8-K 1 a08-10653_18k.htm 8-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 8-K

 

CURRENT REPORT

Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

 

Date of Report (Date of earliest event reported): April 22, 2008

 

Tripath Technology Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

000-31081

 

77-0407364

(State or Other Jurisdiction of Incorporation)

 

(Commission File Number)

 

(I.R.S. Employer Identification No.)

 

1900 O’Farrell St., Suite 320, San Mateo, California

 

94403

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: 425-458-4510

 

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

 

o    Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o    Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o    Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o    Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

 



 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Our disclosure and analysis in this report contains some forward-looking statements. Certain of the matters discussed concerning our operations, cash flows, financial position, economic performance and financial condition, including, in particular, future sales, product demand, the market for our products, competition and the effect of economic conditions include forward-looking statements.

 

Statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” and similar expressions are forward-looking statements. Although we believe that these statements are based upon reasonable assumptions, including projections of orders, sales, operating margins, earnings, cash flow, research and development costs, working capital, capital expenditures, and other projections, they are subject to several risks and uncertainties, and therefore, we can give no assurance that these statements will be achieved.

 

Investors are cautioned that our forward-looking statements are not guarantees of future performance and the actual results or developments may differ materially from the expectations expressed in the forward-looking statements.

 

As for the forward-looking statements that relate to future financial results and other projections, actual results will be different due to the inherent uncertainty of estimates, forecasts and projections may be better or worse than projected. Given these uncertainties, you should not place any reliance on these forward-looking statements. These forward-looking statements also represent our estimates and assumptions only as of the date that they were made. We expressly disclaim a duty to provide updates to these forward-looking statements, and the estimates and assumptions associated with them, after the date of this filing to reflect events or changes in circumstances or changes in expectations or the occurrence of anticipated events.

 

We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. You are advised, however, to consult any additional disclosures we make in our annual, quarterly and current reports. We also note that we have provided a cautionary discussion of risks and uncertainties under the caption “Risk Factors” in this report. These are factors that we think could cause our actual results to differ materially from expected results. Other factors besides those listed here could also adversely affect us.

 

Information regarding market and industry statistics contained in this report is included based on information available to us, which we believe is accurate. We have not reviewed or included data from all sources, and cannot assure stockholders of the accuracy or completeness of the data included in this report. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services.

 

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Item 2.01 Completion of Acquisition or Disposition of Assets.

 

This report is being filed by Tripath Technology Inc., a Delaware corporation (“Tripath” or the “Company”), in connection with the merger of Etelos, Incorporated, a Washington corporation (“Etelos”), with and into Tripath.  Tripath changed its name to Etelos, Inc.

 

As discussed in more detail in Item 5.06 of this report, as a result of the merger, Tripath ceased being a shell company as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

FORM 10-SB DISCLOSURE

 

As disclosed elsewhere in this report, on April 22, 2008, Etelos merged with and into Tripath in a reverse merger transaction. Item 2.01(f) of Form 8-K states that if the registrant was a shell company, like Tripath was immediately before the merger, then the registrant must disclose the information that would be required if the registrant were filing a general form for registration of securities on Form 10-SB.

 

Accordingly, Tripath is providing below the information that would be included in a Form 10-SB if Tripath were to file a Form 10-SB.  Note that the information provided below generally relates to the business enterprise after the merger, except that information relating to periods prior to the effective time of the merger only relates to Tripath unless the context suggests otherwise.  In this report the terms “we,” “us,” “our,” and other similar terms refer to the surviving corporation after the merger.

 

In this report, we rely on and refer to information and statistics regarding our industry that we have obtained from a variety of sources. This information is publicly available for free and has not been specifically prepared for us for use in this report or otherwise. Although we believe that this information is generally reliable, we cannot guarantee, nor have we independently verified, the accuracy and completeness of this information.

 

DESCRIPTION OF BUSINESS

 

Tripath History

 

On April 22, 2008, Etelos merged with and into Tripath, and the surviving corporation changed its name to Etelos, Inc., a Delaware corporation.

 

Before the effective date of the merger, and since February 8, 2007, Tripath was in a Chapter 11 bankruptcy proceeding in the United States Bankruptcy Court for the Northern District of California, Case No. 07-50358.  As a “debtor in possession,” Tripath remained in possession of its assets and properties and continued to operate its business pursuant to Section 1107(a) and 1108 of the Bankruptcy Code. On December 20, 2007, Tripath and Enable Growth Partners LP filed with the bankruptcy court the Third Amended Disclosure Statement Accompanying Third Amended Plan of Reorganization dated December 20, 2007 Proposed by Tripath Technology Inc. and Enable Growth Partners LP, for itself and as agent for the Secured Parties (the “Plan of Reorganization”), which contemplated the merger of Etelos with and into Tripath.  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.  As a result of the foregoing, on April •, 2008, Tripath entered into an agreement and plan of merger with Etelos (the “Merger Agreement”), pursuant to which Etelos merged with and into Tripath, at which time the separate corporate existence of Etelos ceased and Tripath continued after the merger as the surviving corporation and changed its name to Etelos, Inc.  The surviving corporation will conduct the business that was previously conducted by Etelos.

 

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Until Tripath ceased operations, Tripath was a fabless semiconductor company that focused on developing highly efficient power amplification to the digital media and electronics markets.

 

History of Etelos

 

Overview

 

Etelos is a leading provider of software solutions that assist organizations to effectively use Web Applications to accomplish their goals.  Etelos provides a revolutionary Software as a Service (SaaS) ecosystem for building, distributing, and using Web Applications, including a marketplace to deploy and support them; giving businesses choices in Web Applications, hosting, and support services to cost effectively accomplish their goals.

 

Etelos has developed products for Web Applications, which include open standards-based tools for Web developers, businesses and individual users such as the Etelos Application ServerÔ (EASÔ) and the Etelos Development EnvironmentÔ (EDEÔ).  EAS and EDE support many common programming languages and also support the English Application Scripting Engine (EASEÔ), a simple-to-use open standards-based scripting language developed by Etelos.  In order to support broader adoption of EtelosÔ products, EASE and other components of the EDE are provided to developers and users at market appropriate pricing.  This is done to support the development of new Web Applications and the migration of existing Web Applications into the Etelos™ ecosystem where there are tools and other support mechanisms for the marketing, distribution, sales and support of these applications.  Etelos generally receives a transaction fee or a license fee in exchange transactions that occur within the Etelos ecosystem via the Etelos MarketplaceÔ.

 

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.

 

For the year ended December 31, 2007, Etelos had revenue of $304 thousand, a decrease of $12 thousand from the year ended December 31, 2006. As of December 31, 2007, Etelos had over 5,000 active free and paying customers.  Etelos, headquartered in San Mateo, California, with offices in Renton, Washington, was founded in May 1999.

 

Industry Background

 

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

 

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

 

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

 

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

 

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

 

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

 

Etelos™ Products and Services

 

Etelos has developed and offers a range of products and services for developers and for consumers of Web Applications.

 

Etelos development products for Web Applications include open standards-based tools for Web developers, business and individual users such as the Etelos Application ServerÔ (EASÔ) and the Etelos Development EnvironmentÔ (EDEÔ).  EAS and EDE support many common application languages and also support the English Application Scripting Engine (EASEÔ), a simple-to-use open standards scripting language developed by Etelos.  In order to support broader adoption of Etelos-based products, EASE and other components of the Etelos platform are provided to developers and users at market appropriate pricing.  This is done to support the development of new Web Applications and the migration of existing Web Applications into the Etelos ecosystem where there are tools and other support mechanisms for the marketing, distribution, sales and support of these applications.  Etelos generally receives a transaction fee, a subscription fee or a license fee in exchange transactions that occur within the Etelos ecosystem via the Etelos MarketplaceÔ.

 

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

 

Etelos also offers Etelos Ad ServeÔ, an on-demand system for purchasing or publishing advertising in the Etelos ecosystem. Etelos Ad Serve allows a customer to purchase ads to be displayed in Etelos applications (i.e. in Etelos CRMÔ or Etelos ProjectsÔ), or in the Etelos Marketplace. Etelos Ad Serve also allows Etelos partners to become advertising publishers in their own web site or on their applications hosted in the Etelos Marketplace.  Etelos Ad Serve is an important tool for Etelos and development partners to receive revenue while delivering trial or “free” ad-supported subscriptions to applications in the Etelos Marketplace.  In addition to the benefits of revenue, this tool enables wider adoption of Web Applications through reduced or no-cost subscriptions, which serves important viral marketing goals.

 

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

 

The advantages of Etelos products and services are:

 

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

 

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

 

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

 

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

 

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

 

Business Strategy

 

The key elements of the Etelos strategy include:

 

Expanding Leadership in Open Standards-based Web Applications for Business. We are leaders in the development of open standards Web Applications for business.  We provide a comprehensive solution for developers of Web Applications to develop, deliver, support, and sell their products to customers.  We intend to continue to build on our leadership position by continuing to promote the development of high quality open standards Web Applications for business and to expand the range of high quality open standards Web Applications offered in the Etelos Marketplace.

 

Growing Our Customer Base. We intend to expand the range of products offered in the Etelos ecosystem and through the Etelos Marketplace and to continue to expand our direct and indirect sales efforts to generate revenue by providing an environment for the development, distribution, and support of Web Applications.

 

Fostering the Continued Development of the Etelos ecosystem. We provide a dynamic development, distribution, and consumption environment for scaling and providing business solutions to common business problems.  Our ecosystem is being expanded to contain the tools and support programs that help foster continued development of a network of value added development and distribution partners. We also provide programs that enable our development and distribution partners to resell Web Applications we have developed, along with their own products. By using the programming language developers choose, including our own EASE language, and by hosting Web Applications wherever users want, utilizing the Etelos Application Server, the Etelos Development Environment allows our partners to extend solutions using the Etelos platform. We encourage development and sales of Web Applications both separately and as bundled solutions.  Scalable business solutions are more simply achieved at a lower cost through the Build-a-Suite concept, which incorporates the benefits of App Sync and Apps on a PlaneÔ to enable customers to achieve scalable business solutions.

 

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Adding new developers, distributors and consumers to the Etelos Marketplace. SMBs are increasingly seeking global business opportunities, supported in large part by leveraging Web Applications. We believe that there is significant opportunity to address this opportunity and directly provide cost effective scalable solutions to the needs of SMBs globally. In the future, we expect to offer localized versions of products in the Etelos Marketplace for a number of countries and languages.

 

Etelos Offerings

 

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

 

Etelos Developed Web Applications. We provide programs that enable our development and distribution partners to resell Web Applications we have developed, along with their own products.

 

Customer Developed Web Applications. We encourage development and sales of Web Applications both separately and as bundled solutions.

 

Etelos Web Application Hosting. By using almost any programming language a developer chooses, including our own EASE language, and by hosting Web Applications wherever users want, utilizing our Etelos Application Server, the Etelos Development Environment allows our partners to extend solutions using our platform.

 

Programming, Marketing and Distribution Services and Support. Scalable business solutions are more simply achieved at a lower cost through the Build-a-Suite concept.  Build-a-Suite incorporates the benefits of App Sync and Apps on a Plane, together with our professional services offerings, to provide developers, distributors, and business customers the means to deliver and use scalable business solutions.

 

Sales and Marketing

 

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

 

Our Web Applications and Hosting sales generally are the result of word of mouth, marketing programs, or user referrals.  As leads self qualify and most often use credit cards for payment, our sales and support personnel provide web based seminars, forums, and direct support services to ensure continued subscription sales.  The sales cycle typically ranges from days to months, and can vary based on the Web Application, the scope of any customization desired, and the scope of any Professional Services required to meet specific customer requirements.

