UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended: February 28, 2007

[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ____________ to ____________

Commission file number: 0-27587

ARKADOS GROUP, INC.

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

Delaware	22-3586087
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)

220 Old New Brunswick Road

Piscataway, NJ 08854

(Address of principal executive offices)

(732) 465-9300

(Issuer’s telephone number)

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes [X]     No [_]

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act:   Yes [_]   No [X]

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: There were a total of 26,082,221 shares of the registrant’s common stock, par value $0.0001 per share, outstanding as of April 16, 2007.

Transitional Small Business Disclosure Format (Check one):   Yes [_]   No [X]

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Arkados Group, Inc.

Quarterly Report on Form 10-QSB

Quarter Ended February 28, 2007

Table of Contents

PART		PAGE
ITEM 1.	FINANCIAL STATEMENTS
	Balance Sheet as of February 28, 2007 (UNAUDITED)	3
	Statements of Operations - Cumulative	4
	During the Development Stage (March 24, 2004
	to February 28, 2007) and for the Three and Nine Months Ended
	February 28, 2007 (UNAUDITED)
	Statements of Cash Flow - Cumulative During the	5
	Development Stage (March 24, 2004 to February 28, 2007)
	and for the Nine Months Ended
	February 28, 2007 (UNAUDITED)
	Notes to Interim Financial Statements (UNAUDITED)	6 - 17
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS	18 - 33
ITEM 3.	CONTROLS AND PROCEDURES	34
PART II
ITEM 1.	LEGAL PROCEEDINGS	35
ITEM 5.	OTHER INFORMATION	35
ITEM 6.	EXHIBITS	35
SIGNATURES		36
EXHIBITS

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ARKADOS GROUP, INC. & SUBSIDIARIES

(A Development Stage Company)

CONSOLIDATED BALANCE SHEET

(Unaudited)

	Feb 28, 2007
Assets
Current assets
Cash	$	221,287
Accounts receivable		64,067
Inventory		31,100
Total current assets		316,454
Equipment, net		1,324
Deferred financing expenses, net		314,870
Intangible assets, net		54,506
Other assets		27,225
	$	714,379
Liabilities and Stockholders’ Deficiency
Current liabilities:
Accrued expenses and other liabilities	$	1,233,194
Current portion convertible debentures		1,066,500
Payroll taxes and related penalties and interest payable		959,822
Total current liabilities		3,259,516
Convertible Debentures		6,764,525
Commitments & contingencies		—
Stockholders’ deficiency

Convertible preferred stock - $.0001 par value;5,000,0000 shares authorized, zero shares outstanding		—
Common stock, $.0001 par value, 100,000,000 shares authorized 25,003,657 issued and outstanding,		2,505
Additional paid-in capital		15,074,434
Treasury stock		(16,000	)
(Accumulated Deficit during Development Stage)		(24,370,601	)
Total stockholder’s deficiency		(9,309,662	)
	$	714,379

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

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ARKADOS GROUP, INC. & SUBSIDIARIES

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months Ended February 28, 2006			For the Three Months Ended February 28, 2007			For the Nine Months Ended February 28, 2006			For the Nine Months Ended February 28, 2007			Cumulative during the Development Stage (March 24, 2004 to February 28, 2007)
Net Sales	$	—		$	63,920		$	111,083		$	87,642		$	1,032,646
Cost of Goods Sold		—			37,094			78,488			54,019			733,619
Gross Profit		—			26,826			32,595			33,623			299,027
Research and Development Expenses		396,794			372,841			925,483			1,406,512			4,050,622
General and Administrative Expenses		588,498			569,222			1,515,923			2,505,108			11,024,878
Net Loss From Operations		(985,292	)		(915,237	)		(2,408,811	)		(3,877,997	)		(14,776,473	)
Other Income (Expenses):		—			—			—			—			—
Interest Income (Expense)		(79,017	)		(178,974	)		(321,741	)		(495,082	)		(1,316,821	)
Net Loss Before Income Taxes		(1,064,309	)		(1,094,211	)		(2,730,552	)		(4,373,079	)		(16,093,294	)
Provision for Income Taxes		—			—			—			—			—
Net Loss	$	(1,064,309	)	$	(1,094,211	)	$	(2,730,552	)	$	(4,373,079	)	$	(16,093,294	)
Net loss per share
- Basic and diluted	$	(0.05	)	$	(0.04	)	$	(0.12	)	$	(0.17	)
Weighted Average of Common Shares Outstanding - Basic and diluted		23,594,145			25,003,657			23,378,658			24,873,536

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

4

ARKADOS GROUP, INC. & SUBSIDIARIES

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Nine Months Ended February 28, 2006			For the Nine Months Ended February 28, 2007			Cumulative During the Development Stage (March 24, 2004 to February 28, 2007)
Cash Flows From Operating Activities
Net Loss	$	(2,730,552	)	$	(4,373,079	)	$	(16,093,293	)
Adjustments to reconcile net loss to net cash provided by (used) in operating activities
Depreciation and Amortization		75,396			147,361			382,926
Common stock and warrants issued for services and beneficial conversion rights with debt		677,701			702,830			6,462,119
Accounts Receivable		(40,471	)		(54,669	)		(64,067	)
Inventory		—			(31,100	)		(31,100	)
Prepaid and Deferred Expenses		(194,420	)		112,270			(57,343	)
Other assets		—			—			(27,225	)
Accounts Payable and accrued expenses		(561,323	)		377,321			275,727
Net Cash Provided by (Used) in Operating Activities		(2,773,669	)		(3,119,066	)		(9,152,256	)
Cash Flows from Investing Activities
Purchases of capital expenditures and Patents		—			(1,712	)		(104,750	)
Net Cash Used in Investing Activities		—			(1,712	)		(104,750	)
Cash Provided by Financing Activities
Loan payable - related party		53,056			—			1,399,026
Debt discount		—			—			(341,236	)
Contribution of capital		—			—			1,232,646
Proceeds from convertible debt		3,942,384			—			1,066,500
Repayment of debt		—			—			(344,256	)
Issuance (repayment) of Debentures		(690,333	)		3,788,471			7,414,355
Repayment of related party debt		—			(446,406	)		(949,027	)
Net Cash Provided by Financing Activities		3,305,107			3,342,065			9,478,008
Net Increase in Cash		531,438			221,287			221,002
Cash, beginning of the period		9,680			—			285
Cash, end of the period	$	541,120		$	221,287		$	221,287
Supplemental cash flow information
Cash paid for interest	$	26,656		$	—		$	—
Cash paid for taxes	$	—		$	—		$	—

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

5

ARKADOS GROUP, INC. & SUBSIDIARIES

(A Development Stage Company)

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

Nine Months Ended February 28, 2007 and 2006

(Unaudited)

NOTE 1 -        DESCRIPTION OF BUSINESS

Arkados Group, Inc. (the “Company”), a development stage enterprise, is a fabless semiconductor manufacturer that designs, develops, markets, and supplies technology and solutions enabling broadband communications over standard electricity lines. Arkados, “the HomePlug Applications Company,” delivers a universal platform that enables the effortless networking of home entertainment and computer devices using standard electricity lines. The company’s system-on-chip solutions are uniquely designed to drive a wide variety of powerline-enabled consumer electronics and home computing products, such as stereos, radios, speakers, MP3 players, computers, televisions, gaming consoles, security cameras and cable and DSL modems. Arkados customers can bring numerous sophisticated, full-featured products to market faster at a lower overall development cost using a single platform: the company’s versatile and programmable ArkTIC(TM) platform. Arkados solutions leverage the benefits of HomePlug Powerline Alliance specifications and can also be used for in-building and to-the-home Broadband Powerline (“BPL”) applications. The Company is a member of an alliance of several companies referred to as the HomePlug Powerline Alliance, “HomePlug”, for developing the standard of such technologies and a member of the IEEE P1901 working group.

The attached summary consolidated financial information does not include all disclosures required to be included in a complete set of financial statements prepared in conformity with accounting principles generally accepted in the United States of America. Such disclosures were included with the financial statements of the Company at May 31, 2006, and included in its report on Form 10-KSB. Such statements should be read in conjunction with the data herein.

