Ended June 30, 2007

Revenues

Revenues were $45 thousand and $211 thousand for periods ending June 30, 2008 and 2007, respectively. Revenues decreased by $166 thousand, or 78.7 percent, in the six months ending June 30, 2008, compared to same period in 2007. The decrease in revenues is due in part to reductions in revenues generated from the sale of newsletters and related hosting services and a one-time sale of software in June 2007. In addition, as the quarter ending June 30, 2007, was the first quarter of our sales of our customer resource management product, we expected a spike of activity during that quarter, which was not repeated in the quarter ending June 30, 2008.

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Cost of Revenue

Cost of revenue includes our costs of hardware, software and other resources used in delivery of our products and services. Cost of revenue was $249 thousand and $124 thousand for the periods ending June 30, 2008 and 2007, respectively. Cost of revenue for the first six months of 2008 increased by $125 thousand, or by 100.8 percent. The increase in cost of revenue from 2007 to 2008 was primarily attributable to the increased costs of hosting and Internet band-width associated with the deployment of our products and services. Stated as a percentage of revenues, cost of revenue for the first six months of 2008 was 553.3 percent and for the corresponding period of 2007 was 58.8 percent.

Operating Expenses

Research and Development. Research and development expenses include primarily employee and employee related expenses. Research and development expenses were $2,476 thousand and $554 thousand for the periods ending June 30, 2008 and 2007, respectively. Stated as a percentage of revenues, research and development expense for the corresponding periods was 5,502.2 percent and 262.6 percent, respectively. Research and development expenses increased by $1,922 thousand or by 346.9 percent, in the first six months of 2008, compared to the same period in 2007. This increase was primarily due to additional hiring of engineers for research and development.

Sales and Marketing Expenses. Sales and marketing expenses include payroll, employee benefits, and other headcount-related costs associated with sales and marketing personnel and travel, advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses were $801 thousand and $221 thousand for the periods ending June 30, 2008 and 2007, respectively. The $580 thousand, or 267.4 percent, increase in sales and marketing expense was due to increased hiring of sales and marketing personnel and increased focus on sales and marketing activities. Stated as a percentage of revenues, sales and marketing expense for the corresponding periods was 1,780.0 percent and 104.7 percent, respectively.

General and Administrative. General and administrative expenses include payroll and related employee benefits, and other headcount-related costs associated with finance, facilities, legal and other administrative expenses. General and administrative expenses were $1,100 thousand and $155 thousand for the periods ending June 30, 2008 and 2007, respectively. The $945 thousand, or 609.7 percent, increase in general and administrative expense was primarily attributable to increased hiring of accounting, administrative, legal, and compliance personnel and greater use of consultants and temporary personnel as we worked to complete the reverse merger and prepare our infrastructure to support being a public company. Stated as a percentage of revenues, general and administrative expense for the corresponding periods was 2,444.4 percent and 73.5 percent, respectively.

Other Income (Expense)

Net other expense of $13,459 thousand for the six months ending June 30, 2008, $13.4 million is related to the costs associated with completing the Merger with Tripath. The costs include the value of 5,010,000 shares of Etelos common stock paid to Tripath creditors, which were valued on April 22, 2008, at $2.63 per share for a total cost of $13.2 million. The remaining expense consists of legal, according and other professional fees paid in cost to complete the Merger. There were no similiar costs in 2007.

Interest Expense

Net interest expense was $5,765 thousand for the six months ending June 30, 2008, compared to $98 thousand for the comparable period of 2007. Included in interest expense are noncash charges of $960 thousand related to accretion of notes and debentures payable, $77 thousand related to the payment of interest in common stock, $991 thousand related to the recognition of beneficial conversion features on accrued interest on notes payable, which can be converted to common stock, and $3,417 thousand related to the change in the warrant and derivative liability, all of which total $5,445 thousand. The increase in interest expense was primarily due to multiple rounds of convertible debt financing completed during 2007 and the first half of 2008.

Net Loss

Our net loss was $23.8 million and $941 thousand for the periods ending June 30, 2008 and 2007, respectively, an increase of $22.9 million, or 2,429.8 percent. The increase in net loss from 2007 to 2008 was primarily due to decreased revenue and increased salaries and other employee-related costs incurred during a period of transition in which we were deeply involved in preparations for completing the reverse merger process, in addition to the Merger and interest charges explained above.

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Commitments and Contingencies

September 2007 Notes

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

Under the terms of the remaining $1.8 million of the notes that were not converted, principal is payable beginning on September 1, 2008, and the last day of each calendar quarter thereafter, and interest is payable beginning February 1, 2008. On June 15, 2008, the holders of these notes agreed to either convert the accrued interest to shares of common stock at a rate of one share for each $1.35 of interest owed or to add the accrued interest to the principal, and to waive any default arising out of our failure to pay the accrued and unpaid interest through June 15, 2008.