 

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

 

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

 

Service and Support

 

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

 

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

 

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

 

Operations, Technology, and Development

 

Our customers rely on our products and the products of our partners to run their businesses, and, as a result, it is our responsibility to ensure the availability of our service. We continue to improve our infrastructure with the goal of maximizing the availability of our Web Applications and those of our developers, distributors and users.  We host on a highly-scalable network located in a two, secured third-party facilities.  We have facility space, power, and Internet connectivity provided by Network OS and ServePath. In anticipation of future growth, we may engage additional providers and/or expand the number of data centers utilized with existing vendors. Our hosting operations incorporate industry-standard hardware and our EAS operating system and databases and application servers provide a flexible, scalable architecture. Elements of our products’ infrastructure can be replaced or added with no interruption in service, helping to ensure that the failure of any single device will not cause a broad service outage.

 

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Our multi-tenant individual account package architecture allows us to provide our customers with enterprise-class capabilities, high quality of service, security and scalability, all at costs that scale as their use of Web Applications scales. Our architecture enables us to host multiple smaller customers on a single server while preserving the ability to migrate any customer to its own server without interruption or alteration when the customers’ growth and business needs dictate it. In addition to the enhanced flexibility and scalability that our architecture provides, it also is designed to work on inexpensive, industry-standard hardware, thereby providing us a significant cost savings that is reflected in the pricing we are able to offer our customers.

 

Unlike other SaaS companies that deploy major new releases to all customers at once, or roll out all major releases and many upgrades of their products to a portion of their customer base at any one time, we allow our development partners to choose between an “all at once” approach or a “phased release” approach, depending upon the needs and desires of their customers and the nature of their Web Applications.

 

In developing our service offerings, we rely on customer feedback and are spending significantly more time with our customers in user testing sessions as well as informal “ride-alongs” and customer forums. We use the Etelos Idea Network together with forums, email, and blogs to track customer interest in service enhancements and actual results of these enhancements. We develop our offerings using EASE, which is a high performance, robust and easy to use programming language. Finally, we expose many of our internal development tools to third party developers via the Etelos ecosystem to allow extensions to the service that allow any LAMP (Linux, Apache, MySQL and PHP) or LAPP (Linux, Apache, PostGres and PHP) stack application take advantage of the capabilities we develop internally including App Sync and AOP.

 

Customers

 

As of December 31, 2007, Etelos served over 5,000 active customers of diverse sizes and types across a wide variety of industries, with a focus on SMBs, which Etelos defines as businesses with fewer than 1,000 employees, and divisions of larger companies. No single customer accounted for more than 10% percent of Etelos’ revenue in 2006 or 2007.  Customers of all types use Etelos products to achieve a wide variety of business objectives.

 

Competition

 

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

 

Etelos believes that the principal competitive factors in its markets include:

 

·                  Freedom of choice in Web Applications

·                  Service breadth and functionality;

·                  Performance, security, and reliability;

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

·                  Ease of use and replacement;

 

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·              Speed and ease of deployment, integration and configuration;

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

·              Sales and marketing approach; and

·              Financial resources and reputation.

 

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

 

Intellectual Property

 

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

 

As of April 22 2008, we had four U.S. and no foreign patent applications pending. We plan to file additional patent applications in the United States, but since the filing of some of these 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 some of these inventions outside the United States.  We do not know whether our pending or future patent applications will result in the issuance in of patents in the United States or elsewhere, or whether the examination process will require us to narrow our claims. Even if granted, there can be no assurance that the pending patent applications will provide us with protection.

 

We have a number of unregistered trademarks.  We have not registered any trademarks or service marks.  We maintain a policy requiring our employees, consultants and other third parties to enter into confidentiality and proprietary rights agreements and to control access to software, documentation and other proprietary information.

 

We have not maintained operating controls or logs, or initiated or conducted any forensic, code history, ‘genealogy’ or other form of audit, analysis, processes, training, or code review of software code incorporated into any Etelos product or in other products offered by others 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 [a] such software or other software combined or distributed with such software be disclosed or distributed in source code form, or [b] such software or other software combined or distributed with such software, and any related intellectual property,  be licensed on a royalty-free basis, including for the purposes of making additional copies or derivative works of such software.  This may adversely affect our ability to patent certain inventions or to license or distribute certain products – whether by open source license or other form of license or right – and may result in liability to unknown parties for infringement of their patents or other intellectual property rights.

 

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

 

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

 

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

 

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

 

Research and Development

 

During the fiscal years ended December 31, 2006 and December 31, 2007, research and development expenses were $839 thousand and $1.9 million, respectively, and consisted primarily of employee and employee related expenses.

 

Employees

 

As of December 31, 2007, we had approximately 34 full-time employees and 1 part-time employee. We consider our employee relationships to be satisfactory.  From time to time, we also engage temporary employees and consultants. None of our employees are represented by a labor union with respect to his or her employment with us.

 

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RISK FACTORS

 

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information contained in this report before deciding to invest in our common stock.

 

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.

 

Etelos began its operations in 1999 but it did not adopt the SaaS on-demand Web Application delivery model until 2005. As such, Etelos has a limited operating history in the SaaS industry from which to evaluate its business and prospects.  Etelos incurred a net loss of $3.9 million for the year ended December 31, 2007, and has an accumulated deficit of $10.4 million at December 31, 2007.  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.

 

Etelos began its 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 our technology;

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

·                  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.

 

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

 

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

 

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

 

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, 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 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 years ended December 31, 2007 and 2006, 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.

 

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

 

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

 

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

 

We may 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 four United States patent applications covering our technology and we expect to file more patents applications in the near future. The process of seeking patent protection can be lengthy and expensive and we cannot assure you 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 you 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 products.

 

We do not have key man insurance on our key officers, on whom we rely for the management of our business.

 

We depend, to a large extent, on the abilities and participation of our current management team, but have a particular reliance upon Daniel J. A. Kolke, our Chief Technology Officer and Chairman of the Board, and Jeffrey L. Garon, our President and Chief Executive Officer. The loss of the services of either or both of Messrs. Kolke or Garon for any reason may have a material adverse effect on our business and prospects. We cannot assure you that the services of either Messrs. Kolke or Garon will continue to be available to us, or that we will be able to find a suitable replacement for either of them. We do not carry key man life insurance for any key personnel.

 

We may not be able to hire and retain qualified personnel to support our growth and if we are unable to retain or hire such personnel in the future, our ability to improve our products and implement our business objectives could be adversely affected.

 

If one or more of our senior executives or other key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Although both Messrs. Kolke and Garon are under employment agreements, their continued employment cannot be assured.  In addition, competition for senior management and senior technology personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or senior technology personnel, or attract and retain high-quality senior executives or senior technology personnel in the future. Such failure could materially and adversely affect our future growth and financial condition.

 

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We have a history of losses and we may not achieve profitability in the future.

 

We have not been profitable on a quarterly or annual basis since our formation. Our operations resulted in a net loss of $3.9 million for 2007 and $ 1.5 million for 2006.  As of December 31, 2007, our accumulated deficit was $10.4 million. We expect to make significant future expenditures related to the development and expansion of our business. In addition, as a public company, we will incur significant legal, accounting, and other expenses that we did not incur as a private company. As a result of these increased expenditures, we will have to generate and sustain increased revenue to achieve and maintain future profitability. While our revenue has grown somewhat in recent periods, revenue growth may not be sustainable and we may not achieve sufficient revenue to achieve or maintain profitability. We may incur significant losses in the future for a number of reasons, including due to the other risks described in this report, and we may encounter unforeseen expenses, difficulties, complications, delays, and other unknown factors. Accordingly, we may not be able to achieve or maintain profitability and we may continue to incur significant losses for the foreseeable future.

 

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 SMBs to accept on-demand services for Web Applications that they view as critical to the success of their business. Many companies 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.

 

Our customers are 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 to 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 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, 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, SMBs often require higher sales, marketing and support expenditures by vendors that sell to them per revenue dollar generated for those vendors.

 

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If we are unable to cost-effectively market and sell our products to our target customers, then our ability to grow our revenue quickly and become profitable will be harmed.

 

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.

 

Our limited operating history makes it difficult to evaluate our current business and future prospects, and may increase the risk of your investment.

 

Our limited operating history may make it difficult to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries. If we do not address these risks successfully, then our business will be harmed.

 

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.

 

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

 

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

 

Our business depends substantially on customers renewing, upgrading, and expanding their subscriptions for our products.

 

We sell our products 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 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 our products, the prices of our 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.

 

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 service we offer 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 customers and to individuals or businesses whose information was being stored by our customers, our business may suffer, and our reputation will 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.

 

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 34 at December 31, 2007 from 16 at December 31, 2006 and have experienced a drop in our revenue to $304 thousand in 2007 from $316 thousand in 2006. 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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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 Web Applications for business is highly competitive and rapidly changing with relatively low barriers to entry. With the introduction of new technologies and 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 compete to sell our products 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.

 

Many of our customers are price sensitive, and if the prices we charge for our products 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. As the market for our products matures, or as new competitors introduce new products or services that compete with ours, we may be unable to renew our 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 our pricing model or reduce our prices, which could harm our revenue, gross margin, and operating results.

 

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

 

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

 

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If we are unable to develop new products or sell our products into new markets, then our revenue growth will be harmed and we may not be able to achieve profitability.

 

Our ability to attract new customers and increase revenue from existing customers will depend in large part on our ability to enhance and improve our existing products and to 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 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 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.

 

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 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.

 

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 form 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.  These products may include code subject to various forms of ‘open source’, ‘copyleft’, or similar licenses that require as a condition of modification or distribution of software subject to such license(s) that [a] such software or other software combined or distributed with such software be disclosed or distributed in source code form, or [b] such software or other software combined or distributed with such software, and any related intellectual property,  be licensed on a royalty-free basis, including for the purposes of making additional copies or derivative works of such software.  This may adversely affect our ability to patent certain inventions or to license or distribute certain products — whether by open source license or other form of license or right – and may result in liability to unknown parties for infringement of their patents or other intellectual property rights.

 

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.

 

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. Both we and our independent auditors will be testing our internal controls in connection with the audit of 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.

 

During our review for the year ended December 31, 2007, we identified 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 nine 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.

 

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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 services could harm our reputation, result in significant costs to us, and impair our ability to sell our services.

 

The Web Applications underlying our services 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 software and services, and new errors in our existing software and services may be detected in the future. Any 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 and by our customers. The costs incurred in correcting any material defects or errors in our 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.

 

22



 

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

 

Our customers can use our services 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. If the gathering of personal information were to be curtailed, then Web-based applications would be less effective, which may reduce demand for our products and services 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.

 

Our future operating expenses may be adversely affected by changes in our stock price.

 

Some of our outstanding stock options are subject to variable accounting. Under variable accounting, we are required to remeasure the value of the options, and the corresponding compensation expense, on the basis of the value of our common stock at the end of each reporting period until the options are exercised and vested, cancelled, modified, or expire unexercised. As a result, the stock-based compensation expense we recognize in any given period can vary substantially due to changes in the market value of our common stock.

 

Changes in our stock price will result in a decrease in stock-based compensation expense when our stock price declines relative to the previous period and an increase in stock-based compensation expense when our stock price increases relative to the previous period. We are unable to predict the future market value of our common stock and, therefore, are unable to predict the compensation expense that we will record in future periods.

 

23



 

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. For example, on December 16, 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards 123(R) (revised 2004), “Share-Based Payment,” or SFAS No. 123(R). SFAS No. 123(R), which became effective for fiscal periods beginning after June 15, 2005, requires that employee stock-based compensation be measured based on its fair-value on the grant date and treated as an expense that is reflected in the financial statements over the related service period.

 

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

 

·                  issue additional equity securities that would dilute our stockholders;

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

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

·                  incur large charges or substantial liabilities;

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

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

 

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

 

We 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 and 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.

 

24



 

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.

 

Our officers, directors, and affiliates beneficially own approximately 40.4% of our common stock. As a result, 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. 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.

 

Under the terms of the securities purchase agreement dated January 31, 2008, pursuant to which we issued $2.0 million in principal amount of 6% secured convertible debentures and warrants to purchase 666,667 shares of our common stock, the purchasers thereof may rely on the provisions of Rule 144 to effect sales and may 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.