The summary consolidated financial information reflects all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results for such interim periods are not necessarily indicative of the results to be expected for the year.

NOTE 2 -        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Basis of Presentation - The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred net losses of almost $16 million since inception including a net loss in excess of $4 million for the year ended May 31, 2006 and $4.4 million for the nine months ended February 28, 2007. Additionally, the Company had a net working capital deficiency and shareholders’ deficiencies at February 28, 2007 and May 31, 2006 and negative cash flow from operations since inception. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management expects to incur additional losses in the foreseeable future and recognizes the need to raise capital to remain viable. The accompanying consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

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b.      Principles of consolidation - The consolidated financial statements include the accounts of Arkados Group, Inc. (the “Parent”), and it’s wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

c.      Reclassification - Certain amounts have been reclassified to conform to the current period’s presentation. The allocation of costs between Research & Development Expenses and General Administration Expenses has been changed to incorporate all costs of Research & Development including personnel costs, facility cost, and direct research costs for parts and services. Formerly, only direct research expenses for parts and services were included under the caption “Research and Development Expenses”. These reclassifications had no effect on previously reported net earnings

d.      Revenue Recognition - The Company derives revenues from two sources - sales of products and revenues related to service and custom development activities. For product sales, revenue is recognized when our products are shipped to our customers. For sales related to development, the Company recorded revenues pursuant to one long term development contract. The revenues are earned and recorded are based on pre-determined milestones. When revenues within a pre-determined milestone have been partially earned, the Company records such progress billings as “Revenues earned not yet billed.” Such revenues are billable under the terms of the arrangement once the milestone has been fully completed. The Company also monitors estimated costs to complete such long term contract to the revenues to be earned to ensure that if there is an estimated loss to record to complete their obligation to fulfill the terms of such development contract, such loss existed.

e.      Loss Per Share - Basic net loss per common share is computed by dividing net loss by the weighted average number of shares of common stock outstanding. Vested stock options and warrants have not been included as they would be antidilutive.

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f.      Stock Options -. On June 1, 2005 (the first year since the Company’s fiscal year ended May 31, 2006), the Company adopted SFAS 123-R using the modified prospective application, as permitted under SFAS 123-R. Under the application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Per the provisions of SFAS 123-R, the Company has adopted the policy to recognize compensation expense on a straight-line attribution method

SFAS 123-R eliminates the alternative to use the intrinsic value methods of accounting that was provided in SFAS 123, which generally resulted in no compensation expense recorded in the financial statements related to the issuance of stock options. SFAS 123-R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS 123-R establishes fair value as the measurement objective in accounting for share-based payment transactions with employees.

In accordance with SFAS 123, the fair value of each option grant has been estimated as of the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:

	For Three Months Ended	For Three Months Ended
	February 28, 2007	February 28, 2006
Risk free interest rate	4.48%	5.125%
Expected life	5 years	4 years
Dividend rate	0.00%	0.00%
Expected volatility	121.00%	64.74%

g.      New Accounting Pronouncements

FASB 155 - Accounting for Certain Hybrid Financial Instruments

In February 2006, the FASB issued FASB Statement No. 155, which is an amendment of FASB Statements No. 133 and 140. This Statement: a) permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, b) clarifies which interest-only strip and principal-only strip are not subject to the requirements of Statement 133, c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, e) amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement is effective for financial statements for fiscal years beginning after September 15, 2006. Earlier adoption of this Statement is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued any financial statements for that fiscal year. Management believes this Statement will have no impact on the financial statements of the Company once adopted.

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FASB 156 - Accounting for Servicing of Financial Assets

In March 2006, the FASB issued FASB Statement No. 156, which amends FASB Statement No. 140. This Statement establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends Statement 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. By electing that option, an entity may simplify its accounting because this Statement permits income statement recognition of the potential offsetting changes in fair value of those servicing assets and servicing liabilities and derivative instruments in the same accounting period. This Statement is effective for financial statements for fiscal years beginning after September 15, 2006. Earlier adoption of this Statement is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued any financial statements for that fiscal year. Management believes this Statement will have no impact on the financial statements of the Company once adopted.

FASB 157 - Fair Value Measurements

In September 2006, the FASB issued FASB Statement No. 157. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is a relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practices. This Statement is effective for financial statements for fiscal years beginning after November 15, 2007. Earlier application is permitted provided that the reporting entity has not yet issued financial statements for that fiscal year. Management believes this Statement will have no impact on the financial statements of the Company once adopted.

FASB 159 - Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (SFAS 159). This Statement provides companies with an option to measure, at specified election dates, many financial instruments and certain other items at fair value that are not currently measured at fair value. A company that adopts SFAS 159 will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This Statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. This Statement is effective for fiscal years beginning after November 15, 2007, which for us is the first quarter of fiscal 2009. We do not believe that the adoption of SFAS 159 will have a material impact on our results of operations or financial condition.

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NOTE 3 -        REVENUE RECOGNITION

During the three and nine month period ended February 28, 2007, the Company sold and delivered approximately $64,000 and $88,000, respectively, of services and products referenced. The revenue was recognized as was an amount for cost of goods sold amount that was calculated based upon the estimated costs the Company incurred to deliver the products. These costs were, for the most part, related to labor, outside fabrication services, and supplies and materials.

NOTE 4 -        CONVERTIBLE DEBENTURES AND RELATED PARTY PAYABLES

2004 6% Convertible Notes - During the period from October to November 2005, the Company borrowed $500,000 from certain of its existing stockholders for working capital needs and such obligation is represented by notes. The notes, recorded as Related Party Payables, bore interest at 6% per annum and contained certain conversion features which would have been triggered if the Company had sold equity at or above $1.25 per share. No expense was recorded for the beneficial conversion feature, since conversion price was always at or above market. The notes’ maturity was initially October 15, 2005, which was extended from time to time by the holders. In February 2006, the Company and holders of $175,000 of the outstanding principal of the notes agreed to discharge the Company’s obligations for 160,765 shares of common stock and the payment of $81,018. The remaining $325,000 of principal outstanding was held by an affiliate of the Company’s Chairman of the Board. On June 30, 2006, the principal and interest on the remaining $325,000 due were forgiven in exchange for an equivalent amount of 6% secured convertible debentures and warrants.

10% Convertible Notes - During the period from March 18, 2005 to May 12, 2005, the Company issued $750,000 of 10% convertible extendable notes initially due June 8, 2005 (the “10% Notes”). The due date of the 10% Notes was extended at the Company’s option to September 8, 2005 by the Company’s payment of an extension fee aggregating $20,000 for the entire issue and paying interest due on the 10% Notes to June 8, 2005. The Company paid $37,500 of principal with related interest on September 18, 2005 in full payment of two of the outstanding notes and obtained the extension of the $712,500 then remaining notes by paying an additional sum of $20,000 and issuing 85,000 shares of common stock to the remaining holders of the 10% Notes. An expense of $76,500 was recorded related to the issuance of the 85,000 shares of common stock, using a share price of $.90. The Company paid $22,167 of principal pursuant to a mandatory prepayment provision in September, 2005. Principal and accrued interest on the 10% Notes was convertible at the holders’ option into shares of the Company’s common stock only after an event of default, as defined in the Notes at the lower of $0.67 or the average closing bid price of the Company’s common stock on the ten trading days preceding conversion. The conversion right was limited in that it may not be exercised by a holder to the extent it would result in such holder becoming the beneficial owner of more than 4.99% of the Company’s common stock. The 10% Notes were issued with 825,000 of three year common stock warrants exercisable for $0.67 per share in the basis of one warrant for each $1 of principal.

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On December 20, 2005, the Company paid $261,398 in satisfaction of a portion of the 10% Notes, of which $254,333 was principal and $7,064 was interest. The remaining principal balance and interest was satisfied pursuant to agreements with the remaining holders of the 10% Notes on February 1, 2006 by the Company’s payment of $268,824 and the issuance of 293,116 shares of common stock.