The principal payment amounts remaining on our September 2007 notes are scheduled to be paid as follows (in thousands):

Date	September 2007 Notes
9/1/2008	$	441
9/30/2008	$	441
12/31/2008	$	441
3/31/2009	$	441
	$	1,764

Assuming principal payments are made in accordance with the schedule set forth above, the amount of interest to be paid through the March 31, 2009, maturity date is $55.9 thousand with respect to our September 2007 notes, or on average, $3.1 thousand per month.

January 2008 Debentures

In January 2008, we issued our January 2008 Debentures with an aggregate principal amount of $2.0 million. As of June 30, 2008, the entire principal amount ($2.0 million) is outstanding and no payments of principal or interest have become due or paid. Under the terms of these debentures, we are to begin making monthly redemption payments on September 1, 2008. The maturity date of these debentures is January 31, 2010. The total monthly principal payment amounts on our January 2008 Debentures are scheduled to be paid as follows:

Monthly Principal Payment Amount (in thousands)

Date	January 2008 Debentures
9/1/2008	$	111
10/1/2008	$	111
11/1/2008	$	111
12/1/2008	$	111
1/1/2009	$	111
2/1/2009	$	111
3/1/2009	$	111
4/1/2009	$	111
5/1/2009	$	111
6/1/2009	$	111
7/1/2009	$	111
8/1/2009	$	111
9/1/2009	$	111
10/1/2009	$	111
11/1/2009	$	111
12/1/09	$	111
1/1/2010	$	111
1/31/2010	$	113
	$	2,000

Assuming monthly principal payments are made in accordance with the schedule set forth above, the amount of interest to be paid through the January 31, 2010, maturity date is $240 thousand with respect to our January 2008 Debentures, or on average, $13.3 thousand per month.

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April 2008 Debentures

In April 2008, we issued our April 2008 Debentures with an aggregate principal amount of $3.5 million. Under the terms of these debentures, we are to begin making monthly redemption payments upon the earlier of (i) the 1st of the month that follows the effective date of the registration statement we filed to cover the resale of the shares of common stock underlying our April 2008 Debentures, and (ii) November 1, 2008. The maturity date of these debentures is April 30, 2010. The aggregate face value of our outstanding April 2008 Debentures is $3.5 million at June 30, 2008. The total monthly principal payment amounts on our April 2008 Debentures are scheduled to be paid as follows, assuming such payments begin on November 1, 2008:

Monthly Principal Payment Amount (in thousands)

Date	April 2008 Debentures
11/1/2008	$	194
12/1/2008	$	194
1/1/2009	$	194
2/1/2009	$	195
3/1/2009	$	194
4/1/2009	$	195
5/1/2009	$	194
6/1/2009	$	195
7/1/2009	$	194
8/1/2009	$	195
9/1/2009	$	194
10/1/2009	$	195
11/1/2009	$	194
12/1/09	$	195
1/1/2010	$	194
2/1/2010	$	195
3/1/2010	$	194
4/1/2010	$	195
	$	3,500

Assuming monthly principal payments are made in accordance with the schedule set forth above, the amount of interest to be paid through the April 30, 2010, maturity date is $420 thousand with respect to our April 2008 Debentures, or on average, $23.3 thousand per month.

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We have the right to pay interest and monthly principal payments due in respect of our January 2008 and April 2008 Debentures in cash, or upon notice to the holders and compliance with certain equity conditions, we can pay all or a portion of any such payment in common stock valued at a price equal to the lesser of the then effective conversion price (currently $1.35) or 85 percent of the average of the VWAP per share for our common stock for the 10 consecutive trading days immediately prior to the applicable payment date. On the other hand, if the holders voluntarily elect to convert all or a portion of the debentures into common stock, then the conversion price will be the then-effective conversion price. The conversion of these debentures could result in substantial dilution to our existing stockholders.

The equity conditions that we must meet include having a currently effective registration statement covering the shares of common stock issuable upon conversion of the debenture, and having the daily dollar trading volume for our common stock exceed $250,000 for each of the 20 consecutive trading days before the date in question. We do not currently meet these equity conditions and it may prove difficult for us to meet them.

Subject to compliance with certain equity conditions, and subject also to the applicable cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion, we have the right to force conversion of the entire amount of principal and accrued interest of the debentures if the average of the VWAP for our common stock exceeds $3.39 for 20 trading days out of a consecutive 30 trading day period. If the price of our common stock is below $3.39 per share but is substantially above $1.35 per share, then we anticipate that the holders of these debentures will elect to convert monthly payments of interest and principal into shares of common stock rather than receive cash. If the price of our common stock is below $1.35, the current conversion price, then we intend to make principal and interest payments in cash to the extent that our cash flows from operations provide sufficient ability to do so.

If our cash flows from operations are not sufficient to make principal and interest payments in cash, then we will evaluate other equity financing opportunities, the proceeds of which could be used to repay the debentures. If we are unable to pay the principal and interest in cash, or elect not to do so to preserve working capital, then we will make the payments with our common stock pursuant to the terms of the agreements including a conversion price based on the lower of the then effective conversion price or 85 percent of the average of the VWAP per share for our common stock for the 10 consecutive trading days.