 

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.

 

25



 

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 April 22, 2008, we had 22,700,634 split adjusted shares of common stock issued and outstanding held by approximately 145 shareholders of record, including 5,010,000 shares approved for issue under our Plan of Reorganization.  The shares issued under our Plan of Reorganization will be freely trading 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.

 

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.

 

26



 

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 likely 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 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.

 

A limited number of stockholders own substantially all of our stock and may act, or prevent certain types of corporate actions, to the detriment of other stockholders.

 

As of April 22, 2008, our directors, officers and greater than 5% stockholders own substantially all of our issued and outstanding common stock.  Accordingly, these stockholders may, if they act together, exercise significant influence over all matters requiring stockholder approval, including the election of a majority of the directors and the determination of significant corporate actions.  This concentration could also have the effect of delaying or preventing a change in control that could otherwise be beneficial to our stockholders.

 

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% of the total combined voting power of all outstanding securities of the Company. 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.

 

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 Pink Sheets, which may not provide liquidity for our investors.

 

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

 

27



 

The Securities and Exchange Commission’s (“SEC”) order handling rules, which apply to NASDAQ-listed securities, do not apply to securities quoted on the Over-the-Counter Pink Sheets. Quotes for stocks included on the Over-the-Counter Pink Sheets are not listed in newspapers. Therefore, prices for securities traded solely on the Over-the-Counter Pink Sheets 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 Pink Sheets 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 Pink Sheets, the Over-the-Counter Pink Sheets 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 Pink Sheets, 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 (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 $200,000 (or $300,000 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.

 

28



 

We will incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which could harm our operating results.

 

As a public company, we will incur significant legal, accounting, and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with current corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the Securities and Exchange Commission, or SEC. The expenses incurred by public companies for reporting and corporate governance purposes have increased dramatically. We expect these rules and regulations to substantially increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage than used to be available. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.

 

DESCRIPTION OF PROPERTY

 

Our corporate headquarters are located in San Mateo, California and comprise approximately 4,500 hundred square feet of space leased through October 2009.   In addition, we maintain an office in Renton, Washington that comprises approximately 6,000 square feet of space leased through June 2010.  We believe that our existing properties are in good condition and are sufficient and suitable for the conduct of our business. As our existing leases expire and as we continue to expand our operations, we believe that suitable space will be available to us on commercially reasonable terms.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

 

The following discussion and analysis of the consolidated financial condition and results of operations should be read with our consolidated financial statements and related notes appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Risk Factors” and elsewhere in this report. See “Forward-Looking Statements,” above.

 

Overview

 

Business

 

Etelos is a leading provider of software solutions that assist organizations to effectively use Web Applications to accomplish their goals.  Etelos provides a revolutionary SaaS ecosystem for building, distributing, and using Web Applications, including a marketplace to deploy and support them; giving businesses choices in applications, hosting and support services to cost effectively accomplish their goals.

 

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.

 

Etelos revenue has fallen from $316 thousand in 2006 to $304 thousand in 2007, while the cost of goods sold increased from $130 thousand in 2006 to $315 thousand in 2007. As of December 31, 2007, Etelos had over 5,000 active free and paying customers.

 

29



 

Recent Financings

 

January 2008 Private Placement

 

On January 31, 2008, we entered into a securities purchase agreement with three unaffiliated institutional investors for the sale of original issue discount 6% convertible debentures and common stock purchase warrants.  We refer to this transaction as our January 2008 Private Placement.  In this transaction we issued an aggregate of $2.0 million principal amount of debentures and warrants to purchase an aggregate of up to 666,667 shares of our common stock.  The warrants have a term of five years and an exercise price of $0.60 per share, subject to adjustment, including full-ratchet anti-dilution protection.  This transaction resulted in net proceeds to us of $1.9 million.

 

In this report we may refer to the debentures we issued in our January 2008 Private Placement as our January debentures.  The following summarizes the terms of our January debentures and is qualified by reference to a copy of the debenture which is filed as an exhibit to this report:

 

·

 

Term. The debentures are due and payable on January 31, 2010.

·

 

Interest. Interest accrues at the rate of 6% per annum and is payable semiannually on January 1 and July 1, commencing on July 1, 2008.

·

 

Monthly Principal Payments. Monthly principal payments equal to 1/18th of the principal amount due under each debenture begin on September 1, 2008.

·

 

Payments of Principal and Interest. 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 (initially $0.45) or 85% of the average of the volume weighted average price, or VWAP, per share as reported on Bloomberg for our common stock for the 10 consecutive trading days immediately prior to the applicable payment date.

·

 

Early Redemption. We have the option to redeem the debentures before their maturity by payment in cash of 120% of the then outstanding principal amount plus accrued interest and other charges. To redeem the debentures we must meet certain equity conditions, including having an effective registration statement covering the sale by the investors of the shares of our common stock issued upon conversion of the debentures. The payment of the debentures would occur on the 10th day following the date we gave the holders notice of our intent to redeem the debentures. We agreed to honor any notices of conversion that we receive from a holder before the date we pay off the debentures.

·

 

Voluntary Conversion by Holder. The debentures are convertible at anytime at the discretion of the holder at a conversion price per share of $0.45, subject to adjustment including full-ratchet, anti-dilution protection, and subject to a cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion. See
“SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT,” below, for more information regarding the beneficial ownership caps.

·

 

Forced Conversion. Subject to compliance with certain equity conditions, including having an effective registration statement covering the sale by the investors of the shares of our common stock issued upon conversion of the debentures, and subject to the applicable cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion, we also have the right to force conversion if the average of the VWAP for our common stock exceeds $1.13 for 20 trading days out of a consecutive 30 trading day period.

·

 

Security. The debentures are secured by all of our assets under the terms of a security agreement we entered into with the investors.

 

April 2008 Private Placement

 

On April 22, 2008, we entered into a securities purchase agreement with two unaffiliated institutional investors for the sale of original issue discount 6% convertible debentures and common stock purchase warrants.  We refer to this transaction as our April 2008 Private Placement.  In this transaction we issued an aggregate of $3.5 million principal amount of debentures and warrants to purchase an aggregate of up to 1,166,667 shares of our common stock.  The warrants have a term of five years and an exercise price of $0.60 per share, subject to adjustment, including full-ratchet anti-dilution protection.  This transaction resulted in net proceeds to us of $3.4 million.

 

In this report we may refer to the debentures we issued in our April 2008 Private Placement as our April debentures.  The following summarizes the terms of our April debentures and is qualified by reference to a copy of the debenture which is filed as an exhibit to this report:

 

·

 

Term. The debentures are due and payable on April 30, 2010.

·

 

Interest. Interest accrues at the rate of 6% per annum and is payable semiannually on January 1 and July 1, commencing on July 1, 2008.

·

 

Monthly Principal Payments. Monthly principal payments equal to 1/18th of the principal amount due under each debenture begin on September 1, 2008.

·

 

Payments of Principal and Interest. 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 (initially $0.45) or 85% of the average of the volume weighted average price, or VWAP, per share as reported on Bloomberg for our common stock for the 10 consecutive trading days immediately prior to the applicable payment date.

·

 

Early Redemption. We have the option to redeem the debentures before their maturity by payment in cash of 120% of the then outstanding principal amount plus accrued interest and other charges. To redeem the debentures we must meet certain equity conditions, including having an effective registration statement covering the sale by the investors of the shares of our common stock issued upon conversion of the debentures. The payment of the debentures would occur on the 10th day following the date we gave the holders notice of our intent to redeem the debentures. We agreed to honor any notices of conversion that we receive from a holder before the date we pay off the debentures.

·

 

Voluntary Conversion by Holder. The debentures are convertible at anytime at the discretion of the holder at a conversion price per share of $0.45, subject to adjustment including full-ratchet, anti-dilution protection, and subject to a cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion. See
“SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT,” below, for more information regarding the beneficial ownership caps.

·

 

Forced Conversion. Subject to compliance with certain equity conditions, including having an effective registration statement covering the sale by the investors of the shares of our common stock issued upon conversion of the debentures, and subject to the applicable cap on the beneficial ownership of our shares of common stock by the holder and its affiliates following such conversion, we also have the right to force conversion if the average of the VWAP for our common stock exceeds $1.13 for 20 trading days out of a consecutive 30 trading day period.

·

 

Security. The debentures are secured by all of our assets under the terms of a security agreement we entered into with the investors.

 

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The 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 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 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 debentures have the right to accelerate all amounts outstanding under the debenture and demand payment of a mandatory default amount equal to 130% of the amount outstanding plus accrued interest and expenses.

 

As further discussed under “Liquidity and Capital Resources,” below, we believe our cash balance at December 31, 2007, plus the net proceeds from our January 2008 and April 2008 Private Placements, is sufficient to fund our operations through at least December 2008.  If cash reserves are not sufficient to sustain operations, 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.

 

Going Concern Issue

 

We remain dependent on outside sources of funding until our results of operations provide positive cash flows.  Our independent auditors issued a going concern qualification in their report dated April 22, 2008, with our current level of funding substantial doubt about our ability to continue as a going concern is a reasonable conclusion.

 

During the years ended December 31, 2007 and 2006, we have been unable to generate cash flows sufficient to support our operations and have been dependent on debt and equity raised from qualified individual investors.  We experienced negative financial results as follows (in thousands):

 

 

 

2007

 

2006

 

Net loss attributable to common shareholders

 

$

(3,956

)

$

(1,462

)

Negative cash flow from operations

 

(3,060

)

(1,022

)

Working capital

 

(3,391

)

(2,038

)

Stockholders’ deficit

 

(4,946

)

(2,054

)

 

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

 

We have supported current operations by raising additional operating cash through the private sale of our convertible debentures.  This has provided us with the cash flows to continue our business plan, but have 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.

 

31



 

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.

 

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 that affect the reported amounts and related disclosures.  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

 

The Company provides, when appropriate, an allowance for doubtful accounts to ensure trade receivables are not overstated due to un-collectibility. The collectibility of the Company’s 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. As of December 31, 2007 and 2006 there was no allowance for doubtful accounts.

 

Revenue Recognition

 

The Company recognizes revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, or SAB 104, “Revenue Recognition in Financial Statements”. The Company recognizes revenue when all of the following criteria are met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred, 3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured.

 

Our significant accounting policies are described in more detail in the notes to consolidated financial statements included elsewhere in this filing.  If actual results differ significantly from our estimates and projections, then there could be a material effect on our financial statements.  Please see “Note 3. Summary of Significant Accounting Policies” to our financial statements included in this report.

 

Results of Operations

 

Fluctuations in Operating Results

 

We are in the early stages of our operations. Our results of operations are likely to fluctuate from period to period.  We anticipate that our quarterly and annual results of operations will be impacted for the foreseeable future by several factors, including the timing and volume of sales of our products.  Due to these factors, each of which will have a substantial impact on our future operations, we believe that the period-to-period comparisons of our operating results are not a good indication of our future performance.

 

Year Ended December 31, 2007 Compared with Year Ended December 31, 2006

 

Revenues

 

Revenues were $304 thousand and $316 thousand for fiscal 2007 and 2006, respectively. Revenues decreased by $12 thousand, or 3.8%, in fiscal 2007 compared to fiscal 2006. The decrease in fiscal 2007 revenue is due in part to our focus on fewer key products and the timing of release of those products.

 

Cost of Good Sold

 

Cost of good sold includes our costs of hardware, software and other resources used in delivery of our products and services. Cost of good sold were $315 thousand and $130 thousand for fiscal year 2007 and 2006, respectively. Cost of good sold for 2007 increased by $185 thousand, or by 142.3%.  The increase in cost of good sold from 2006 to 2007 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 good sold for the corresponding periods was 103.6% and 41.1%, respectively.