2005 6% Convertible Notes - During the quarters ended August 31, 2005 and November 30, 2005, the Company raised $912,500 and $154,000, respectively,of gross proceeds from the private placement of an aggregate of 10.665 units (the “Units”) each consisting of $100,000 principal amount 6% convertible subordinated promissory notes (the “6% Notes”) and 14,286 detached warrants (the “Warrants”) to purchase a like number of shares of the Company’s common stock, for $0.35 per share. The Company issued an aggregate of 152,359 Warrants to the purchasers of the Units, which have been valued at $74,802 and will be amortized as interest expense over the term of the 6% Notes. In addition, the Company issued 238,213 common stock warrants exercisable at $0.65 as part compensation to the placement agent, which have been valued at $111,668 and will be amortized as interest expense along with other expenses of the offering. Both the $0.35 and $0.65 Warrants have a “net exercise” provision that permits the holder to convert the Warrants into shares of the Company’s common stock. The 6% Notes (1) are due July 7, 2007 with interest at the annual rate of 6% from the date of original issuance (increasing to 12% per annum from an event of default as defined in the 6% Notes); (2) are unsecured obligations of the Company and subordinated to senior secured loans to the Company (if any) from banks, finance companies and similar institutions that extend credit in the regular cause of such institution’s business; (3) are convertible, subject to certain conditions and at two different price levels ($1.125 and $1.575 for a period of twenty trading days following the bid price of common stock closing above $1.50 and $2.50, respectively, for a period of five consecutive trading days), into shares of common stock; and (4) may be redeemed by the Company in certain limited circumstances described below prior to maturity. Since the beneficial conversion feature of the 6% Notes is (at the lowest price) at a price greater than the market price of the stock upon issuance of the 6% Notes, no value has been estimated or recorded for the beneficial conversion feature.

Related Party Borrowings - Through December 19, 2005, the Company borrowed $253,075 from three directors and one stockholder. These advances were due on demand with interest at the annual rate of 6% and $225,000 was paid on January 10, 2006. As more fully described in the next section of this note, this related party borrowing was converted into shares of the Company’s common stock with the holders.

6% Secured Debentures - On December 19, 2005, the Company borrowed $267,900 from one of the accredited investors that ultimately purchased 6% secured convertible debentures (the “6% Secured Debentures”) in the December 28, 2005 financing. The loan was made on an unsecured basis, was due on demand and was forgiven in exchange for $267,900 of the $2.0 million principal amount of the 6% Secured Debentures and related warrants. On December 28, 2005, the Company issued $2.0 million aggregate principal amount and authorized $3.5 million 6% Secured Debentures to three institutional investors. The 6% Secured Debentures have a term of three years and mature on December 28, 2008, pay interest at the rate of 6% per annum, payable semi-annually on January 1 and July 1 of each year beginning July 1, 2006, and are secured by a grant of a security interest into substantially all of the Company’s assets. The Company may elect to pay interest on the 6% Secured Debentures in cash or in shares of common stock, subject to certain conditions related to the market for such shares stock and the registration of the shares issuable upon conversion of the 6% Secured Debentures under the Securities Act of 1933, as amended (the “Securities Act”).

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The 6% Secured Debentures are convertible at any time at the option of the holder into shares of the Company’s common stock at a price of $0.85 per share, subject to adjustment as set forth therein. If after the effective date of the registration statement we agreed to file under the Securities Act (the “Registration”), the closing price for the Company’s common stock exceeds $1.70 for any 20 consecutive trading days, then the Company may, within one trading day after the end of such period, require the holders of the 6% Secured Debentures to immediately convert all or part of the then outstanding principal amount of their 6% Secured Debentures. The terms of the conversion rights also contain certain dilution provisions.

The Company has reviewed the accounting for registration rights terms relating to the shares of common stock issuable upon the conversion and exercise, respectively, of the 6% Secured Convertible Debentures and related warrants under the recently adopted FSP EITF 00-19-2. The Company granted demand registration rights to the purchasers of the 6% Secured Debentures which requires the Company to file an initial registration 45 days following demand. Under the registration rights agreement, the Company incurs a penalty if it fails to file within the 45 day period or if the SEC had not declared the registration effective 90 days after filing. The holders of the 6% Secured Debentures have not demanded registration. The Company believes they can comply with a demand for registration in a timely manner and therefore no accrual for the registration rights penalties has been made.

On December 28, 2005, pursuant to the purchase agreements with the purchasers of the 6% Secured Debentures, the Company issued warrants to purchase an aggregate of 941,176 shares of common stock for $1.00 per share, on or prior to December 28, 2010 and short term warrants to purchase up to an aggregate of 941,176 additional shares of common stock for $0.85 per share, each subject to anti-dilution adjustments, including a “full ratchet down” to the purchasers of the 6% Secured Debentures. The short term warrants are exercisable at any time prior to the earlier of December 28, 2007 and twelve months after the effective date of the Registration Statement. If no effective registration statement is obtained after one year, then such warrants have a cashless exercise option feature.

Upon the occurrence of certain events of default, defined in the 6% Secured Debentures including events of default under the transaction documents related to the financing, the full principal amount of the 6% Secured Debentures, together with interest and other amounts owing, become immediately due and payable, the principal obligation increases to 130% of the principal balance and the interest rate increases to 18%.

The transaction documents relating to the 6% Secured Debentures issued in December 2005 contained a covenant that the Company would obtain the conversion of an aggregate of $746,600 principal and related interest into shares of the Company’s Common Stock at or above $0.67 per share on or before January 15, 2006. On February 1, 2006, as part of the sale of an additional $375,884 of the 6% Secured Debentures described above, the Company and the holders of all outstanding 6% Debentures agreed to modify the covenant

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to permit the Company to issue 604,956 shares of common stock and pay $405,744 in full satisfaction of such outstanding principal and interest concurrently with the additional investment and waived prior defaults. Two of the parties that agreed to accept shares of common stock in lieu of repayment were directors of the Company, of which one received 75,078 shares in satisfaction of $50,303 of principal and interest and the other received 76,969 shares in lieu of $51,989 of principal and interest.

On February 1, 2006 and February 24, 2006 the Company issued $375,884 and $500,000, respectively, of additional principal of 6% Secured Debentures on substantially the same terms as those debentures issued on December 28, 2005. On February 1, 2006 and February 24, 2006 the Company also issued 176,887 and 235,294 each of additional short and long term warrants, respectively, to the purchasers of the additional 6% Secured Debentures.

On March 31, 2006, the Company issued $500,000 additional principal of the 6% Secured Debentures to a limited liability company owned equally by the wife of our chairman and another director on substantially the same terms as the 6% Secured Debentures issued on December 28, 2005.

A debt discount was recorded of $47,504 and $161,640, respectively for such short and long term warrants issued with these 6% Secured Debentures. The amortization recorded attributed to the debt discounts amounted to $22,547 and has been recorded as interest expense for the year ended May 31, 2006.

The Company received an advance of $500,000 from one of the holders of 6% Secured Debentures on June 1, 2006. The advance was due on demand and forgiven in exchange for $500,000 principal amount of 6% Secured Debentures and related warrants on June 30, 2006.

The Company issued $1,773,471 aggregate principal amount of 6% Secured Debentures on June 30, 2006. The consideration received by the Company for the Secured Debentures consisted of $500,000 cash, forgiveness of repayment of the $500,000 advance received June 1, 2006, forgiveness of $773,470 related party debt due to Andreas Typaldos, the Company’s Chairman and principal shareholder and a limited partnership controlled by his wife. The debentures have a term of three years and mature on December 28, 2008. The 6% Secured Debentures pay interest at the rate of 6% per annum, payable semi-annually on January 1 and July 1 of each year beginning January 1, 2007. These debentures are on substantially the same terms as, and rank pari passu to, an aggregate of $3,875,884 of 6% Secured Debentures outstanding as of May 31, 2006. The Company issued 834,575 short term and 834,574 long term warrants to the purchasers of the 6% Secured Debentures and entered into a security agreement granting the purchasers a security interest in its assets to secure the Company’s obligations under the debentures. Obligations under the debentures are guaranteed by the Company’s wholly-owned operating subsidiary. The debt discount for such short and long term warrants issued with these 6% Secured Debentures and the related amortization attributed to the debt discount amounts are reflected as interest expense for three month and nine month period ending February 28, 2007.