If we are unable to make all payments, whether in cash or stock, due on our September 2007 notes and our January Debentures and April Debentures, then we would be in default under such securities. The holders of such securities would be entitled to demand that all amounts due thereunder be immediately paid in cash, and with respect to our January Debentures and April Debentures, the holders would have the right to demand that we pay 130 percent of the outstanding principal amount and the interest rate accrues at a rate equal to the lesser of 18% per annum or the maximum rate permitted under applicable law. In addition, the holders of our January Debentures and April Debentures would have the right to foreclose on all of our assets pursuant to the terms of the security agreement we entered into with such holders and they would have the right to take possession of our assets and operate our business.

Operating and Capital Leases

We have non-cancelable leases for corporate facilities and equipment. Rent expense under the leases totaled $126 thousand and $49 thousand for the periods ending June 30, 2008 and 2007, respectively. Future minimum rental payments required under non-cancelable leases are as follows for the twelve months ending June 30:

	Operating Leases		Capital Leases

2009	$	263	$	25
2010	160		15
2011	6		13
2012	6		9
2013	2		—
Total minimum lease payments	$	437	$	62
Less: amount representing interest			(18		)
Present value of minimum lease payments			44
Less: current portion of capital lease obligations			(17		)
Long-term capital lease obligations			$	27

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We have supported current operations by raising additional operating cash through the private sale of our convertible debentures. This has provided us with the cash inflows to continue our business plan, but has not resulted in significant improvement in our financial position. We are considering alternatives to address our cash flow situation that include: (1) raising capital through additional sale of our common stock and/or debentures and (2) reducing cash operating expenses to levels that are in line with current revenues.

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

Recent Accounting Pronouncements

In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (FSP FAS 157-2), which delays the effective date of Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (SFAS 157) for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. We are currently evaluating the impact of adopting FSP FAS 157-2 for non-financial assets and non-financial liabilities on our consolidated financial position, cash flows, and results of operations.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (FAS 141R), which requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired, FAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Also, in December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (FAS 160), which clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. FAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our consolidated financial position, cash flows, and results of operations.

In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (FSP EITF 03-6-1), which requires entities to apply the two-class method of computing basic and diluted earnings per share for participating securities that include awards that accrue cash dividends (whether paid or unpaid) any time common shareholders receive dividends and those dividends do not need to be returned to the entity if the employee forfeits the award. FSP EITF 03-6-1 will be effective for the Company on January 1, 2009 and will require retroactive disclosure. The Company is currently evaluating the impact of adopting FSP EITF 03-6-1 on its consolidated financial position, cash flows, and results of operations.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we become subject to various legal proceedings and claims, both asserted and unasserted, that arise in the ordinary course of business. Litigation in general, and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict. An unfavorable resolution of one or more of these lawsuits would materially adversely affect our business, results of operations, or financial condition. We cannot estimate the loss or range of loss that may be reasonably possible for any of the contingencies described above and accordingly have not recorded any associated liabilities in our consolidated balance sheets. We accrue legal costs when incurred.

In July 2008, Kaufman Bros. L.P. filed suit against us in the United States District Court for the Southern District of New York (Case No. 08 CV 5716). The complaint arises out of an advisory services agreement, pursuant to which Kaufman Bros. was to provide us with advisory services in connection with financings and strategic transactions. We notified Kaufman Bros that we believed it had failed to provide the required services under the agreement, and that we were therefore entitled to terminate the agreement for cause. In the suit, Kaufman Bros. was seeking (i) monetary damages of $400,000 for anticipatory breach of the agreement; (ii) $73,800 in fees allegedly owed in connection with a previously closed financing transaction; (iii) an injunction prohibiting us from cancelling any shares issued to Kaufman Bros. as compensation, (iv) a declaration from the court that we are not entitled to a refund of any fees previously paid to Kaufman Bros., and (v) a declaration that we are obligated to pay Kaufman Bros. a commission on any financing or transaction that we enter into within 18 months following the termination of the agreement. On July 15, 2008, Kaufman Bros. voluntarily filed a notice of dismissal without prejudice. Settlement discussions were unsuccessful and Kaufman Bros. has re-filed substantially the same claims in the Supreme Court of New York - County of New York ( Index No. 08-602239). The Company has been served and is developing its defense plan.

ITEM 1A. RISK FACTORS

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

Risks Related to our Business

We have a limited operating history, have experienced significant expenditures related to funding our initial product development, and are currently carrying a net loss. If our business model is not successful, or if we are unable to generate sufficient revenue to offset our start-up expenditures, then we may not become profitable, and the value of your investment may decline.