 

Operating Expenses

 

Research and Development.  Research and development expenses include primarily employee and employee related expenses. Research and development expenses were $1,856 thousand and $839 thousand for fiscal year 2007 and 2006, respectively. Stated as a percentage of revenues, research and development expense for the corresponding periods was 610.5% and 265.5%, respectively.  Research and development expenses increased by $1,017 thousand, or by 121.2%, in fiscal 2007 compared to fiscal 2006.  This increase was primarily due to increased hiring of engineers for research and development.

 

32



 

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 $771 thousand and $348 thousand for fiscal year 2007 and 2006, respectively. The $423 thousand, or 121.6%, increase in sales and marketing expense was due to increased hiring of sales and marketing personnel and greater focus on sales and marketing activities. Stated as a percentage of revenues, sales and marketing expense for the corresponding periods was 253.6% and 110.2%, respectively.

 

General and Administrative.  General and administrative expenses include payroll and related employee benefits, and other headcount-related costs associated with finance, facilities, and legal and other administrative fees. General and administrative expenses were $876 thousand and $396 thousand for fiscal year 2007 and 2006, respectively. The $480 thousand, or 121.2%, 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.  Stated as a percentage of revenues, general and administrative expense for the corresponding periods was 288.2% and 125.2%, respectively.

 

Other Income (Expense)

 

Interest Expense. Net interest expense was $362 thousand for 2007 compared to $97 thousand for 2006. The increase in interest expense was primarily due to multiple rounds of convertible debt financing during 2007.

 

Net Loss

 

Our net loss was $3.9 million and $1.5 million for fiscal year 2007 and 2006, respectively, an increase of $2.4 million, or 270.5%.  The percentage change in the net loss from 2006 to 2007 was primarily due to increased hiring and employee-related costs and decreased revenues in a period of transition for Etelos.

 

Liquidity and Capital Resources

 

On December 31, 2007, we had $928 thousand in cash and cash equivalents, and prepaid expenses of $21 thousand. Our working capital deficit at December 31, 2007 was $3.4 million, compared to a deficit of $2.0 million at December 31, 2006.

 

Net cash used by operating activities during the year ended December 31, 2007 was $3.1 million, compared to $979 thousand during the year ended December 31, 2006. The primary use of cash from operating activities in 2007 was research and development expenses of $1.9 million.

 

Net cash provided by financing activities for 2007 was $4 million, primarily from the issuance of notes.  During the year ended December 31, 2007, we issued 6% convertible notes at an original issue discount of 10% with a face value of $3.3 million.  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 1st day of each calendar quarter thereafter.

 

In connection with the issuance of these notes, we issued warrants to purchase up to 3,174,000 shares of our common stock at an exercise price of $0.40 and a term of 5 years.  At December 31, 2007, warrants to purchase 1,929,000 shares have been exercised.

 

33



 

We believe our cash balance, including the net proceeds from our January 2008 and April 2008 Private Placements, is sufficient to fund our operations through at least December 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 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.

 

Commitments and Contingencies

 

January Debentures

 

In January 2008, we issued our January debentures with an aggregate principal amount of $2.0 million. Under the terms of these debentures, we are to begin making monthly redemption payments upon the earlier of the effective date of the registration statement we are required to file to register for resale of the shares of common stock issuable upon conversion of these debentures or November 1, 2008.  The maturity date of these debentures is January 31, 2010.  The aggregate face value of our outstanding debentures is $2.0 million at April 22, 2008.  The total monthly principal payment amounts on our January debentures are scheduled to be paid as follows, Under assuming such payments begin on September 1, 2008:

 

Monthly Principal Payment Amount

 

Date

 

January
Debentures

 

9/1/2008

 

$

111,111.12

 

10/1/2008

 

$

111,111.12

 

11/1/2008

 

$

111,111.12

 

12/1/2008

 

$

111,111.12

 

1/1/2009

 

$

111,111.12

 

2/1/2009

 

$

111,111.12

 

3/1/2009

 

$

111,111.12

 

4/1/2009

 

$

111,111.12

 

5/1/2009

 

$

111,111.12

 

6/1/2009

 

$

111,111.12

 

7/1/2009

 

$

111,111.12

 

8/1/2009

 

$

111,111.12

 

9/1/2009

 

$

111,111.12

 

10/1/2009

 

$

111,111.12

 

11/1/2009

 

$

111,111.12

 

12/1/09

 

$

111,111.12

 

1/1/2010

 

$

111,111.12

 

1/31/2010

 

$

111,111.12

 

 

 

$

2,000,000

 

 

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 debentures, or on average, $13.3 thousand per month.

 

April Debentures

 

In April 2008, we issued our April 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 the effective date of the registration statement we are required to file to register for resale of the shares of common stock issuable upon conversion of these debentures or November 1, 2008.  The maturity date of these debentures is April 30, 2010.  The aggregate face value of our outstanding debentures is $3.5 million at April 22, 2008.  The total monthly principal payment amounts on our April debentures are scheduled to be paid as follows, Under assuming such payments begin on September 1, 2008 (dollar amounts in thousands):

 

Monthly Principal Payment Amount

 

Date

 

April
Debentures

 

9/1/2008

 

$

194,400.00

 

10/1/2008

 

$

194,400.00

 

11/1/2008

 

$

194,400.00

 

12/1/2008

 

$

194,400.00

 

1/1/2009

 

$

194,400.00

 

2/1/2009

 

$

194,400.00

 

3/1/2009

 

$

194,400.00

 

4/1/2009

 

$

194,400.00

 

5/1/2009

 

$

194,400.00

 

6/1/2009

 

$

194,400.00

 

7/1/2009

 

$

194,400.00

 

8/1/2009

 

$

194,400.00

 

9/1/2009

 

$

194,400.00

 

10/1/2009

 

$

194,400.00

 

11/1/2009

 

$

194,400.00

 

12/1/09

 

$

194,400.00

 

1/1/2010

 

$

194,400.00

 

1/31/2010

 

$

194,400.00

 

 

 

$

3,500,000

 

 

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 debentures, or on average, $23.3 thousand per month.

 

34



 

We have the right to pay interest and monthly principal payments due in respect of our January and April 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 $0.45) or 85% 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.  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.

 

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 $1.13 for 20 trading days out of a consecutive 30 trading day period.  If the price of our common stock is below $1.13 per share but is substantially above $0.45 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 $0.45, 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% 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.

 

Operating and Capital Leases

 

We have non-cancelable leases for corporate facilities and equipment.  Rent expense under the leases totaled $146.7 thousand and $44.3 thousand for the years ended December 31, 2007 and 2006, respectively.  Future minimum rental payments required under non-cancelable leases are as follows for the years ending December 31:

 

 

 

 

Operating
Leases

 

Capital
Leases

 

2008

 

 

$

269

 

$

25,895

 

2009

 

 

269

 

20,570

 

2010

 

 

97

 

13,286

 

2011

 

 

 

13,286

 

2012

 

 

 

2,214

 

Thereafter

 

 

 

 

Total minimum lease payments

 

 

$

 635

 

$

75,251

 

Less amount representing interest

 

 

 

 

22,841

 

Present value of minimum lease payments

 

 

 

 

52,410

 

Less current portion

 

 

 

 

16,179

 

Total long term portion

 

 

 

 

$

36,231

 

 

35



 

Recent Financings

 

January and April  2008 Private Placements

 

The following table sets forth the (i) gross proceeds we received from each investor in our January and April 2008 Private Placement and (ii) amount of payments that we may be required to make under the terms of our January and April debentures assuming all such payments are made in cash when due and monthly redemption payments begin September 1, 2008 (dollar amounts in thousands).

 

(In Thousands)

 

Gross

 

Payments through December 31, 2008

 

Payments from January 1, 2009 through
January 31, 2010

 

Investor Name

 

Proceeds

 

Principal

 

Interest

 

Total (1)

 

Principal

 

Interest

 

Total (2)

 

Enable Growth Partners LP

 

$

4,000

 

$

889

 

$

73

 

$

962

 

$

3,111

 

$

117

 

$

3,228

 

Hudson Bay Fund LP

 

$

970

 

$

216

 

$

18

 

$

234

 

$

754

 

$

14

 

$

768

 

Hudson Bay Overseas Fund LTD

 

$

530

 

$

118

 

$

10

 

$

128

 

$

412

 

$

15

 

$

427

 

 

 

$

5,500

 

$

1,222

 

$

101

 

$

1,323

 

$

4,278

 

$

146

 

$

4,423

 

 


(1) Averages to $330 thousand per month from September 1, 2008, through December 31, 2008.

(2) Averages to $340 thousand per month from January 1, 2009, through January 31, 2010.

 

The conversion price for the debentures is currently $0.45 and the exercise price of these warrants is currently $0.60 per share.  Assuming that we pay all future principal and interest payments in cash on their respective due dates, the total principal and interest payments for such debentures aggregate to $5.8 million over their respective terms.  We received net proceeds after expenses of $5.3 million from our January 2008 and April 2008 Private Placements.  The ratio of (i) the total amount of payments over the term of the debentures to (ii) net proceeds is 109%.

 

Recent Accounting Pronouncements

 

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, which supplements Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes, by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. FIN 48 requires the tax effect of a position to be recognized only if it is “more-likely-than-not” to be sustained based solely on its technical merits as of the reporting date. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are recognized. If the tax position is considered more likely than not to be sustained, the amount to record is measured at the largest amount of benefit that is grater than 50% likely of being realized upon ultimate settlement. This is a different standard for recognition than was previously required. The more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. At adoption, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. Any necessary adjustment is recorded directly to opening retained earnings in the period of adoption and reported as a change in accounting principle. The Company adopted FIN 48 starting January 1, 2007. The adoption of FIN 48 did not have a material effect on the Company’s financial statements.

 

In September 2006, the Securities and Exchange Commission published Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements “ (SAB 108). The interpretations in SAB 108 are being issued to address diversity in practice in quantifying financial statement misstatements and the potential under current practice to build up improper amounts on the balance sheet. This guidance applies to fiscal years ending after November 15, 2006 and early application in interim periods is encouraged. The adoption of SAB 108 did not have an effect on the Company’s financial statements.

 

In September 2006, the FASB issued SFAS No. 157 (“FAS 157”), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. FAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. FAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company are currently evaluating the impact of FAS 157, but do not expect the adoption of FAS 157 to have a material impact on the financial position, results of operations, or cash flows.

 

36



 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of FAS 159 to have a material impact.

 

Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements as of the year ended December 31, 2007, nor do we have any as of April 22, 2008.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

The following table sets forth certain information with respect to the beneficial ownership of our common stock as of April 22, 2008 by (i) any person or group owning more than 5% of our common stock, (ii) each director, (iii) each executive officer named in the Summary Compensation Table and (iv) all executive officers and directors as a group.  Immediately following the merger, we had 22,700,634 shares of common stock issued and outstanding.  In determining the percent of common stock owned by a person, (a) the numerator is the number of shares of the class beneficially owned by such person, and (b) the denominator is the total shares of that class outstanding on April 22, 2008. Unless otherwise stated, each beneficial owner has sole power to vote and dispose of the shares and the address of such person is c/o the Company, at Etelos, Inc., 1900 O’Farrell St., Suite 320, San Mateo, CA 94403.

 

Name and Address of Beneficial Owner

 

Amount and Nature of
Beneficial Ownership

 

Percentage of Class
Beneficially Owned

 

Officers and Directors

 

 

 

 

 

Daniel J. A. Kolke

 

5,107,547

(1)

7.4

%

Jeffrey L. Garon

 

2,383,333

(2)

10.5

%

Ronald A. Rudy

 

817,833

(3)

3.6

%

Gregory Ruff

 

51,000

(4)

0.2

%

Ahmad Baitalmal

 

240,654

(5)

1

%

Directors and Officers as a group

 

8,600,367

 

22.2

%

5% Stockholders (other than officers or directors)

 

 

 

 

 

Enable Growth Partners LLP

 

5,868,364

(6)

25.6

%

Don Morissette

 

8,174,020

 

36.0

%

Hudson Bay Fund LP

 

1,363,636

(7)

6.0

%

 


(I) Consists of (i)1,600,629 shares of common stock, (ii) 3,433,333 shares of common stock issuable upon exercise of options, (iii) 73,585 shares of common stock held by Mr. Kolke’s spouse.