A debt discount was recorded of $34,819 and $104,020, respectively for such short and long term warrants issued with these 6% Secured Debentures on June 30, 2006.

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On June 30, 2006, the Company signed a letter amendment to the consulting agreement with Andreas Typaldos dated May 21, 2004. The amendment removes the condition that the Company raise $1,000,000 of equity financing before paying consulting fees that accrued at the rate of $15,000 per month commencing June 1, 2006 as an inducement for Mr. Typaldos forgiving the $360,000 of accrued and unpaid fees in exchange for the $360,000 principal amount of 6% Secured Debentures and related warrants.

On August 18, 2006, the Company entered into an amendment agreement with the holders of $3,875,884 principal amount of 6% Secured Debentures outstanding as of May 31, 2006, including a limited liability company owned by the wife of our Chairman, and one of our directors. The Amendment agreement makes material changes to the securities purchase agreements, warrants, registration rights agreements, security agreements and other ancillary documents we executed in connection with an aggregate of $3,875,884 of 6% debentures the Company sold during the period from December 28, 2005 to March 31, 2006. The material changes give the holders the same rights of redemption in the event of a cash purchase of our assets as those held by the of $1,773,470.83 aggregate principal amount of 6% Secured Debentures issued on June 30, 2006. As a result of the Amendment, all of the 6% Secured Debentures and warrants must be redeemed by the Company at a premium if it agrees to sell all of the Company’s assets to a third party for cash and cash equivalents. In addition, as a result of the amendment, all holders of the 6% Secured Debentures have the right to have shares of Common Stock issuable upon conversion of the debentures and exercise of the related warrants registered for resale under the Securities Act of 1933 within 60 days after receiving written demand of the holders of 60.1% of such securities and have it declared effective 90 days thereafter.

On September 26, 2006, October 19, 2006 and November 30, 2006, the Company issued $500,000, $500,000 and $400,000, respectively, of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company. Debt discounts were recorded of $17,209 and $53,516, respectively for 658,824 short and 658,824 long term warrants issued with these 6% Secured Debentures.

On January 8, 2007 and February 28, 2007, the Company issued $288,000 and $327,000, respectively, of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company. Debt discounts were recorded of $29,511 and $54,492, respectively for 289,410 short and 289,410 long term warrants issued with these 6% Secured Debentures.

The amortization recorded attributed to the debt discounts amounted to $30.936 and has been recorded as interest expense for the quarter ended February 28, 2007. For the nine months ended February 28, 2007, amortization expense totaled $80,335.

After giving effect to this additional issuance and amendments, as of February 28, 2007, there was $7,164,355 principal amount of the 6% Secured Debentures outstanding, as well as 3,321,462 of the long tem warrants and 3,321,462 of the short term warrants outstanding.

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Other Obligations - As a consequence of the Company raising an aggregate of $3 million of financing since June 2004 and pursuant to the Company’s May 2004 employment agreement with its chief executive officer, $91,875 of deferred salary payments for the period from May 2004 to January 2006 representing 24.5% of his agreed salary for such period and a bonus of $65,333 was due December 29, 2005 and has not yet been paid. The Company’s chief executive officer temporarily waived the right to receive immediate payment of the $65,333 until Feb 28, 2007. This amount has not been paid and is the Company is negotiating with Mr. Logvinov to extend the date.

NOTE 5 -        PAYROLL LIABILITIES

On January 17, 2006, the Company paid an aggregate of $873,993 of payroll liabilities of the company from which it acquired assets in 2004 at a public foreclosure sale, representing all of the fiduciary funds due. The Company had agreed to pay up to $1.2 million of such liabilities and accrued an additional $600,000 in the event there were any additional claims related to interest and penalties pursuant to its 2004 merger agreement. Currently, there is $960,000 still recorded on the Company’s books as due and outstanding to both the federal and state tax authorities for delinquent payroll taxes, penalties and interest. The Company does not believe that it has a legal obligation to pay anything more to any taxing authority, but until such clearance is received from the appropriate agencies, the Company has elected to keep the liability on its books.

NOTE 6 -        DEFERRED FINANCING EXPENSES

The Company capitalizes financing expenses of legal fees, finders fees, value of warrants issued in connection with the related convertible debt financing. These fees will be amortized over the related term of the convertible debt instruments issued in such financing, which approximates two years.

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NOTE 7 -        EQUITY BASED COMPENSATION

Effective June 1, 2005, the Company adopted SFAS 123R “Accounting for Stock-Based Compensation” (“SFAS 123”).

Compensation based stock option and warrant activity for warrants and qualified and unqualified stock options are summarized as follows:

	Shares			Weighted Average Exercise Price
Outstanding at May 31, 2006		6,886,652		$	.64
Granted		2,135,000			.68
Exercised		—			—
Expired or cancelled		(175,604	)		.01
Outstanding at February 28, 2007		8,841,048		$	.65

Information, at date of issuance, regarding stock option grants during the period ended February 28, 2007.

	Shares		Weighted- Average Exercise Price		Weighted- Average Fair Value
Period ended February 28, 2007
Exercise price exceeds market price		300,000	$	.85	$	.99
Exercise price equals market price		1,835.000	$	.65	$	.54
Exercise price is less than market price		—		—		—

The compensation expense attributed to the issuance of the options and warrants will be recognized as they vest / are earned. The Company has recorded $90,021 and $268,117 of compensation for these options vested / earned in the three and nine month periods ended February 28, 2007, respectively. In addition, options in the amount of 240,000 were awarded to a consultant in February, 2007; an expense in the amount of $80,917 was recognized in the third quarter of 2007 for these options. These stock options and warrants are exercisable for three to ten years from the grant date.

The employee stock option plan stock options are exercisable for ten years from the grant date and vest over various terms from the grant date to three years.

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The issuance of warrants attributed to debt issuances are summarized as follows:

	Shares		Weighted Average Exercise Price
Outstanding at May 31, 2006		4,392,874	$	.840
Granted		3,465,618		.925
Exercised		—		—
Expired or cancelled		—		—
Outstanding at February 28, 2007		7,858,492	$	.87

Information, at date of issuance, regarding warrant grants during the period ended February 28, 2007.

	Shares		Weighted- Average Exercise Price		Weighted- Average Fair Value
Period ended February 28, 2007
Exercise price exceeds market price		3,465,618	$	.925	$	.085
Exercise price equals market price		—		—		—
Exercise price is less than market price		—		—		—

Interest expense attributed to the aforementioned warrants is being amortized over the ratable term of each respective debt arrangement. See convertible debentures and related party payables above.

NOTE 8 -       SUBSEQUENT EVENTS

On March 2, 2007, Arkados closed on the acquisition of ASTER Wireless, Inc. for 1 million shares of Arkados stock. Based in Rochester, New York, ASTER Wireless, Inc. is a wireless multimedia systems and solutions company that provides wireless modules, software and intellectual property to major consumer electronics (CE) manufacturers. Four Aster employees were hired during the acquisition and granted 259,000 options. In addition, the Aster employees received signing bonuses aggregating 78,564 shares of the Company’s restricted common stock.

On March 6, 2007, the Company sold $20,000 6% Secured Debentures and related warrants to an institutional investor. On March 28, 2007, the Company received $150,000 as an advance from an institutional holder of its 6% Secured Debentures. The advance is due on demand and is expected to be forgiven in exchange for the issuance of an additional $150,000 principal amount of 6% Secured Debentures and related warrants.

In  March 2007, the Company’s board of directors amended the Company’s 2004 Stock Option and Restricted Stock Plan to increase the number of share which can be the subject of awards from 10,000,000 to 15,000,000.  The board granted 800,000 seven year options exercisable at $0.38 to a newly appointed officer and 1,000,000 seven year options exercisable at $0.33 to the Company’s Chief Executive Officer.  Each option grant vest in equal annual installments on the first three anniversaries of the date of grant.  

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

Throughout this Current Report on Form 10-QSB, the terms “we,” “us,” “our” and “our company” refers to Arkados Group, Inc. and its subsidiaries.