We began our operations in 1999 but we did not adopt the SaaS on-demand Web Applications delivery model until 2005. As such, we have a limited operating history in the SaaS industry from which to evaluate our business and prospects. We incurred a net loss of $23.8 million for the six months ended June 30, 2008, and $4.0 million for the year ended December 31, 2007, and have an accumulated deficit of $15.8 million at June 30, 2008. We cannot assure you that our future planned operations will be implemented successfully or that we will ever have profits. Furthermore, we are experiencing the initial costs and uncertainties of a young operating company, including start-up expenditures, unforeseen costs and difficulties, complications, and delays, all of which must be resolved and/or paid without the benefit of a predictable revenue stream. We cannot be sure that we will be successful in meeting these challenges and addressing these risks and uncertainties. If we are unable to do so, then our business will not be successful.

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

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

· maintain and improve our technology;

· expand our product offerings and maintain the high quality of products offered in the Etelos Marketplace^TM;

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

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

· maintain adequate control of our expenses;

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

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

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

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

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

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

· minimize the time and resources required to implement products from the Etelos Marketplace;

· maintain high levels of customer satisfaction;

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

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

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

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

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

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

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

The market for our products may not develop further, or it may develop more slowly than we expect, either of which would harm our business.

The market in which we participate is intensely competitive, and if we do not compete effectively, then our operating results may be harmed.

The market for SaaS on-demand Web Applications for business is new highly competitive and rapidly changing with relatively low barriers to entry. With the introduction of new technologies and new market entrants, we expect competition to intensify in the future. In addition, pricing pressures and increased competition generally could result in reduced sales, reduced margins, or the failure of our products to achieve or maintain more widespread market acceptance. Often we offer products in the Etelos Marketplace that compete against existing systems that our potential customers have already made significant expenditures to install. Competition in our market is based principally upon service breadth and functionality; service performance, security and reliability; ability to tailor and customize services for a specific company, vertical or industry; ease of use of the service, speed and ease of deployment, integration and configuration; total cost of ownership, including price and implementation and support costs; professional services implementation; and financial resources of the vendor.

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

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

Our continued growth is dependent upon our ability to raise capital from outside sources. Our ability to obtain financing will depend upon a number of factors, including our financial condition and results of operations, the condition of the economy, and conditions in relevant financial markets. If we are unable to obtain financing, as needed, on a timely basis and on acceptable terms, our financial position, competitive position, growth, and profitability may be adversely affected.

We may not be able to effectively control and manage our growth.

If our business and markets grow and develop, then it will be necessary for us to finance and manage expansion in an orderly fashion. In addition, we may face challenges in managing expanding product offerings and in integrating acquired businesses with our own. Such eventualities will increase demands on our existing management, workforce, and facilities. Failure to satisfy such increased demands could interrupt or adversely affect our operations and cause longer product development time frames and administrative inefficiencies.

We have experienced rapid growth in recent periods. If we fail to manage our growth effectively, then we may be unable to execute our business plan, maintain high levels of service, or address competitive challenges adequately.

We have increased our number of full-time employees to 46 at June 30, 2008, from 16 at June 30, 2007, and have experienced a drop in our revenue for the six months ending June 30, to $22 thousand in 2008, from $106 thousand in 2007. Our operating plan has placed, and our anticipated growth plan is expected to continue to place, a significant strain on our managerial, administrative, operational, financial, and other resources. We intend to further expand our overall business, customer base, headcount, and operations. We will be required to continue to improve our operational, financial, and management controls and our reporting procedures and we may not be able to do so effectively. As such, we may be unable to manage our expenses effectively in the future, which may negatively impact our gross margins or operating expenses in any particular quarter.

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

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

We depend on a large number of customers.

Our revenue is dependent, in large part, on many orders from a large number of customers. Sales to our five largest customers were de minimus during the quarter and six months ended June 30, 2008 and 2007, respectively. We believe that revenue derived from the current and future large number of customers will continue to represent a significant portion of our total revenue.

Our inability to secure and maintain a sufficient number of large customers would also have a material adverse effect on our business, operating results, and financial condition. Moreover, our success will depend in part upon our ability to obtain orders from new customers, as well as the financial condition and success of our customers and general economic conditions.

Our business depends substantially on customers renewing, upgrading, and expanding their subscriptions for products offered in the Etelos Marketplace.

We distribute products in the Etelos Marketplace pursuant to agreements of varying subscription periods. Our customers have no obligation to renew their subscriptions after their subscription period expires, and these subscriptions may not be renewed at the same or higher levels. Moreover, under specific circumstances, our customers may have the right to cancel their subscription agreements before they expire. We have limited historical data with respect to rates of customer subscription renewals, upgrades, and expansions so we may not accurately predict future trends in customer renewals. Our customers’ renewal rates may decline or fluctuate because of several factors, including their satisfaction or dissatisfaction with the products offered in the Etelos Martketplace, the prices of the service, the prices of services offered by our competitors, or reductions in our customers’ spending levels. If our customers do not renew their subscriptions, renew on less favorable terms, or do not purchase additional functionality or subscriptions, then our revenue may grow more slowly than expected or decline and our profitability and gross margins may be harmed.