(2) Mr. Garon’s shares are under the terms of his employment agreement, subject to our right to repurchase the shares over a 36 month period from August 2007.

(3) Consists of (i) 807,833 shares of common stock, and (ii) 10,000 shares of common stock issuable upon exercise of options.

(4) Consists of (i) 41,000 shares of common stock, and (ii) 10,000 shares of common stock issuable upon exercise of options.

(5) Consists of (i) 211,321 shares of common stock and (ii) 29,333 shares of common stock issuable upon exercise of options.

(6) Does not include 3,407,407 shares of common stock acquirable upon the conversion of debentures and exercise of warrants held by the stockholder or its affiliates, all of which are subject to conversion or exercise caps. Pursuant to the terms of the debentures and warrants, the number of shares of common stock that may be acquired by the stockholder upon any conversion or exercise of such security is limited, to the extent necessary, to ensure that following such conversion or exercise, the number of shares of our common stock then beneficially owned by the stockholder and any other persons or entities whose beneficial ownership of common stock would be aggregated with the stockholder for purposes of the Exchange Act does not exceed 4.99% of the total number of shares of our common stock then outstanding.  Such cap may be increased to 9.99% by the stockholder upon 61 days notice, but may not be increased or waived thereafter.

(7) Does not include 1,277,778 shares of common stock acquirable upon the conversion of debentures and exercise of warrants held by the stockholder or its affiliates, all of which are subject to conversion or exercise caps. Pursuant to the terms of the debentures and warrants, the number of shares of common stock that may be acquired by the stockholder upon any conversion or exercise of such security is limited, to the extent necessary, to ensure that following such conversion or exercise, the number of shares of our common stock then beneficially owned by the stockholder and any other persons or entities whose beneficial ownership of common stock would be aggregated with the stockholder for purposes of the Exchange Act does not exceed 4.99% of the total number of shares of our common stock then outstanding.  Such cap may be increased to 9.99% by the stockholder upon 61 days notice, but may not be increased or waived thereafter.

 

As a result of the closing of the merger, the former shareholders of Etelos now own 78% of the total outstanding shares of our capital stock.  Reference is made to the disclosure set forth above under this Item 5.01 of this report, which disclosure is incorporated herein by reference.

 

37



 

DIRECTORS AND EXECUTIVE OFFICERS

 

Immediately before the closing of the merger, Tripath had no directors or executive officers.  Dr. Adya Tripathi, who served as Tripath’s chairman and chief executive officer since its inception in 1995, resigned shortly after Tripath filed its voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the Northern District of California on February 8, 2007.  Since that time until the effective time of the merger, Mr. Gary Sawka served as the Designated Responsible Individual for Debtor in Possession for Tripath.

 

Set forth below is information regarding the directors and current executive officers immediately after the effective time of the merger.  Executive officers are elected annually by our board of directors. Each executive officer holds his office until he resigns or is removed by our board of directors or his successor is elected then qualified.  Directors are elected each year by our stockholders at the annual meeting. Each director holds his office until his successor is elected and qualified or resignation or removal.

 

Name

 

Position

 

Age

Daniel J. A. Kolke

 

Chairman and Vice President & Chief Technology Officer

 

37

Jeffrey L. Garon

 

Director and Chief Executive Officer

 

47

Ronald A. Rudy

 

Director

 

66

Gregory Ruff

 

Director

 

54

 

Daniel J. A. Kolke.

 

Mr. Kolke founded Etelos in May 1999.  It is his vision and energy as the key architect that has driven development of the Etelos Ecosystem.  Currently, Mr. Kolke is a director and Vice President & Chief Technology Officer of Etelos.

 

Jeffrey L. Garon.

 

Jeffrey L. Garon joined Etelos in August 2007 and currently serves on the board of directors and as its president and chief executive officer.  Before joining Etelos, from September 2006 until August 2007, Mr. Garon was Managing Director of investment banking responsible for all West Coast activities at Kaufman Bros., L.P.  From February 2005 until October, 2006, Mr. Garon served as vice president and chief financial officer of Tripath.  From March 1998 to March 2004 he served as vice president of finance and administration and chief financial officer of, and subsequently as a consultant to, Silicon Storage Technology, Inc.; and from February 1994 to March 1998, as president of The Garon Financial Group, Inc., a Silicon Valley venture capital and venture consulting firm; and from March 1993 to February 1994 as vice president and chief financial officer of Monster Cable Products, Inc. He is a graduate of California State University, Northridge and has an MBA in International Finance from Loyola Marymount University.

 

Ronald A. Rudy.

 

Ronald A. Rudy has been an independent investor and consultant to the mortgage industry since September, 2005; he has served on the board of directors since March 1, 2006. He founded Portland Mortgage Company in 1983 and served as its President and CEO until it was acquired in 1994. Portland Mortgage Company was the largest independent Mortgage Banking Company in Oregon and Southwest Washington.

 

Mr. Rudy served as President of the Oregon Mortgage Bankers Association in 1989 and as President of Oregon Executives in 2003. Mr. Rudy served on the Board of Governors for The Mortgage Bankers Association from 1996-2003 and on the National Board of Directors of The Mortgage Bankers Association in 2003-2004. He also was president of the Portland Guadalajara Sisters Association in 2000 and a member of its board of directors from 1996-2001.

 

38



 

Gregory Ruff.

 

Gregory Ruff is the founder of White Space Strategy, a consulting firm founded in 2007 to focus on innovation and new market creation; his book, “White Space” will be published mid 2008. He has served on the board of directors since March 1, 2006.  From 1996 until 2007, he was the principal of G.L. Ruff & Company, a market change focused strategy-consulting firm based in San Francisco, CA and affiliated with Geoffrey Moore’s Chasm Group.

 

Mr. Ruff has been consulting to high tech companies since 1987 when he joined Booz, Allen and Hamilton as an engagement manager following a 13-year career in sales, marketing and management at Hewlett Packard. At Booz Allen, Mr. Ruff consulted to industry leaders in companies ranging from American Express to IBM and led teams that restructured markets and companies. In 1990, Mr. Ruff joined Regis McKenna Inc. to develop a new Market Strategy Consulting Practice and later became managing partner at Regis McKenna Inc.

 

There are no family relationships among our directors or executive officers. To our knowledge, none of our directors and executive officers has been involved in any of the following proceeding during the past five years: (i) any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time; (ii) any conviction in a crimina proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); (iii) being subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; or (iv) being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.

 

EXECUTIVE COMPENSATION

 

The following table sets forth all compensation awarded to, earned by, or paid by Etelos to its named executive officers during the years ended December 31, 2007 and 2006.

 

Summary Compensation Table

 

Name and Principal Position

 

Year

 

Salary
($)

 

Bonus
($)

 

Stock
Awards
(4) ($)

 

Option
Awards
(5) ($)

 

All Other
Compensation
($)

 

Total
($)

 

Jeffrey L. Garon (1)

 

2007

 

$67,813

 

0

 

$121,550

 

0

 

0

 

$189,363

 

Chief Executive Officer

 

2006

 

0

 

0

 

0

 

0

 

0

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Daniel J.A. Kolke (2)

 

2007

 

$127,158

 

0

 

0

 

$182,100

 

0

 

$309,256

 

Chief Technology Officer

 

2006

 

$104,000

 

0

 

0

 

0

 

0

 

$104,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ahmad Baitalmal (3)

 

2007

 

$138,065

 

0

 

0

 

$1,879

 

0

 

$139,944

 

Chief Technology Officer

 

2006

 

$70,633

 

0

 

0

 

0

 

0

 

$70,633

 

 


(I) Mr. Garon was appointed as president of chief executive officer of Etelos in August 2007.

 

(2) Mr. Kolke served as our chief executive officer until Mr. Garon took such office in August 2007, Mr. Kolke currently serves as vice president of chief technology officer of Etelos.

 

(3) Mr. Baitalmal served as our chief technology officer until Mr. Kolke took such office in August 2007. Mr. Baitalmal currently serves as Chief Product Architect of Etelos.

 

(4) This represents the fair market value, as determined by independent appraisal, of 7,150,000 shares issued to Mr. Garon pursuant to his employment agreement.

 

(5) Represents the amount recognized for financial statement reporting purposes for 2007 in respect of outstanding option awards in accordance with SFAS 123(R).  The assumptions made in valuing option awards reported in this column are discussed in “Note 3.  Summary of Significant Accounting Policies - Stock Based Compensation” and “Note 3.  Summary of Significant Accounting Policies - Share-Based Compensation Information under SFAS No.123(R)”and “Note 6.  Accounting for share-based compensation” to our financial statements included in this report.

 

Under the terms of the agreement between Etelos and Mr. Garon regarding his employment as chief executive officer of Etelos, Mr. Garon is entitled to receive base salary in the amount of $175,000 payable in accordance with the company’s payroll policies. In addition, in connection with his employment, on August 11, 2007, Etelos issued Mr. Garon a restricted stock award of 7,150,000 shares of common stock, of which 1,787,500 shares vested upon grant, another 1,787,500 shares vest on August 11, 2008 and the balance vests ratably during the 24 month period following August 11, 2008. If Mr. Garon’s employment with Etelos is terminated for any reason, the unvested portion of the restricted stock award is forfeited.

 

On August 11, 2007, Etelos granted Mr. Kolke an option to purchase up to 10,300,000 shares of common stock at an exercise price of $0.017 per share, of which 2,575,000 options vested upon grant, 2,575,000 options vest on August 11, 2008, and the balance vest ratably during the 24 months following August 11, 2008. If not exercised, the option expires on August 11, 2017.

 

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Outstanding Equity Awards at Fiscal Year End

 

The following table sets forth information concerning unexercised options, stock that has not vested and equity incentive plan awards for each named executive officer outstanding as of December 31, 2007:

 

Outstanding Equity Awards at Fiscal Year-End

 

 

 

Option Awards

 

Stock Awards

 

Name

 

Number of
Securities
Underlying
Unexercised
Options
(1)
exercisable

 

Number of
Securities
Underlying
Unexercised
Options
(2)
unexercisable

 

Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Opitions

 

Option
Exercise
Price
($)

 

Option
Expiration
Date

 

Number
of
Shares
or
Units of
Stock
That
Have Not
Vested
(3)

 

Market
Value of
Shares
or
Units of
Stock
That
Have Not
Vested
($)

 

Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units
or Other
Rights
That
Have Not
Vested

 

Equity
Incentive
Plan
Awards:
Market
or
Payout
Value
of
Unearned
Shares,
Units
or Other
Rights
That
Have Not
Vested
($)

 

Jeffrey L. Garon

 

 

 

 

 

 

5,362,500

 

91,163

 

 

 

Daniel J.A.Kolke

 

3,433,334

 

6,866,666

 

 

0.017

 

08-11-2017

 

 

 

 

 

Ahmad Baitalmal

 

333

 

 

 

10.50

 

09-27-2010

 

 

 

 

 

Ahmad Baitalmal

 

633

 

 

 

10.50

 

05-01-2010

 

 

 

 

 

Ahmad Baitalmal

 

 

35,000

 

 

0.017

 

11-07-2017

 

 

 

 

 

 


(1) Consists of (i) the vested portion of options granted to Mr.Kolke pursuant to his employment agreement, and (ii) fully-vested options issued to Mr. Baitalmal.

(2) Consists of the unvested portion of (i) options issued to Mr. Kolke pursuant to his employment agreement, which vest over 36 months from August 2007, and (ii) options issued to Mr. Baitalmal which vest over 48 months from November 7, 2007.