Introductory Comment - Forward-Looking Statements

Statements contained in this report include “forward-looking statements” within the meaning of such term in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which could cause actual financial or operating results, performances or achievements expressed or implied by such forward-looking statements not to occur or be realized. Such forward-looking statements generally are based on our best estimates of future results, performances or achievements, predicated upon current conditions and the most recent results of the companies involved and their respective industries. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “can,” “will,” “could,” “should,” “project,” “expect,” “plan,” “predict,” “believe,” “estimate,” “aim,” “anticipate,” “intend,” “continue,” “potential,” “opportunity” or similar terms, variations of those terms or the negative of those terms or other variations of those terms or comparable words or expressions.

Readers are urged to carefully review and consider the various disclosures made by us in this Quarterly Report on Form 10-QSB and our Form 10-KSB for the period ended May 31, 2006, and our other filings with the U.S. Securities and Exchange Commission. These reports and filings attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this Form 10-QSB speak only as of the date hereof and we disclaim any obligation to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

Background

Arkados is a development stage company that designs, develops, markets and supplies technologies and solutions enabling broadband communications over standard electricity lines. We have made announcements marking the beginning of our transition from a research and development entity to a commercial enterprise as further described below.

Arkados views our business as being “the HomePlug Applications Company” by delivering a universal platform that enables networking of home entertainment and computer devices using standard electricity lines. The company’s system-on-chip solutions are uniquely designed to drive a wide variety of powerline-enabled consumer electronics and home computing products, such as stereos, radios, speakers, MP3 players, computers, televisions, gaming consoles, security cameras and cable and DSL modems. Arkados’ solutions are designed to enable our customers to bring numerous sophisticated, full-featured products to market faster at a lower overall development cost by using a single platform: the company’s versatile and programmable ArkTIC(TM) platform.

Arkados is a member of an international alliance of over seventy companies called the HomePlug Powerline Alliance. The mission of the alliance is to enable and promote rapid availability, adoption and implementation of cost effective, interoperable and standards-based home powerline networks and products. Arkados solutions leverage the benefits of HomePlug Powerline Alliance technology specifications and can also be used for in-building and to-the-home (BPL) applications.

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We are demonstrating our completed chip and reference design products to existing and potential customers including OEMs (Original Equipment Manufacturers) and ODMs (Original Design Manufacturers). Such customers, if they ultimately agree to design our chips into their end-user products (as is the case with OEMs) or in the products of their own OEM customers (as is the case with ODMs), could be responsible for the introduction of multiple end user products into the market, based on the timetables required for such product introductions. Such an event could in turn produce multiple revenue streams, including revenues streams from each potential OEM customer that uses our chips in their end-user products. In the case of each potential ODM customer that uses our chips in the designs of the multiple OEM customers served by each ODM, there could be multiple revenue streams attributable to each ODM that chooses to work with our chips. In both cases, however, such revenue streams will affect future quarters, based on the timetable associated with the deployment of end-user products by such OEM and ODM customers.

The quarter brought significant announcements that has further progressed our business on several fronts. In particular, following a Pan-Asian Tour, we are seeing the results of our aggressive sales and marketing efforts as evidenced by our announcements surrounding demonstrations at both the 2007 International Consumer Electronics Show (January, Las Vegas) and CeBIT 2007 (March, Hannover Germany). Arkados solutions (based on our Direct-to-speaker™ and Vid-Quick™ reference designs) were demonstrated by Analog Devices Inc. (Boston, MA), Channel Vision Technology (Costa Mesa, CA), devolo AG (Aachen, Germany), GigaFast (Los Angeles, CA), Good Way Technology Co. Ltd. (Taiwan), HomePlug Powerline Alliance (International), Meiloon Industrial Co. Ltd (Taiwan), PAC Electronics Co. Ltd. (Taiwan), and Zylux (International). Demonstrated Arkados solutions included the following applications: the distribution of whole-house synchronized music from an iPod® dock, personal computer or other audio source to a variety of connected speakers and amplifiers; whole-house video streaming via IPTV or conventional video sources; and whole-house surveillance video from a variety of security cameras to an existing television. Each of these demonstrations represents a milestone in our customer and partner acquisition processes.

In support of our semiconductor and software solutions, we announced a number of reference designs that are designed to assist our customers in building end-user products. Our current reference designs are divided into two series: Direct-to-Speaker™ reference designs for audio solutions, and Vid-Quick™ reference designs for video solutions.

Those reference designs targeted for audio include the following solutions: The Arkados Direct-to-Speaker MFi iPod Dock creates whole-house music from the world’s most popular digital music player; The Arkados Direct-to-Speaker Audio Receivers receive audio content and can display data (such as song title and artist information) and relay controls sent to the music source from any location; The Arkados Direct-to-Speaker Internet Radio is a HomePlug certified reference design that can tune into internet radio stations without the use of a computer; The Arkados Direct-to-Speaker Virtual Audio Driver runs on Windows® platforms and adds an audio device driver, allowing users to transport audio to locations around the whole house; The Arkados Direct-to-Speaker Low-Latency Audio Transport is for applications such as intercoms, remote subwoofers, and public announcement systems.

Reference designs for whole-house video applications (which incorporate high performance Blackfin® processors from Analog Devices for their software programmable video codec processing Capabilities) include the following: The Arkados Vid-Quick IPTV Video Receiver is designed to serve as a low-cost IPTV set-top box, capable of receiving video streams using a broad range of compression codecs such as H.264, WMA, MPEG-4, etc.; The Arkados Vid-Quick Surveillance Video Receiver

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receives video data from a variety of HomePlug-certified video cameras and displays the output on an ordinary television; The Arkados Vid-Quick Digital Picture Frame is capable of displaying still images obtained through the HomePlug network from a variety of sources.

Our intellectual property protection program was further strengthened with the award of an additional patent in October of 2006 and another in March of 2007.

We have continued to gain significant industry presence through speaking engagements at industry conferences such as the Winter Conference of the United Power Line Council, Connections at CES, the ACCESS ’06 Executive Business Forum, and several events presented by the HomePlug Powerline Alliance.

We have also announced the expansion of our Technical and Business Advisory Panel through the appointment of Dr. Jack Merrow, Director of Market Management for Leviton Integrated Networks & Controls. Dr. Merrow joins Mr. Kamal Gunsagar, who has served on the panel since 2005.

During the third quarter of 2007, Arkados recognized revenue of approximately $60,000 from chip sales. The chips are to be used in an iPod® dock which was demonstrated at CES earlier this year, as well as in other applications. In addition, there is a $60,000 in backlog, as of February 28, 2007.

We anticipate growth of product revenues, much of which will be recognized in the later half of calendar year 2007. We have been actively pursuing contracts since the Consumer Electronics Show, at which we established a critical mass in terms of market presence and sales activity. The Arkados chips sold will be used for a next-generation iPod dock produced by one of the few companies manufacturing such docks today. The dock uses HomePlug technology to transfer audio from a single iPod to a number of speakers throughout the house -- creating whole-house music playing in a synchronized fashion. Arkados believes that the almost 100 million consumers who have purchased an iPod from Apple® represent a ready-made market for audio and video accessories and that by working with various accessory makers it can maximize its market penetration quickly and efficiently.

We have financed operating losses since September 2004 with the proceeds primarily from related party lending from our major stockholder and affiliated lenders, as well as other stockholders and lenders, and from a capital raise to qualified investors through a retail brokerage firm. From December 2005 to February 28, 2007, we sold an aggregate $7,144,354 of 6% secured convertible debentures due December 28, 2008 of which $5,475,884 was purchased by institutional investors and the balance of $1,273,470 by parties affiliated with our Chairman, his wife and another director. Of the $1,668,470, $855,000 was for cash payments and the balance of $813,470 was by way of forgiveness of debt for borrowed money and unpaid consulting fees. Despite these milestones in improving our financial position, our business plan to aggressively market our chips remains constrained by our limited capital resources. During the year ended May 31, 2006, our focus began to shift to sales and marketing and customer acquisition mode, after developing and demonstrating reference designs and prototypes of end-user products that utilized our AI-1100 chip, the first in our family of ArkTIC Ô solutions and demonstrated its capabilities and competitive advantages.