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

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

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

Our success depends, in part, on our ability to protect our proprietary technologies. We own five (5) filed United States patent applications covering our technology and we expect to file more U.S. patent applications in the future. We have filed to protect most of those patents in many foreign countries. But the process of seeking patent protection can be lengthy and expensive and we cannot assure that our patent applications will result in patents being issued, or that our existing or future issued patents will be sufficient to provide us with meaningful protection or commercial advantages.

We also cannot assure that our current or potential competitors do not have, and will not obtain, patents that will prevent, limit or interfere with our ability to make, use or sell our technology or operate the Etelos Marketplace.

Our success depends in large part on our ability to protect and enforce our intellectual property rights.

We rely on a combination of patent, copyright, service mark, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights on a global basis, all of which provide only limited protection. We cannot assure you that any patent will issue from our currently pending patent applications in a manner that gives us the protection that we seek, if at all, or that any future patents issued to us will not be challenged, invalidated, or circumvented. Since the filing of some of these patent applications may have been, or will be, made after the date of first sale or disclosure of the subject inventions, patent protection may not be available for these inventions outside the United States. Any patents that may issue in the future may not provide sufficiently broad protection or they may not prove to be enforceable in actions against alleged infringers. Also, we cannot assure you that any future service mark or trademark registrations will be issued for pending or future applications or that any registered service marks or trademarks will be enforceable or provide adequate protection of our domestic and foreign proprietary rights.

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

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

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

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

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

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

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

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

Our success and future growth depends to a significant degree on the skills and continued services of our management team, especially Daniel J.A. Kolke, our Chief Technology Officer and Chairman of the Board, and Jeffrey L. Garon, our President and Chief Executive Officer. We do not maintain key man insurance on any members of our management team, including Messrs. Garon or Kolke. Our future success also depends on our ability to attract, retain and motivate highly skilled technical, managerial, sales, marketing and service and support personnel, including members of our management team. Competition for sales, marketing, and technology development personnel is particularly intense in the software and technology industries. As a result, we may be unable to successfully attract or retain qualified personnel. Our inability to attract and retain the necessary personnel could harm our business.

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Our quarterly operating results may fluctuate in the future. As a result, we may fail to meet or exceed the expectations of research analysts or investors, which could cause our stock price to decline.

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

We believe that our quarterly revenue and operating results may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance.

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

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

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

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

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

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

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

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

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

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

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

If we are unable to develop new products or services, sell our products or services into new markets, or add Marketplace partners to offer their products or services in the Etelos Marketplace, then our revenue growth will be harmed and we may not be able to achieve profitability.

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

When we become subject to Section 404 of the Sarbanes-Oxley Act of 2002, if we fail to maintain proper and effective internal controls or are unable to remediate the material weakness in our internal controls, then our ability to produce accurate and timely financial statements could be impaired and investors’ views of us could be harmed.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. We are in the process of documenting, reviewing, and improving our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, which requires annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors addressing this assessment. We will be testing our internal controls for the year ending December 31, 2008, and, as part of that documentation and testing, identifying areas for further attention and improvement.

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During our review for the year ended December 31, 2007, we identified a material weakness in our internal controls. The material weakness relates to the need for accounting personnel who possess the skill sets necessary to operate and report as a public company, and specifically the skills necessary to ensure that adequate review of critical account reconciliations is performed and that supporting documentation is complete, accurate, and in accordance with generally accepted accounting principles. We have recruited and are continuing to recruit additional finance and accounting personnel to address this observation. We believe we have made progress in addressing this material weakness and expect to complete the remediation in the next six to fifteen months. If our remediation efforts are insufficient to address the material weakness or take longer than we expect, or if additional material weaknesses in our internal controls are discovered in the future, then we may fail to meet our future reporting obligations, our financial statements may contain material misstatements and the price of our common stock may decline.

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

Because we recognize subscription revenue over the term of the applicable agreement, the lack of subscription renewals or new service agreements may not be reflected immediately in our operating results.

The majority of our quarterly revenue is attributable to subscription agreements entered into during the current and previous quarters. A decline in new or renewed service agreements in any one quarter may not be fully reflected in our revenue in that quarter but will harm our revenue in future quarters. As a result, the effect of significant downturns in sales and market acceptance of our products and services in a particular quarter may not be fully reflected in our operating results until future periods. Our subscription model also can make it difficult for us to rapidly increase our revenue through additional sales in any period, because revenue from new customers must be recognized over the applicable subscription term.

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

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

· a reduction in sales or delay in market acceptance of our services;

· sales credits or refunds to our customers;

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

· diversion of development resources;

· harm to our reputation; and/or

· increased warranty and insurance costs.

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

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

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

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

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

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

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

We have not collected any sales or other taxes from our customers or remitted any such taxes to any taxing jurisdiction where we may be required to do so. We have begun an analysis of this issue but to date have not made any accrual for any potential liability. In addition, additional taxing jurisdictions at various local, national and super-national levels may seek to impose sales or other tax collection obligations on us. We have not recorded sales or other tax liabilities for the years ended December 31, 2007 or 2006, in respect of sales or other tax liabilities in any jurisdiction. A successful assertion that we should be collecting sales or other taxes on our service could result in substantial tax liabilities for past sales, discourage customers from purchasing our products, or otherwise harm our business and operating results.