(3) Consists of shares issued to Mr. Garon subject to repurchase by the Company pursuant to his employment agreement, which vest over 36 months from August, 2007.

 

 

Director Compensation

 

During the fiscal year ended December 31, 2007, directors (except for Jeffrey L. Garon, for the period of his service as a director from August 2007 though December 2007) were paid $1,000 per month for attending regular and special meetings of our board of directors.  The table below sets forth the compensation the member of our board of directors received during the fiscal year ended December 31, 2007.

 

Director Compensation

 

Name

 

Fees
Earned or
Paid in
Cash ($)

 

Option
Awards ($)

 

All Other
Compensation (1)

 

Total ($)

 

Jeffrey L. Garon

 

0

 

0

 

0

 

0

 

Daniel J.A. Kolke

 

$

12,000

 

0

 

0

 

12,000

 

Ronald A. Rudy

 

$

12,000

 

0

 

0

 

12,000

 

Gregory Ruff

 

$

12,000

 

0

 

42,574

 

56,574

 

Ahmad Baitalmal(2)

 

$

8,000

 

0

 

0

 

8,000

 

Michael Wise (3)

 

$

11,000

 

0

 

0

 

11,000

 

 


(1) Payment for Consulting Services performed by Mr. Ruff for Etelos and related expenses.

(2) Mr. Baitalmal resigned from the Board in August 2007.

(3) Mr. Wise resigned from the Board in December 2007.

 

On March 5, 2008, our board of directors adopted a board compensation plan providing for (a) existing non-executive board members to receive options to acquire up to 10,000 split-adjusted shares of our common stock at an exercise price of $0.40 per share, which vest as to 50% on the 12 month anniversary of the date of grant and the remaining 50% on the 24 month anniversary of the date of grant; (b) new non-executive board members to receive options to acquire up to 10,000 split-adjusted shares of our common stock at an exercise price equal to the fair market value of our common stock on the date of grant, which vest as to 50% on the 12 month anniversary of the date of grant and the remaining 50% on the 24 month anniversary of the date of grant; (c) all re-elected board members to receive, upon their re-election, options to acquire up to 10,000 split-adjusted shares of our common stock at an exercise price equal to the fair market value of our common stock on the date of grant, which vest as to 100% on the 12 month anniversary of the date of grant; and (d) a quarterly

 

40



 

payment of $1,500.00 to each non-executive member of the board for their expenses in connection with attendance at quarterly board meetings and periodic board committee meetings.

 

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

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

Related Transactions

 

Etelos previously entered into a series of loan transactions (collectively, the “Kolke Loans”) with the parents and two brothers of its chairman and chief technology officer , Mr. Daniel J.A. Kolke.  In connection with settlement of the Kolke Loans, the Company entered into three unsecured promissory notes in the aggregate principal amount of $815,827.42 which will become secured by certain presently unidentified assets of Etelos if and when Mr. Daniel J.A. Kolke is no longer neither an employee nor member of the board of directors of the company.

 

Parent Companies

 

We do not have a parent company.

 

Director Independence

 

Our board of directors currently consists of four members, Daniel J. A. Kolke, Jeffrey L. Garon, Ronald A. Rudy and Gregory Ruff.  Messrs. Rudy and Ruff are considered independent under the definition of independence established by the Nasdaq Stock Market.

 

DESCRIPTION OF SECURITIES

 

Our authorized capital stock consists of 360,000,000 shares of common stock, no par value, and 240,000,000 shares of preferred stock, no par value. Our preferred stock may be issued from time to time in one or more series, each such series to consist of such number of shares and to have such terms, rights, powers and preferences as determined by our board of directors.  Our board of directors is authorized to determine and alter the rights, preferences and privileges granted to and imposed upon any wholly unissued series of preferred stock, and to fix the number of shares of any series of preferred stock and the designation of any such series of preferred stock. Our board of directors, within the limits and restrictions stated in any resolutions of our board of directors originally fixing the number of shares constituting any series, may increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of any series subsequent to the issue of shares of that series.  The following summary is qualified in its entirety by reference to our amended and restated certificate of incorporation and bylaws, copies of which are filed as exhibits to our filings with the SEC and are incorporated herein by this reference.

 

41



 

Common Stock

 

As of April 22, 2008, there were 22,700,634 shares of common stock outstanding that were held of record by approximately 145 stockholders. Holders of our common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. In the event of our liquidation, dissolution, or winding up, holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities. Our common stock has no preemptive, conversion, or other rights to subscribe for additional securities. There are no redemption or sinking fund provisions applicable to our common stock. The rights, preferences, and privileges of holders of common stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of preferred stock that we may designate and issue from time to time in the future.

 

We have reserved 7,237,185 shares of common stock for issuance pursuant to the terms of our convertible debentures and warrants.

 

Preferred Stock

 

As of April 22, 2008, we had no shares of preferred stock issued or outstanding.

 

MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

Shares of Tripath common stock were quoted on the OTC Bulletin Board under the symbol “TRPH” from January 2006 to February 2007, at which time the common stock was de-listed from the OTC Bulletin Board.  Since then, the common stock has been trading on the Pink Sheets.

 

In connection with the merger, a market maker has filed an application to have our common stock quoted on the OTC Bulletin Board, which is pending as of April 22, 2008.  The shares of Etelos, Incorporated have been privately held and never traded publicly. We cannot give any assurances as to when, if ever, our common stock will be quoted on the OTC Bulletin Board.

 

The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices and volume information in over-the-counter equity securities.  The OTC Bulletin Board securities are traded by a community of market makers that enter quotes and trade reports.  This market is extremely limited and any prices quoted may not be a reliable indication of the value of our common stock.

 

Holders

 

Immediately following the issuance of our common stock in connection with the merger, there were 68,138,900 shares of common stock outstanding held by approximately 145 holders of record.

 

Dividends

 

Our board of directors has not declared a dividend on our common stock during the last two fiscal years or the subsequent interim period and we do not anticipate the payments of dividends in the near future as we intend to reinvest our profits to grow our business.

 

42



 

Securities Authorized for Issuance under Equity Compensation Plans

 

The table below sets forth information as of December 31, 2007, with respect to compensation plans under which Etelos common stock is authorized for issuance.  The figures related to equity compensation plans approved by security holders relate to options granted under the 1999 Stock Option Plan and the 2007 Stock Incentive Plan.  Etelos does not have any equity compensation plans not approved by its security holders.

 

Plan Category

 

Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
(a)

 

Weighted-
average
exercise
price of
outstanding
options,
warrants and
rights
(b)

 

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column a)
(c)

 

Equity compensation plans approved by security holders

 

27,256,373

 

$

0.108

 

331,262

 

 

LEGAL PROCEEDINGS

 

In the course of business, the Company has been, and may continue to be, involved in various claims seeking monetary damages and other relief.  The amount of the ultimate liability, if any, from such claims cannot be determined. However, in the opinion of the Company’s management, the ultimate liability for any legal claims currently pending against the Company will not have a material adverse affect on the Company’s financial position, results of operations or cash flows.

 

CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS

 

As reported in our Current Report on Form 8-K filed on May 18, 2007, on March 2, 2007, Stonefield Josephson, Inc., or Stonefield, Tripath’s then independent registered public accounting firm, ceased its relationship with Tripath as a result of Tripath’s failure to pay Stonefield’s outstanding invoices.

 

The audit reports of Stonefield on Tripath’s consolidated financial statements as of September 30, 2007 and 2006 and for the period ended December 31, 2007 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended September 30, 2007 and 2006, and the three month period ended December 31, 2007, did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles.

 

During the fiscal years ended September 30, 2007 and 2006 and from October 1, 2006 to the date of Stonefield’s cessation of its relationship with Tripath, there were no disagreements with Stonefield on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which if not resolved to Stonefield’s satisfaction, would have caused it to make reference to the subject matter of the disagreement in connection with its reports. During the same period, there have been no reportable events, as that term is described in Item 304(a)(1)(iv) of Regulation S-K.

 

Etelos engaged Stonefield as its independent registered public accounting firm in February 2008. In addition, Tripath engaged Stonefield as its independent registered public accounting firm in February 2008.

 

RECENT SALES OF UNREGISTERED SECURITIES

 

In April 2008, we entered into a securities purchase agreement with two institutional investors for the sale of 6% convertible debentures and common stock purchase warrants.  We issued in the aggregate $3.5 million face amount of debentures and warrants to purchase 1,166,667 shares of our common stock in exchange for net proceeds of $3.4 million after deducting fees and offering expenses.

 

In January 2008, we entered into a securities purchase agreement with three institutional investors for the sale of 6% convertible debentures and common stock purchase warrants.  We issued in the aggregate $2.0 million face amount of debentures and warrants to purchase 222,222 shares of our common stock in exchange for net proceeds of $1.9 million after deducting fees and offering expenses.

 

43



 

During the period October 2006 to June 2007, we issued 20% convertible notes with a value of $850,000 (the “20% Notes”), together with warrants to purchase up to 850,000 shares of our common stock.  The warrants have an exercise price of $0.03 and a three year term.

 

During the period from October 2007 to December 2007, we issued 600,000 shares of common stock upon exercise of the warrants we issued with the 20% Notes.

 

During the period August 2007 to October 2007, we issued 6% convertible notes at an original issue discount of 10% with a face value of $3,326,400, along with warrants to purchase up to 3,024,000 shares of our common stock.  The warrants have an exercise price of $0.40 and a five year term.

 

During the period from October 2007 to December 2007, we issued 1,929,000 shares of common stock upon exercise of the warrants we issued with the 6% Notes.

 

Each of the transactions described above was exempt from registration under the Securities Act pursuant to Section 4(2) thereof and/or, with respect to the issuance of common stock upon exercise of warrants, Section 3(a)(9) thereof.  None of the transactions was conducted in connection with a public offering, and no public solicitation or advertisement was made or relied upon by the investor in connection with this offering, and, with respect to the issuance of common stock upon exercise of the warrants, shares of common stock were exchanged for outstanding warrants exclusively with the holder thereof and no commission or other remuneration was paid or given directly or indirectly for soliciting such exchange.

 

INDEMNIFICATION OF DIRECTORS AND OFFICERS

 

Pursuant to our articles of incorporation and bylaws, our officers and directors who may be made a party to any proceeding, including a law suit, because of his or her position, may be indemnified from personal liability. This indemnification includes payment of all costs, charges, and expenses, including amounts paid to settle an action or satisfy a judgment, actually and reasonably incurred in a civil, criminal or administrative proceeding. The indemnification is intended to be to the fullest extent permitted by law.

 

Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended, may be permitted to our directors or officers pursuant to the foregoing provisions, we have been informed that, in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable.

 

WHERE YOU CAN FIND MORE INFORMATION

 

We have filed with the SEC, located on 100 F Street NE, Washington, D.C. 20549, Current Reports on Form 8-K, Quarterly Reports on Form 10-QSB, Annual Reports on Form 10-KSB, and other reports, statements and information as required under the Securities Exchange Act of 1934, as amended.

 

The reports, statements, and other information that we have filed with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

 

The SEC maintains a web site (http://www.sec.gov.) that contains the registration statements, reports, proxy, and information statements and other information regarding registrants that file electronically with the SEC such as us. You may access our SEC filings electronically at this SEC website. These SEC filings are also available to the public from commercial document retrieval services.

 

44



 

ITEM 3.02             UNREGISTERED SALES OF EQUITY SECURITIES

 

Pursuant to the order issued by the bankruptcy court in connection with the approval of the Plan of Reorganization, as of the effective date of the merger, Tripath issued 5,000,000 shares in the aggregate of its common stock to its secured creditors and 10,000 shares in the aggregate to its unsecured creditors.  The issuance of such shares of common stock was exempt from registration under the Securities Act of 1933 pursuant to Section 3(a)(7) thereof.