We require additional funding for the expansion of our research and development efforts, expansion of our management team and sales and marketing organization, and to fund product commercialization efforts. In March, 2007, we acquired the assets of Aster Wireless, Inc., retained

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four of their engineering staff as employees and one person as a consultant, which significantly added to our engineering capability and skill sets. The acquisition is expected to add approximately $60,000 of anticipated monthly operating expenses and no material revenue.

With the completion of the acquisition, Jim Stoffel, Chairman and Acting CEO of ASTER Wireless, Inc., has joined Arkados Group’s Technical and Business Advisory Panel. Stoffel retired from Eastman Kodak in 2005 where he was “Kodak’s first Digital CTO” and served as Sr. Vice President, Director of R&D worldwide, and Chief Technical Officer during his approximately eight years with the company. In addition, Jim spent over 20 years with Xerox Corporation serving in numerous leadership roles, including VP Corporate Research & Technology and VP and General Manager Advanced Imaging Business Unit. He serves on the boards of Harris Corporation, Melbourne FL; HSTX Networks, Raleigh Durham, NC; and the Applied Science and Technology Research Institute (ASTRI), Hong Kong’s lead technology and IP development institution. He is also on the Research and Graduate Studies Advisory Council of the University of Notre Dame and served as Chairman of the Board of the Information Technology Industry Council, Washington DC, until December 2006.

We use Fujitsu Japan for all of our wafer fabrication and assembly, and Fujitsu and GDA Technologies for a portion of our design and testing. This “fabless” manufacturing strategy is designed to allow us to concentrate on our design strengths, minimize fixed costs and capital expenditures, access advanced manufacturing facilities, and provide flexibility on sourcing multiple leading-edge technologies through strategic alliances. We expect to qualify each product, participate in process and package development, define and control the manufacturing process at our suppliers where possible and practicable, develop or participate in the development of test programs, and perform production testing of products in accordance with our quality management system. If possible, we plan to use multiple foundries, assembly houses, and test houses.

If we are unable to raise funds to finance our working capital needs, we will not have the capital necessary for ongoing operations and for making our chip ready for mass production and we could lose professional staff necessary to develop our products and the value of our technology could be impaired. In addition, the lack of adequate funding could jeopardize our development and delivery schedule of our planned products. Such delays could in turn jeopardize relationships with our current customers, strategic partners and prospective suppliers.

Results of Operations

For The Three Months Ended February 28, 2007

During the three month period ended February 28, 2007, we had $64,000 of revenues from chip sales compared to $0 for the same period in 2006. The chips are to be used in an iPod® dock which was demonstrated at CES earlier this year, as well as in other applications. In addition, there is a $60,000 in backlog, as of February 28, 2007. Total operating expenses for the three month period ended February 28, 2007 were $942,000 compared to total operating expenses for the same period of 2006 of $985,000. In both periods, the most significant expenses were personnel, professional fees and research related expenses; the favorable variance from last year and last quarter is related to a build-up of research spending in the quarter ending November 2006 as we focused on development of samples and demonstrations for customer acquisition activity. As a result of the increase in outstanding debt, our interest expense increased during the three month period as well from $79,000 in 2006 to $179,000 in 2006.

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For The Nine Months Ended February 28, 2007

During the nine month period ended February 28, 2007, we had $87,000 of revenues compared to $111,000 for the same period in 2006. Revenues were a combination of revenues from chip sales in the amount of $63,000 and revenues from service contracts in the amount of $25,000 related to the achievement of certain milestones remaining under a long term development contract. The chips are to be used in an iPod® dock which was demonstrated at CES earlier this year, as well as in other applications. Total operating expenses for the nine month period ended February 28, 2007 were $3.9 million compared to total operating expenses for the same period of 2006 of $2.4 million. In both periods, the most significant expenses were personnel, professional fees and related expenses, which increased in the most recent period as we demonstrated our products and increased marketing staff and efforts. As result of the increase in outstanding debt, our interest expense increased during the nine month period as well from $322,000 in 2006 to $495,000 in 2007.

Commencing in March 2007, we anticipate operating expenses to increase by $180,000 per quarter as a result of the addition of engineering staff, consulting fees and facilities expenses from the acquisition of Aster Wireless, Inc.

Liquidity and Capital Resources

Our principal source of operating capital has been provided in the form of equity investments and, the private placement of debt securities coupled with warrants and related party loans. We do not have any significant sources of revenue from our operations. No assurance can be given that we can engage in any public or private sales of our equity or debt securities to raise working capital. We have depended, in part, upon loans from our present stockholders or management and there can be no assurances that our present stockholders or management will make any additional loans to us.

During the nine month period ended February 28, 2007, we issued $3.788 million of secured convertible debentures and warrants to institutional investors and related parties for $3.0 million of cash proceeds and the cancellation of $413,470 of outstanding related party debt, and $380,000 of liabilities related to accrued consulting fees due to our Chairman under our 2004 consulting agreement. There can be no assurance that our efforts to convert our outstanding debt or to raise additional capital will be successful, or even if successful will fund our planned operations or capital commitments.

At February 28, 2007, we had $221,000 in cash and negative working capital of $2.9 million, compared to no cash and negative working capital of $2.26 million at May 31, 2006. The change resulted from improvements from the sale of the 6% three year secured debentures during the period from December 28, 2005 to August 31, 2006 and the retirement of the short term related party debt, offset by the classification of $1,066,500 of previously long term debt as short term.

Our present material commitments are the compensation of our employees, including our executive officers, payment of $1,066,550 of convertible debt due June 30, 2007 and professional and administrative fees and expenses associated with the preparation of our filings with the Securities and Exchange Commission and other regulatory requirements.

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Commitments

We do not have any commitments which are required to be disclosed in tabular form as of February 28, 2007.

Critical Accounting Policies

Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our accounting policies are described in Note 2 of the notes to our consolidated financial statements included in this report. Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following is a brief discussion of the more significant accounting policies and methods used by us. In addition, Financial Reporting Release No. 67 was recently released by the SEC to require all companies to include a discussion to address, among other things, liquidity, off-balance sheet arrangements, contractual obligations and commercial commitments.

Basis of Presentation

Our consolidated financial statements have been prepared assuming we will continue as a going concern despite substantial doubt as to our ability to do so. Management anticipates losses in the foreseeable future and plans to finance losses by raising additional capital. If we are unable to continue as a going concern, adjustments would have to be made to the carrying value of assets.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended (“SAB 101”). SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. Under the provisions of SAB 101, we recognize revenue when products are shipped, and the collection of the resulting receivable is probable. If revenues are from a long term arrangement, revenues are recognized when pre-determined milestones, which generally are related to substantial scientific or technical achievement, are accomplished.

Accounting for Stock Based Compensation

The computation of the expense associated with stock-based compensation requires the use of a valuation model. SFAS 123(R) is a new and very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility, expected option lives, and expected option forfeiture rates, to value equity-based compensation. We currently use a Black-Scholes option pricing model to calculate the fair value of its stock options. We primarily use historical data to determine the assumptions to be used in the Black-Scholes model and have no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions to reflect future stock price volatility and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards. SFAS 123(R) requires the recognition of the fair value of stock compensation in net income. Although every effort is made to ensure the accuracy of our estimates and assumptions, significant unanticipated changes in those estimates, interpretations and assumptions may result in recording stock option expense that may materially impact our financial statements for each respective reporting period.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements.

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Risk Factors that May Affect Results of Operations and Financial Condition

This report contains forward-looking statements and other prospective information relating to future events. These forward-looking statements and other information are subject to risks and uncertainties that could cause our actual results to differ materially from our historical results or currently anticipated results including the following:

Dependence on financing.

Since we are not generating significant revenue we are dependent on outside sources of financing. We have financed our operations by offering convertible debt (secured and unsecured) securities in private placements, in some cases with equity incentives for the investor in the form of warrants to purchase our common stock and have borrowed from affiliates of our Chairman of the Board. We have sought and will continue to seek various sources of financing but there are no commitments from anyone to provide us with financing. If we are unable to obtain financing, we may have to suspend operations, sell assets and will not be able to execute our business plan.

We are dependent on the consent of the holders of 60% of the principal amount of our outstanding 6% Secured Convertible Debentures due December 28, 2008 to obtain future financing.