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

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

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

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

An acquisition, investment, or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the businesses, technologies, products, services offerings, personnel, or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, the target’s software is not easily adapted to work with ours, or we are unable to retain the customers of any acquired business due to changes in management or otherwise. Acquisitions may also disrupt our business, divert our resources, and require significant

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management attention that would otherwise be available for operation and development of our business. Moreover, the anticipated benefits of any acquisition, investment, or business relationship may not be realized or we may be exposed to unknown liabilities. For one or more of those transactions, we may:

· issue additional equity securities that would dilute our stockholders;

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

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

· incur large charges or substantial liabilities;

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

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

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

We may be subject to taxes and penalties regarding past tax years.

To date, we have not filed all required federal or state income and franchise tax returns or paid or accrued any amounts for taxes that might be due on such returns. Although we believe the amounts due in this respect are de minimus, because we have incurred substantial operating losses which we believe will exceed, in the aggregate, all operating income, no assurances can be given in this regard. Further, we are in arrears in payment of employment related taxes to various tax authorities. We are in contact with those authorities and are making payments to bring these matters current. The amounts due in this respect have been accrued and are included in our audited financial statements for the period ending December 31, 2007. However, no assurances can be given that we will not be assessed additional penalties or interest for failing to make these payments when due.

We may be subject to other legal claims.

In July 2008, Kaufman Bros. L.P. filed suit against us in the United States District Court for the Southern District of New York (Case No. 08 CV 5716). The complaint arises out of an advisory services agreement, pursuant to which Kaufman Bros. was to provide us with advisory services in connection with financings and strategic transactions. We notified Kaufman Bros. that we believed it had failed to provide the required services under the agreement, and that we were therefore entitled to terminate the agreement for cause. In the suit, Kaufman Bros. was seeking (i) monetary damages of $400,000 for anticipatory breach of the agreement; (ii) $73,800 in fees allegedly owed in connection with a previously closed financing transaction; (iii) an injunction prohibiting us from cancelling any shares issued to Kaufman Bros. us Compensation, (iv) a declaration from the court that we are not entitled to a refund of any fees previously paid to Kaufman Bros., and (v) a declaration that we are obligated to pay Kaufman Bros. a commission on any financing or transaction that we enter into within 18 months following the termination of the agreement. On July 15, 2008, Kaufman Bros. voluntarily filed a notice of dismissal without prejudice. Settlement discussions were unsuccessful and Kaufman Bros. has re-filed substantially the same claims in the Supreme Court of New York-County of New York (Index No. 08-602239). The Company has been served and is developing its defense plan.

Risks Related to an Investment in our Common Stock.

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

As of June 30, 2008, our officers, directors, and affiliates beneficially own approximately 75.5 percent of our common stock. As a result, if they act together, they are able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions, including business combinations. This concentration could also have the effect of delaying or preventing a change in control that could otherwise be beneficial to our stockholders. The interests of our officers, directors, and affiliates may differ from other stockholders. Furthermore, the current ratios of ownership of our common stock reduce the public float and liquidity of our common stock which can in turn affect the market price of our common stock.

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

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

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

The purchasers of our January 2008 and April 2008 Debentures and related warrants may, subject to compliance with Rule 144, rely on the provisions of Rule 144 to resell the shares of our common stock acquired upon the conversion of the debentures and exercise of the warrants. We have no way of knowing whether or when such shares may be sold. Depending upon market liquidity at the time, a sale of shares by such investors at any given time could cause the trading price of our common stock to decline. The sale of a substantial number of shares of our common stock, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

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

The purchasers of our January 2008 and April 2008 Debentures and related warrants, as well as the holders of our other outstanding convertible notes, may, subject to compliance with Rule 144, rely on the provisions of Rule 144 to resell the shares of our common stock acquired upon the conversion and exercise of such securities. We have no way of knowing whether or when such shares may be sold. Depending upon market liquidity at the time, a sale of shares by such investors at any given time could cause the trading price of our common stock to decline. The sale of substantial number of shares of our common stock, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

In addition, in connection with our January 2008 and April 2008 Debentures, in the aggregate, we issued a total of $5.5 million principal amount of convertible debentures, convertible into 4,074,074 shares of our common stock, and warrants to purchase an additional 611,111 shares of our common stock. We have agreed to register for resale by the investors the shares of common stock issuable upon the conversion of the debentures and the exercise of the warrants we issued in those private placements. We are also registering for resale 586,667 shares of common stock issuable upon conversion of notes issued in September 2007. The conversion or exercise into our common stock and the registration of that common stock could result in a substantial increase in the number of shares in our public float. Depending upon market liquidity at the time a resale of our common stock is made by the investors in such private placements, such sale could cause the trading price of our common stock to decline. In addition, the sale of a substantial number of shares of our common stock, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

We have significant indebtedness and agreed to certain restrictions as a result of our recent private placement of convertible debentures.