 

In addition, in connection with the merger, Tripath issued 17,690,634 shares of its common stock in the aggregate to the holders of Etelos capital stock.  The issuance of such shares of common stock was exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) thereof.  Such shares of common stock are restricted shares, and the holders thereof may not sell, transfer or otherwise dispose of such shares without registration under the Securities Act of 1933 or an exemption therefrom.

 

Immediately following the closing of the merger, Tripath had 22,700,634 shares issued and outstanding, with the former stockholders of Etelos holding approximately 78% of such issued and outstanding shares.

 

ITEM 5.01                                       CHANGES IN CONTROL OF REGISTRANT

 

Reference is made to the disclosure set forth under Items 2.01 and 3.02 of this report, which disclosure is incorporated herein by reference.

 

In connection with the merger, there was a change of control of Tripath as result of the issuance of 22,700,634 shares of Tripath common stock, which represented 78% of outstanding common stock immediately following such issuance.  In addition, the following individuals were appointed to the Tripath board of directors effective as of April 22, 2008, none of whom were on the Tripath board of directors immediately before the merger: Daniel J. A. Kolke, Jeffrey L. Garon, Ronald A. Rudy and Gregory Ruff.

 

ITEM 5.02                                  DEPARTURE OF DIRECTORS OR PRINCIPAL OFFICERS; ELECTION OF DIRECTORS; APPOINTMENT OF PRINCIPAL OFFICERS

 

Reference is made to the disclosure set forth under Item 2.01 of this report, which disclosure is incorporated herein by reference.

 

Upon the closing of the merger, Gary Sawka, who had been serving as the Designated Responsible Individual for Debtor in Possession, resigned from such position effective April 22, 2008.

 

Effective as of April 22, 2008, we appointed (i) Jeffrey L. Garon as our President and Chief Executive Officer; (ii) Daniel J. A. Kolke as Vice President & Chief Technology Officer, (iii) David S.G. MacKenzie as our Vice President & Chief Financial Officer and Chief Accounting Officer, and (iv) Kennedy A. Brooks as Vice President & General Counsel and Secretary.

 

Effective as of April 22, 2008, in connection with the closing of the merger, Daniel J. A. Kolke, Jeffrey L. Garon, Ronald A. Rudy, and Gregory Ruff were each appointed to our board of directors.

 

For certain biographical and other information regarding the newly appointed officers and directors, see the disclosure under Item 2.01 of this report, which disclosure is incorporated herein by reference.

 

45



 

ITEM 5.06             CHANGE IN SHELL COMPANY STATUS

 

As a result of our acquisition of Etelos, as described in Item 2.01, which description is in its entirety incorporated by reference in this Item 5.06, Tripath ceased being a shell company as such term is defined in Rule 12b-2 under the Exchange Act.

 

ITEM 9.01             FINANCIAL STATEMENTS AND EXHIBITS

 

(a) Financial Statements of Business Acquired

 

Appended to this report are the audited financial statements of Etelos, Incorporated for the fiscal years ended December 31, 2006 and December 31, 2007.

 

(b) Pro Forma Financial Information

 

Pro forma income statements are not presented in this filing because Tripath had no operating transactions during the previous year. All assets and liabilities of Tripath were transferred to a separate bankruptcy estate and were not part of the merger.

 

(d) Exhibits

 

Exhibit
No.

 

Description

2.1

 

Plan Proponents’ Third Amended Plan of Reorganization for the Debtor dated December 20, 2007

2.2

 

Agreement and Plan of Merger dated April 22, 2008 between Tripath Technology Inc. and Etelos, Incorporated

3.1

 

Amended and Restated Certificate of Incorporation of Tripath Technology Inc.

3.2

 

Bylaws of Etelos, Inc.

4.1

 

Form of common stock purchase warrant issued in connection with the January 2008 financing

4.2

 

Form of original issue discount 6.0% senior secured convertible debenture issued in connection with the January 2008 financing

10.1

 

Loan and Security Agreement by and among Etelos, Incorporated and Bridge Bank, National Association dated October 5, 2007

10.2

 

The anti-dilution agreement entered between Etelos, Incorporated and each of Don Morissette and Ronald A. Rudy, as amended, dated March 6, 2008

10.3

 

Settlement Agreement and General Release of Claims dated December 30, 2007, among (i) Etelos, Incorporated, (ii) Robyn and Daniel J.A. Kolke, (iii) Selma and Daniel A. Kolke, (iv) Kristin and Desmond D. Kolke,, and (v) Crystal and Raymond D. Kolke

10.4

 

Promissory Note dated December 30, 2007 issued to Selma and Daniel A. Kolke

10.5

 

Promissory Note dated December 30, 2007 issued to Daniel J.A. Kolke

10.6

 

Promissory Note dated December 30, 2007 issued to Desmond D. Kolke

10.7

 

Securities Purchase Agreement by and among Etelos, Incorporated and the purchasers identified therein dated as of January 31, 2008

10.8

 

Registration Rights Agreement by and among Etelos, Incorporated and the purchasers identified therein dated as of January 31, 2008

10.9

 

Security Agreement dated as of January 31, 2008 by and among Etelos, Incorporated and the holders of the original issue discount 6.0% senior secured convertible debentures issued in connection with the January 2008 financing

 

46



 

SIGNATURE

 

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.

 

 

Etelos, Inc.

 

Registrant

 

 

April 22, 2008

By:

/s/ Jeffrey L. Garon

 

Jeffrey L. Garon Chief Executive Officer

 

As Principal Executive Officer

 

and on behalf of Registrant

 

47




 

Report of Independent Registered Public Accounting Firm

 

Board of Directors

Etelos, Incorporated

San Mateo, California

 

We have audited the accompanying balance sheets of Etelos, Incorporated (“the Company”) as of December 31, 2007 and 2006, and the related statements of operations, stockholders’ deficit, and cash flows for each of the two years ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing and opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Etelos, Incorporated as of December 31, 2007 and 2006, and the results of its operations and cash flows for each of the two years ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has experienced recurring losses, which raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regards to these matters are also discussed in Note 3. The 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 the Company be unable to continue as a going concern.

 

 

/s/ Stonefield Josephson, Inc.

 

San Francisco, California

April 22, 2008

 

F-2



 

ETELOS, INCORPORATED

BALANCE SHEETS

(in thousands)

 

 

 

Years Ended December 31,

 

 

 

2007

 

2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

928

 

$

15

 

Accounts receivable

 

 

11

 

Prepaid expenses

 

21

 

70

 

Total current assets

 

949

 

96

 

Property and equipment, net

 

50

 

24

 

Other assets

 

41

 

 

 

 

 

 

 

 

Total assets

 

$

1,040

 

$

120

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

249

 

$

214

 

Accounts payable related parties

 

56

 

9

 

Accrued payroll and related expenses

 

514

 

133

 

Other accrued expenses

 

236

 

53

 

Deferred revenues

 

8

 

10

 

Line of credit

 

 

450

 

Current portion notes payable, net of discounts

 

3,166

 

552

 

Current portion notes payable to related parties

 

187

 

766

 

Current portion capital leases

 

16

 

8

 

Total current liabilities

 

4,431

 

2,195

 

Long-term notes payable, net of discounts

 

889

 

 

Long-term notes payable to related parties

 

629

 

 

Long-term capital leases

 

36

 

16

 

Total liabilities

 

5,985

 

2,211

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

Preferred stock, $0.00 par value: 240,000,000 shares authorized with liquidation preferences

 

 

 

 

 

Series A: 12,500,000 shares authorized; 66,500 shares issued and outstanding

 

665

 

665

 

Series B: 22,500,000 shares authorized; 120,000 shares issued and outstanding

 

2,400

 

2,400

 

Series C: 60,000,000 shares authorized; 4,447,812 shares issued and outstanding

 

568

 

568

 

Common stock: $0.00 par value, 360,000,000 shares authorized;

 

 

 

 

 

Issued and outstanding - 20,373,938 in 2007 and 10,504,938 in 2006

 

1,758

 

754

 

Additional paid in capital

 

97

 

 

Accumulated deficit

 

(10,434

)

(6,478

)

Total stockholders’ deficit

 

(4,946

)

(2,091

)

 

 

 

 

 

 

Total liabilities and stockholders’ deficit

 

$

1,040

 

$

120

 

 

The accompanying notes form an integral part of theses financial statements

 

F-3



 

ETELOS, INCORPORATED

STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

 

 

Years Ended December 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Revenues

 

$

304

 

$

316

 

Cost of goods sold

 

315

 

130

 

Gross profit

 

(11

)

186

 

Operating expenses:

 

 

 

 

 

Research and development

 

1,954

 

811

 

Sales and marketing

 

812

 

337

 

General and administrative

 

923

 

383

 

Total operating expenses

 

3,689

 

1,531

 

Loss from operations

 

(3,700

)

(1,345

)

Interest expense, net

 

362

 

97

 

Other expense / (Income)

 

(106

)

20

 

Loss before income tax benefit

 

(3,956

)

(1,462

)

Income tax benefit

 

 

 

Net loss

 

$

(3,956

)

$

(1,514

)

 

 

 

 

 

 

Basic and diluted net loss per share

 

(0.29

)

(0.14

)

 

 

 

 

 

 

Shares used in computing basic and diluted net loss per share

 

13,721

 

10,505

 

 

The accompanying notes form an integral part of theses financial statements

 

F-4



 

ETELOS, INCORPORATED

STATEMENTS OF STOCKHOLDERS’ DEFICIT

(in thousands, except share data)

 

 

 

Preferred Stock

 

 

 

 

 

 

 

 

 

Total

 

 

 

Series A

 

Series B

 

Series C

 

Common Stock

 

Additional Paid

 

Accumulated

 

Stockholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Shares

 

Amount

 

Shares

 

Amount

 

in Capital

 

Deficit

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2005

 

66,500

 

665

 

120,000

 

2,400

 

4,447,812

 

568

 

10,504,938

 

754

 

 

(5,016

)

(629

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

(1,462

)

(1,462

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2006

 

66,500

 

665

 

120,000

 

2,400

 

4,447,812

 

568

 

10,504,938

 

754

 

 

(6,478

)

(2,091

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock for investment bank fees

 

 

 

 

 

 

 

90,000

 

90

 

 

 

90

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock for warrants exercised

 

 

 

 

 

 

 

2,629,000

 

793

 

 

 

793

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock for officer’s service

 

 

 

 

 

 

 

7,150,000

 

121

 

 

 

121

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock based compensation

 

 

 

 

 

 

 

 

 

27

 

 

27

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issurance of options for note settlement

 

 

 

 

 

 

 

 

 

65

 

 

65

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issurance of warrants for financing agreement

 

 

 

 

 

 

 

 

 

5

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

(3,956

)

(3,956

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2007

 

66,500

 

$

665

 

120,000

 

$

2,400

 

4,447,812

 

$

568

 

20,373,938

 

$

1,758

 

$

97

 

$

(10,434

)

$

(4,946

)

 

The accompanying notes form an integral part of theses financial statements

 

F-5



 

ETELOS, INCORPORATED

STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Year Ended December 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(3,956

)

$

(1,462

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

18

 

3

 

Gain on settlement of debt

 

(106

)

 

Issuance of stock for bank fees

 

90

 

 

Amortization of notes discount

 

80

 

 

Issuance of warrants for financing agreement

 

5

 

 

Stock based compensation

 

148

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

11

 

349

 

Prepaid expenses and other current assets

 

49

 

(61

)

Other assets

 

(41

)

 

Accounts payable

 

35

 

32

 

Accrued payables related parties

 

47

 

9

 

Accrued payroll and related expenses

 

381

 

77

 

Other accrued expenses

 

183

 

53

 

Deferred revenues

 

(2

)

(2

)

Net cash used in operating activities

 

(3,060

)

(1,002

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from notes payable

 

3,624

 

386

 

Payment of notes payable

 

(30

)

 

Proceeds from notes payable to related parties

 

50

 

182

 

Payment on capital lease

 

(14

)

(3

)

Net change in line of credit

 

(450

)

450

 

Proceeds from issuance of common stock

 

793

 

 

Net cash provided by financing activities

 

3,973

 

1,015

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

913

 

13

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of year

 

15

 

2

 

 

 

 

 

 

 

Cash and cash equivalents at end of year

 

928

 

15

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid for income taxes

 

 

 

Cash paid for interest

 

 

 

Supplemental disclosures of non-cash financing activities:

 

 

 

 

 

Acquisition of equipment under Capital Leases

 

42

 

27

 

 

 

 

 

 

 

Issuance of notes for a discount

 

302

 

 

 

 

 

 

 

 

Settlement of notes payable for warrants

 

65

 

 

 

The accompanying notes form an integral part of theses financial statements

 

F-6



 

Etelos, Incorporated

Notes to Financial Statements

For the Fiscal Years Ended December 31, 2006 and 2007

 

1. Organization

 

The Company was incorporated in the State of Washington on May 6, 1999. Etelos is a leading provider of software productivity solutions that assist organizations to effectively use Web Applications.  Etelos provides a revolutionary Software-as-a-Service ecosystem for building, distributing and using Web Applications, including a marketplace to deploy and support them; giving businesses choices in applications, hosting and support services to cost effectively accomplish their goals.