Under the terms of $7,144,354 principal amount of 6% Secured Convertible Debentures due December 28, 2008 issued during the period from December 2005 to February 28, 2007, we are prohibited from issuing shares of our common stock, securities convertible into or giving right to purchase our common stock or debt securities without the consent of the holders of 60% of the outstanding principal amount of the secured debentures. Since December 2005 when we initially issued $2,000,000 principal amount of secured debt, such holders have consented to the issuance of additional 6% secured debentures and related warrants and have purchased $4,835,884 of the additional $5,644,354 principal amount sold. There is no assurance that the holders will continue to provide additional funds to us or that they will consent to any future financing, although the holders of the requisite percentage of outstanding principal balance have recently consented to a family limited partnership affiliated with our chairman, advancing funds to the Company and the issuance of additional 6% Secured Convertible Debentures and related warrants. Our ability to continue our operations depends on our ability to obtain financing. If adequate funds are not available on acceptable terms, we may not be able to retain existing and/or attract new employees, support product development and fabrication, take advantage of market opportunities, develop or enhance new products, pursue acquisitions that would complement our existing product offerings or enhance our technical capabilities to develop new products or execute our business strategy.

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If we fail to comply with the new rules under the Sarbanes-Oxley Act related to accounting controls and procedures, or if material weaknesses or other deficiencies are discovered in our internal accounting procedures, our stock price could decline significantly and raising capital could be more difficult.

If we fail to comply with the new rules under the Sarbanes-Oxley Act related to accounting controls and procedures, or if material weaknesses or other deficiencies are discovered in our internal accounting procedures, our stock price could decline significantly and raising capital could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. We are in the process of documenting and testing our internal control procedures, and we may identify material weaknesses in our internal control over financial reporting and other deficiencies. If material weaknesses and deficiencies are detected, it could cause investors to lose confidence in our Company and result in a decline in our stock price and consequently affect our financial condition. In addition, if we fail to achieve and maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our Common Stock could drop significantly. In addition, we cannot be certain that additional material weaknesses or significant deficiencies in our internal controls will not be discovered in the future.

We have identified significant deficiencies in our disclosure controls and if we are not able to remediate them the timeliness of our periodic reporting could be impacted.

Our management determined, in connection with their evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, that such procedures were not effective to ensure that information required to be disclosed by us was recorded, processed and reported within the time periods specified in the SEC’s rules and forms Although our management has taken actions to improve the effectiveness of these procedures, its has not been able to conclude that such controls are effective. Our stock price, ability to obtain financing and the listing of our common stock on the OTCBB would be adversely impacted if we are not able to improve these procedures.

Inability to obtain additional financing would result in the suspension of our business.

Our ability to continue our operations depends on our ability to obtain financing. If adequate funds are not available on acceptable terms, we may not be able to retain existing and/or attract new employees, support product development and fabrication, take advantage of market opportunities, develop or enhance new products, pursue acquisitions that would complement our existing product offerings or enhance our technical capabilities to develop new products or execute our business strategy.

We have not generated revenues from our principal intended activities and we have been dependent on one customer for substantially all of out revue

As a development stage company, we have generated limited revenue principally from providing development services. We have not sold mass produced semiconductors, which is the

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primary part of our expected revenue stream going forward. In addition, substantially all of our revenue has been from one customer. It is difficult, in a market that is rapidly evolving, to evaluate the future sales performance of powerline technology, and our implementation of it. We may not successfully address any of these risks and may never have significant revenue.

We expect losses will continue for the foreseeable future. Our stock price may be affected by such losses.

In our short history, we have not reported an operating profit and do not expect to report a profit in the near future, if at all. Our business has experienced losses from operations since it began operations. Losses are likely to continue, and may cause volatility in our stock price.

Consumer demand may not develop as we anticipate, and our business will suffer.

The initial and primary customers of our semiconductors are expected to be OEMs of devices with uses for connectivity. OEM acceptance of powerline technology will be driven by consumer demand for home connectivity. If consumer demand does not develop as we anticipate, our products will sell slowly, or not at all, and our business will suffer.

There are several factors that may affect the expansion of the home connectivity market:

·           the emergence of competing standards for home connectivity

·           new content or products that attract a large consumer base

·           interoperability between different products in the same market

·           the success of marketing by OEMs

·           the cost and availability of connected products using this technology or competing technologies

We have only limited ability to influence in the resolution of the foregoing.

Powerline solutions for home connectivity may not gain acceptance.

Ethernet and Wireless technologies enjoy a large market share of the home connectivity market. As the market broadens to include audio/video applications, it is unclear which medium will be predominant. Among the competing physical mediums, including coaxial cable, Ethernet, phone line, and wireless, many are actively supported by various trade associations that represent the interests of a variety of companies. Some have greater market acceptance. If powerline technology does not achieve market acceptance, there may be less demand or no demand at all, and our business will suffer.

Powerline technologies, other than the technologies implemented by Arkados may proliferate.

Arkados is developing products that comply with the specification for in-home powerline networking developed by members of the HomePlug Powerline Alliance. However, there may be other competing, independent efforts in this market. To the extent that a competing effort establishes the predominant industry standard for powerline technologies that are not based on Arkados’ chosen technologies, or if no standard predominates in each market, our business will suffer.

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Products that incorporate our chosen technologies may fail in operation, or fail to be certified by standards organizations.

Our OEM customers may produce products that fail to work properly, either as a consequence of the inclusion of our semiconductors and software, or an unrelated problem, our business may suffer. If products that incorporate our solutions fail to pass standards test, our business will suffer.

We may be unable to sell volumes of semiconductors.

While we plan to attract customers with plans for large numbers of products, there may be cases when significant effort results in few semiconductors sold. When a company agrees to develop products that use our solutions, and agrees to purchase our solutions in volume, we consider the agreement a “design win.” Achieving a design win does not create a binding commitment from that customer. A design win is merely an expression of interest by a customer to make volume purchases, but at any time a customer can discontinue using our solutions. To the extent that we are unable to convert design wins into volume sales, our business will suffer.

We may not be able to attract and retain engineering and technical talent, our business may suffer.

The needs of the business will dictate our hiring, but we expect to need personnel in our technical and engineering disciplines, as well as in operational roles. Since powerline technologies is a narrow engineering and technical specialty and we have limited financial resources, attracting experienced talent is difficult. If we are unable to attract and retain qualified personnel our ability to develop and produce our products will be limited.

Our solutions have a long development and sales cycle. We may continue to incur significant expenses before revenues are realized.

Significant company resources must be dedicated to research and development, production and sales and marketing in order to properly sell solutions into our target markets. Products are developed based on forecasts from analysts, and we will incur substantial product development expenses before generating associated revenues. Customers typically spend two to nine months in testing before volume production of its own products, which incorporate our solution. Sales cycles are lengthy and produce delays between the time we incur expenses for research, development, sales and marketing efforts, and the time that we generate revenue, if any revenue is generated. If we do not generate revenue after we have incurred substantial expenses to develop and market any of our products, our business will suffer.

We will depend on our OEM and ODM customers to produce successful products that incorporate our solutions.

Our customers are OEMs and ODMs in our target markets. They integrate our integrated circuits into their products. If their products are not successful, we may not sell volume quantities of our semiconductors. OEM and ODM products may be unsuccessful for many reasons which are beyond our control. Any of these reasons may harm our business.

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We will rely on third parties to fabricate, assemble and test our solutions, which may increase costs or create delays.

As a “fabless” semiconductor manufacturer, we do not own or operate a semiconductor fabrication, assembly or testing facility. For our first semiconductor product we have entered into an agreement with GDA Technologies, to manage this process for us. In the future GDA or contract foundries, assembly, and test houses selected by us may also be adversely affected for reasons beyond our control. This may result in our inability to obtain products within the time frames, volumes or costs we require, or at all. Any disruption in the availability of products, or problems associated with the delivery, quality or cost of fabrication, assembly and testing of our products may cause our business to suffer.

Our specifications may result in unacceptable manufacturing yields from our suppliers, which may increase our product costs or reduce supplies.