We incurred $5.5 million in principal amount of indebtedness as a result of the issuance of our January 2008 and April 2008 Debentures. The debentures carry substantial covenants that impose significant restrictions on us, including restrictions against incurring additional indebtedness, creating any liens on our property, amending our certificate of incorporation or bylaws, redeeming or paying dividends on shares of our outstanding common stock, and entering into certain related party transactions. The debentures also carry substantial covenants that impose significant requirements on us, including, among others, requirements that:

·		we pay interest and other charges on the debentures;

·		we use the proceeds from the sale of the debentures only for permitted purposes;

·		while the debentures are outstanding, if we issue equity or equity linked securities at a price lower than the conversion price of the debentures, then the conversion price of the debentures will be reduced to the same price of the equity or equity linked securities so issued;

·		we keep reserved out of our authorized shares of common stock sufficient shares to satisfy our obligation to issue shares on conversion of the debentures and the exercise of the related warrants issued in connection with the sale of the debentures;

·		we may not, directly or indirectly, redeem, purchase or otherwise acquire any capital stock or set aside any monies for such redemption, purchase or other acquisition.

Our ability to comply with these provisions may be affected by changes in our business condition or results of our operations, or other events beyond our control. The breach of any of these covenants could result in a default under the debentures, permitting the holders thereof to accelerate the maturity of the debentures and demand repayment in full. Such actions by such holders could impair our ability to operate or cause us to seek bankruptcy protection.

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

Our January 2008 and April 2008 Debentures impose significant covenants on us, some of which may impair our ability to issue additional debt or equity, if necessary. For example, the investors in our April 2008 Debentures have the right to participate in any financing we undertake through the date that is the 12 month anniversary of the effectiveness of the registration statement we agreed to file for the re-sale of our shares of common stock issuable upon conversion and exercise of our April 2008 Debentures.

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If we pay interest or principal on the debentures in shares of common stock when our stock price is low, the holders thereof have the ability to negatively affect our stock price and to create a greater dilution to our stockholders.

We have the right to pay interest and monthly principal payments in cash, or upon notice to the holders and compliance with certain equity conditions, including having a currently effective registration statement covering the shares of common stock issuable upon conversion of the debentures, we can pay all or a portion of any such payment in common stock valued at a price equal to the lesser of the then effective conversion price or 85 percent of the average of the VWAP per share as reported on Bloomberg for our common stock for the 10 consecutive trading days immediately prior to the applicable payment date. To the extent that we pay principal or interest in common stock during a period when our common stock price is low, such investor will receive a larger number of shares of our common stock as a result of the conversion, which such investor could sell at high volumes to drive the VWAP downward. Downward pressure on the price of our common stock from consecutive conversions could result in the investors receiving payment on the debentures at successively lower conversion rates, thereby causing a successively greater dilution of our stockholders, and causing a downward spiraling affect on the price of our stock (a so-called “death spiral”). Further, to the extent that conversion of the debenture requires us to issue more shares of common stock, we are obligated to register the additional shares of stock under a new registration statement.

Our failure to secure registration of the common stock could result in substantial liquidated damages.

Under the terms of the registration rights agreements we entered into with the investors in connection with our January 2008 and April 2008 Debentures, we agreed to file a registration statement covering the resale of the shares of common stock underlying the securities we sold in such private placements, and to maintain the effectiveness of the registration statements (subject to certain limitations) for a period of time until the holders can sell the underlying common stock without volume restrictions under Rule 144 of the Securities Act. If the registration statement is not declared effective within an agreed to time period, or if we fail to maintain the effectiveness of the registration statement, we are required to pay to the investors partial liquidated damages. Since the registration statement was effective on July 31, 2008, after the deadline in the registration rights agreement, we may be liable for liquidated damages, in the amount of $14.7 thousand, which we have accrued as a liability.

Our failure to repay the January 2008 and April 2008 Debentures could result in substantial penalties against us, and legal action which could substantially impair our operations.

The debentures we issued require monthly principal payments equal to 1/18th of the principal amount due under each debenture. The debentures accrue interest at the rate of 6 percent per annum, payable quarterly and on each monthly principal payment. We have the right to pay interest and monthly principal payments in cash, or upon notice to the holders and compliance with certain equity conditions, we can pay all or a portion of any such payment in common stock. To repay the debentures in cash, we will be required to use our limited working capital or raise additional funds. If we are unable to repay the debentures when required, either in cash or in common stock, the holders could commence legal action against us. Any such action could impose significant costs on us and require us to curtail or cease operations.

In addition, January 2008 and April 2008 Debentures define certain events of default, including without limitation failure to make a payment obligation, failure to observe other covenants of the debenture or related agreements (subject to applicable cure periods), breach of representation or warranty, bankruptcy, default under another significant contract or credit obligation, delisting of our common stock, a change in control, failure secure and maintain an effective registration statement covering the resale of the common stock underlying the debentures and the warrants, or failure to deliver share certificates in a timely manner. In the event of default, which is not cured within specified grace periods, the holders of the debentures have the right to accelerate all amounts outstanding under the debentures and demand payment of a mandatory default amount equal to 130 percent of the amount outstanding under the debenture, plus accrued interest and expenses. If we were unable to repay the mandatory default amount when required, the holders could commence legal action against us. Any such action could impose significant costs on us and require us to curtail or cease operations.