 

2. Basis of Presentation

 

The financial statements included herein have been prepared by Etelos, Incorporated (the “Company”), in accordance with accounting principles generally accepted in the United States and reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary to state fairly the Company’s financial position, results of operations, and cash flows for the periods presented.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.

 

3. Going Concern

 

The financial statements have been prepared by Etelos, Incorporated assuming that the Company will continue as a going concern. The Company has experienced recurring losses, which raise substantial doubt the Company’s ability to continue as a going concern. The 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 the Company be unable to continue as a going concern.

 

4. Summary of Significant Accounting Policies

 

Cash and Cash Equivalents

 

Investment securities with maturity of ninety days or less at the time of purchase are considered cash equivalents.

 

Accounts Receivable

 

Accounts receivable are recorded at the invoiced amount and generally do not bear interest. Amounts collected on trade accounts receivable are included in net cash provided by operating activities in the statements of cash flows.

 

Allowance for Doubtful Accounts

 

The Company provides, when appropriate, an allowance for doubtful accounts to ensure trade receivables are not overstated due to un-collectibility. The collectibility of the Company’s 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. As of December 31, 2007 and 2006 there was no allowance for doubtful accounts.

 

Deferred Revenue

 

Deferred revenue represents money received or promised but not recognized as revenue because the work has not been completed or the software subscription has been fully delivered, and therefore is deferred until the work is completed or the software subscription is fully delivered when it is then transferred to the appropriate revenue account.   The Company does not have a concentration of risk in any one account as subscriptions tend to be subscribed to by many individual subscribers as compared to a small number of large enterprises.

 

F-7



 

Property and Equipment

 

Property, furniture, equipment, and leasehold improvements are stated at historical cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the assets, which the Company currently believes are three to five years. Fixed assets is composed of computer equipment with accumulated depreciation of approximately $3 thousand and $20 thousand as of December 31, 2006 and 2007, respectively.

 

Fair Value of Financial Instruments

 

The Company’s balance sheet includes the following financial instruments: cash, accounts receivable, accounts payable, and accrued liabilities. The Company considers the carrying amount of working capital items to approximate the fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization.

 

Internal Use Software

 

The Company capitalizes internally developed software costs in accordance with the Statement of Position 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”).  The Company also capitalizes software development costs in accordance with SFAS NO. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed” under which certain software development costs incurred subsequent to the establishment of the technological feasibility may be capitalized and amortized over the estimated useful lie of the related products.   The intangible asset costs, if any, are amortized on a straight-line basis over the estimated useful life of the software, once it is a variable for its intended use.  The Company had fully amortized all internally developed software costs as of December 31, 2005. No expenditures during the years ending December 31, 2006 and 2007 qualified for capitalization.

 

Revenue Recognition

 

Revenues are recognized on licensing transactions and product sales using the criteria in Securities and Exchange Commission Staff Accounting Bulletin 104, “Revenue Recognition in Financial Statements” (SAB 104).  For revenue transactions that involve software or software related products, we recognize revenue under the guidance established by Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2).  Both SAB 104 and SOP 97-2 state that revenue must be recognized when persuasive evidence of an arrangement exists, delivery of the product or performance of the service has occurred, no significant company obligations with regard to implementation or integration exist, the fee is fixed or determinable and collectability is reasonably assured.  Arrangements for which the fees are not deemed reasonably assured for collection are recognized upon cash collection.

 

The Company provides Web Applications as a subscription service using the Software-as-a-Service (SaaS) or software-on-demand business model.  Revenues from subscriptions are generally collected and recognized in the period invoiced.  However, should the subscription collected upon be for more than one period in advance, the revenue is deferred and recognized ratably over the number of excess periods reflected by the advance payment.

 

Research and Development

 

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 development of new products and enhancements to existing products are expensed as incurred.

 

F-8



 

Stock Based Compensation

 

On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”), that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for equity instruments of the enterprise. The statement eliminates the ability to account for share-based compensation transactions, as the Company formerly did, using the intrinsic value method as prescribed by Accounting Principles Board (“APB”) Opinion No. 25,  “Accounting for Stock Issued to Employees,” and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expense in its consolidated statements of operations.

 

Under SFAS 123(R), the Company is required to select a valuation technique or option-pricing model that meets the criteria as stated in the standard, which includes a lattice model and the Black-Scholes Merton model. For 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, the Company recorded compensation cost in the statement of operations based on the fair value of the award for the requisite service period. The Company adopted the Black-Scholes Merton model. The adoption of SFAS 123(R), applying the “modified prospective method,” as elected by the Company, requires the Company to value stock options as of January 1, 2006, the first day of the Company’s fiscal year 2006. SFAS 123(R) requires the Company 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 the Company expensing $27 thousand in fiscal 2007 and a total of $0 for fiscal 2006. As of December 31, 2007, total unrecognized compensation costs related to unvested stock options was $633 thousand, which is expected to be recognized as an expense over a weighted average period of approximately 7 years. The Company adjusted for this cumulative effect and recognized an increase in stock-based compensation, which was recorded within the research & development; sales and marketing; and general and administrative expense on the Company’s statements of operations.

 

SFAS 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 the Company’s loss position, there were no such tax benefits during the years ended December 31, 2007 and 2006. Prior to the adoption of SFAS 123(R), those benefits would have been reported as operating cash flows had the Company received any tax benefits related to stock option exercises.

 

Share-Based Compensation Information under SFAS No. 123(R)

 

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 year ended December 31, 2007, were calculated based on the following assumptions (annualized percentages):

 

 

 

Year Ended
December 31,
2007

 

 

 

 

 

Estimated fair value

 

0.017

 

 

 

 

 

Expected lives (in years)

 

7

 

 

 

 

 

Volatility

 

55

%

 

 

 

 

Risk-free interest rate

 

4.2

%

 

 

 

 

Dividend yield

 

0

%

 

F-9



 

The Company used implied volatility of market-traded options for the expected volatility assumption input to the Black- Scholes Merton model. The risk-free interest rate assumption is based upon the US Treasury yield curve in effect at the time of the grant. The Company historically has not declared dividends and therefore the dividend yield was assumed to be zero in the model.

 

Income Taxes

 

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” which utilizes the liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

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 common stock outstanding during the period. Diluted net loss per share is computed based on the weighted average number of common stock and dilutive potential common stock outstanding. The calculation of diluted net loss per share excludes potential common stock if the effect is anti-dilutive. Potential common stock consists of incremental common stock issuable upon the exercise of stock options, shares issuable upon conversion of convertible preferred stock, common stock issuable upon the exercise of common stock warrants, and common stock issuable upon the conversion of convertible debentures.

 

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 fiscal year ended
December 31,

 

 

 

2007

 

2006

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(3,956

)

$

(1,462

)

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

Weighted average common stock

 

13,721

 

10,505

 

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

$

(0.29

)

$

(0.14

)

 

Use of Estimates

 

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

F-10



 

Segment Reporting

 

The Company has one operating segment because the Company is not organized into multiple segments for the purpose of making operating decisions or for assessing performance. The chief operating decision maker evaluates performance, makes operating decisions, and allocates resources based on financial data consistent with the presentation in the accompanying financial statements.

 

5. Recently Issued Accounting Standards

 

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes,” which supplements Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes,” by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. FIN 48 requires the tax effect of a position to be recognized only if it is “more-likely-than-not” to be sustained based solely on its technical merits as of the reporting date. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, then no benefits of the position are recognized. If the tax position is considered more likely than not to be sustained, then the amount to record is measured at the largest amount of benefit that is grater than 50% likely of being realized upon ultimate settlement. This is a different standard for recognition than was previously required. The more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. At adoption, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. Any necessary adjustment is recorded directly to opening retained earnings in the period of adoption and reported as a change in accounting principle. The Company has not yet adopted FIN 48 but does not expect it to have a material impact.

 

In September 2006, the Securities and Exchange Commission published Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). The interpretations in SAB 108 are being issued to address diversity in practice in quantifying financial statement misstatements and the potential under current practice to build up improper amounts on the balance sheet. This guidance applies to fiscal years ending after November 15, 2006 and early application in interim periods is encouraged. The adoption of SAB 108 did not have an effect on the Company’s financial statements.

 

In September 2006, the FASB issued SFAS No. 157 (“FAS 157”), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. FAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. FAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company are currently evaluating the impact of FAS 157, but do not expect the adoption of FAS 157 to have a material impact on the financial position, results of operations, or cash flows.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of FAS 159 to have a material impact.

 

F-11



 

6. Stock Option Plans

 

On November 1, 1999, the Company adopted the 1999 Stock Option Plan (the “1999 Plan”) and on November 11, 2007, adopted the 2007 Stock Incentive Plan (the “2007 Plan”).  Both are incentive plans for employees, directors, consultants, agents, and independent contractors and are administered by the Board of Directors, which was authorized to grant incentive stock options (“ISOs”) and non-statutory stock options (“NSOs”) to employees, directors, and consultants for up to 5,000,000 shares of common stock under the 1999 Plan and 4,843,250 under the 2007 Plan.  ISOs may be granted only to employees of the Company (including officers and directors who are also employees). NSOs may be granted to employees, non-employee directors, and consultants of the Company.  Under the 2007 Plan, upon the first date that the Company is publicly held, no employee of the Company will be eligible to be granted options covering more than 500,000 shares of common stock during any calendar year.

 

Upon adoption of the 2007 Plan, 165,000 options which had been granted under the 1999 Plan and shares reserved for issuance under the 1999 Stock Option Plan relating to un-granted options were cancelled.  Under the 2007 Plan, ISOs and NSOs are granted at a price that is not to be less than 100 percent of the fair market value of the common stock on the date of grant, as determined by the Board of Directors. Generally, the options granted to new employees under the 2007 Plan vest over a period of 4 years with 25 percent vesting on the first anniversary date from the date of grant and then monthly thereafter over the remaining 36 months. Subsequent discretionary stock options, generally vest equally each month over 48 months. Options granted to shareholders who own more than 10 percent of the outstanding stock of the Company at the time of grant must be issued at prices not less than 110 percent of the estimated fair value of the stock on the date of grant. Options under the 2007 Plan may be granted for exercise periods up to 10 years.

 

7. Accounting for share-based compensation

 

The following table summarizes stock option activity under the Company’s stock option plans (in thousands, except per share data):

 

Options

 

Shares

 

Weighted Average
Exercise Price Per
Share

 

Weighted Average
Remaining
Contractual Life

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2006

 

204,000

 

$

0.30

 

8.0

 

$

60.4

 

 

 

 

 

 

 

 

 

 

 

Granted

 

16,321,261

 

$

0.34

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercised

 

(15

)

$

0.38