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

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

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The market price of our securities could be adversely affected by sales of registered and restricted securities.

Actual sales or the prospect of future sales of shares of our common stock pursuant to a prospectus or under Rule 144 may have a depressive effect upon the price of, and market for, our common stock. As of June 30, 2008, 23,052,624 shares of our common stock were issued and outstanding, of which 17,695,634 are “restricted securities” and under some circumstances may, in the future, be under a registration under the Securities Act or in compliance with Rule 144 adopted under the Securities Act. In general, under Rule 144, subject to the satisfaction of other conditions, a person who has beneficially owned restricted shares of common stock for at least one year is entitled to sell, within any three month period, a number of shares that does not exceed the greater of 1 percent of the total number of outstanding shares of the same class; or if the common stock is quoted on NASDAQ or a stock exchange, the average weekly trading volume during the four calendar weeks immediately preceding the sale. We cannot predict what effect, if any, that sales of shares of common stock, or the availability of these shares for sale, will have on the market prices prevailing from time to time. Nevertheless, the possibility that substantial amounts of common stock may be sold in the public market may adversely effect prevailing prices for our common stock and could impair our ability to raise capital in the future through the sale of equity securities.

In addition to the 17,695,634 shares of “restricted securities” that were issued and outstanding as of June 30, 2008, we have filed a registration statement seeking to register for resale an aggregate of 1,906,557 shares of our common stock. The additional overhang represented by these registered securities could also have a depressive effect on the public trading price of our common stock.

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

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

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

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

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

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

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

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

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

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

Significant amounts of our outstanding common stock will be available for resale into the market, which could potentially cause the market price of our common stock to drop significantly, even if our business is doing well.

As of June 30, 2008, we had 23,052,624 shares of common stock issued and outstanding held by approximately 145 shareholders of record, including 5,010,000 shares that were issued pursuant to the court approved plan of reorganization. The shares issued under the plan of reorganization are freely tradable securities. The market price of our common stock could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them in an excessive amount relative to the market demand for our shares. An excessive sale of our shares may result in a substantial decline in the price of our common stock and limit our ability to raise capital, even if our business is doing well.

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

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

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

·		significantly reduce the equity interest of our current stockholders;

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

·		adversely affect prevailing market prices for our common stock.

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

·		develop or enhance our products and services;

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

·		acquire complementary technologies, products or businesses;

·		expand operations;

·		hire, train and retain employees; and/or

·		respond to competitive pressures or unanticipated working capital requirements.

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

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

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

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

The 2007 Stock Incentive Plan and all options issued under the 2007 Stock Incentive Plan contain provisions for acceleration of all unvested options in the event of a change of control, which might be a disincentive to acquisition of the Company as a liquidation strategy.

The 2007 Stock Incentive Plan and all options currently issued thereunder and options granted outside such plan provides for accelerated vesting of all unvested options in the event of a change of control, which is defined as an acquisition by a single person of more than 50 percent of the total combined voting power of all of our outstanding securities. This may be regarded as a barrier to retention of key employees following a change-of-control acquisition and therefore make such an acquisition more costly or difficult, and therefore an unattractive strategic option, for a prospective acquiror.

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

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

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

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

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

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

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

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

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

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

Our common stock is subject to Rule 15g-1 through 15g-9 under the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” which imposes certain sales practice requirements on broker-dealers which sell our common stock to persons other than established customers and “accredited investors” (generally, individuals with net worths in excess of $1 million or annual incomes exceeding $200 thousand (or $300 thousand together with their spouses)). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of such common stock. Additionally, our common stock is likely to be subject to the SEC regulations for “penny stock.” Penny stock includes any equity security that is not listed on a national exchange and has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock, a disclosure schedule set forth by the SEC relating to the penny stock market must be delivered to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for the common stock. The regulations also require that monthly statements be sent to holders of penny stock which disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.

Part I — Financial Information

Item 1.	Financial Statements (unaudited)	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	26
Item 4.	Controls and Procedures	26

Part II — Other Information

Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3.	Defaults Upon Senior Securities	43
Item 4.	Submission of Matters to a Vote of Security Holders	43
Item 5.	Other Information	43
Item 6.	Exhibits	43

Exhibit No.		Description
31.1*		Certification of Periodic Report by the Principal Executive Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Periodic Report by the Principal Financial Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*		Certification of Principal Executive Officer pursuant to 18 U.S.C, Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certification of Principal Financial Officer pursuant to 18 U.S.C, Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

August 18, 2008		ETELOS, INC.

	By:	/s/ David S.G. MacKenzie
		David S.G. MacKenzie
		Vice President & Chief Financial Officer and Chief Accounting Officer