We write specifications and create designs and our third-party suppliers manufacture chips based on those specifications and designs. We have not yet entered into volume production of our products, and our specifications may fall short of producing volumes of semiconductors effectively and efficiently. This may cause dies on our wafers to function poorly, if at all. The term “yield” is used to express the proportion of functional die expressed as a percentage of total die on a wafer. If expected yields are not reached, our product costs will increase. We may also experience problems when our products are scaled to smaller geometries. Problems with yield may not be identified until late in the product development cycle, or even once an end-product is built and sold. Yield problems are difficult to detect, time consuming and expensive to correct. These issues could affect our intention to delver products to customers in a timely manner.

Defects in our products could hurt the business by harming our reputation, decreasing our market acceptance, losing customer accounts, and creating liabilities for our company.

Integrated circuits are highly complex products, and may contain defects or bugs which may not be detected until other products that incorporate ours are shipped and being used by end-users. Defects may harm our reputation and make customers reluctant to buy our products. Correcting these defects is an expensive process. If defects are not discovered until after we have commenced commercial production of a new product, we might incur substantial additional development costs. If we fail to solve problems in time, we may incur product recall, repair or replacement costs. These problems may also result in claims against us by our customers or consumers. Any such problems could divert our company resources from other development efforts. Moreover, we would likely lose, or experience a delay in, the market acceptance of our products. We could also lose credibility with our current and prospective customers.

Regulation in certain regions of the world may be restrictive to the use of the powerline communication technologies, which may impact our ability to sell our products worldwide.

Our powerline communication products are designed to operate on frequencies where emissions are controlled by the local regulations. The limitations of the signal levels may decrease the performance of products based on our semiconductors and as the result make them unusable. As a result, the demand for our semiconductors in the regions affected by such regulations may be limited or nonexistent. Should government regulations change in the future, making operation of our customers’ products at their current radio frequency bands subject to restrictive regulation, or subjecting the frequencies on which our products operate to restrictions, our customers’ desire to purchase our products could diminish and our business may suffer.

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Future Federal Communications Commission, or FCC, regulation may restrict sales of our products adversely affecting our business.

Our powerline communication products are designed to operate on frequencies that are not currently restricted by FCC regulations. OEM products incorporating our ICs are regulated by the FCC. Operation of these products currently is not restricted by the FCC as long as the products do not interfere with other radio frequency, or RF, bands licensed by the FCC. We cannot assure you that this will continue to be the case. Should government regulations change in the future, making operation of our customers’ products at their current radio frequency bands subject to restrictive regulation, or subjecting the frequencies on which our products operate to restrictions, our customers’ desire to purchase our products could diminish and our business may suffer.

Our business is highly dependent on the expansion of the consumer digital entertainment electronics market.

We expect that the main growth in our product demand will be driven by the consumer digital entertainment electronics market. We are focusing on audio/video transmission and distribution products for the in-home use. We expect the consumer digital market to expand; however, our strategy may not be successful. Given current economic conditions in the United States and internationally, as well as the large installed base of consumer electronics products, consumer spending on home electronic products may not increase as expected. In addition, the potential decline in consumer confidence and consumer spending relating to future terrorist attacks could have a material adverse effect on our business.

Our success depends on our ability to introduce new products on a timely basis.

Our success depends upon our ability to develop new products for new and existing markets, to introduce these products in a timely manner, and to have these products gain market acceptance. The development of new products is highly complex and we may experience delays in developing and introducing them. Successful product development and introduction depend on a number of factors, including:

·       proper new product definition,

·       timely completion of design and testing of new products,

·       assisting our customers with integration of our components into their new products, including providing support from the concept stage through design, launch and production ramp,

·       successfully developing and implementing the software necessary to integrate our products into our customers’ products,

·       achievement of acceptable manufacturing yields,

·       availability of wafer, assembly, and test capacity,

·       market acceptance of our products and the products of our customers

·       obtaining and retaining industry certification requirements.

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Although we seek to design products that have the potential to become industry standard products, we cannot assure you that the market leaders will adopt any products introduced by us, or that any products that may be initially accepted by our customers that are market leaders will become industry standard products. Both revenues and margins may be materially affected if new product introductions are delayed, or if our products are not designed into successive generations of our customers’ products. We cannot assure you that we will be able to meet these challenges, or adjust to changing market conditions as quickly and cost-effectively as necessary to compete successfully. Our failure to develop and introduce new products successfully could harm our business and operating results.

Successful product design and development is dependent on our ability to attract, retain, and motivate qualified design engineers, of which there is a limited number. Due to the complexity and variety of CMOS, precision linear and mixed-signal circuits, the limited number of qualified circuit designers and software engineers, and the limited effectiveness of computer-aided design systems in the design of such circuits, we cannot assure you that we will be able to successfully develop and introduce new products on a timely basis.

Strong competition in the high-performance integrated circuit market may harm our business.

The integrated circuit industry is intensely competitive and is characterized by rapid technological change, price erosion, and design and other technological obsolescence. Because of shortened product life cycles and even shorter design-in cycles in a number of the markets that we serve, particularly consumer entertainment, our competitors have increasingly frequent opportunities to achieve design wins in next-generation systems. In the event that competitors succeed in supplanting our products, our desired market share may not be attainable and/or sustainable and net sales, gross margins, and results of operations would be adversely affected.

In the powerline communication segment, our principal competitors include Intellon, Conexant, Maxim, DS2, Panasonic, Yitran, and Spidcom. In Network and Media Processors, our principal competitors include Conexant, Cirrus Logic, Micrel, Texas Instruments, Atmel, and Sharp. Many of our competitors have substantially greater financial, engineering, manufacturing, marketing, technical, distribution and other resources, broader product lines, greater intellectual property rights, and longer relationships with customers than we have. We also expect intensified competition from emerging companies and from customers who develop their own integrated circuit products. In addition, some of our current and future competitors maintain their own fabrication facilities, which could benefit them in connection with cost, capacity and technical issues.

Increased competition could adversely affect our business. We cannot assure you that we will be able to compete successfully in the future or that competitive pressures will not adversely affect our financial condition and results of operations. Competitive pressures could reduce market acceptance of our products and result in price reductions and increases in expenses that could adversely affect our business and our financial condition.

Our products may be characterized by average selling prices that decline over short time periods; if we are unable to introduce new products with higher selling prices or reduce our costs, our business and operating results could be harmed.

Historically in the integrated circuit industry, average selling prices of products have decreased over time, while manufacturing costs may remain fixed. If we are unable to introduce new products

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with higher margins or to reduce manufacturing costs to offset anticipated decreases in the prices of our products, our operating results may be adversely affected. In addition, because of high fixed costs in our industry, we are limited in our ability to reduce total costs quickly in response to any revenue shortfalls. Because of these factors, we may experience material adverse fluctuations in our future operating results on a quarterly or annual basis.

Our products are complex and could contain defects, which could reduce sales of those products or result in claims against us.

Product development in the markets we serve is becoming more focused on the integration of multiple functions on individual devices. In addition to that powerline communication is a relatively new technology. There is a general trend towards increasingly complex products. The greater integration of functions and complexity of operations of our products increase the risk that our customers or end users could discover latent defects or subtle faults after volumes of product have been shipped. This could result in:

·   material recall and replacement costs for product warranty and support,

·   adverse impact to our customer relationships by the occurrence of significant defects,

·   delay in recognition or loss of revenues, loss of market share, or failure to achieve market acceptance, and

·   diversion of the attention of our engineering personnel from our product development efforts.

The occurrence of any of these problems could result in the delay or loss of market acceptance of our products and would likely harm our business, and may result into our inability to secure a reasonable share of the market, In addition, any defects or other problems with our products could result in financial or other damages to our customers who could seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend.

We will rely on independent foundries to manufacture our products, which will subject us to increased risks.

We will rely on independent foundries to manufacture all of our wafers. In order to produce our silicon we need to secure appropriate manufacturing services and capacities. Our reliance on outside foundries will involve several risks and uncertainties, including the:

·   inability to secure appropriate manufacturing services and capacities

·   possibility of an interruption or loss of manufacturing capacity

·   lack of control over delivery schedules, quality assurance, manufacturing yields and costs

·   possible misappropriation of our intellectual property

·   inability to reduce our costs as quickly as competitors who manufacture their own products and are not bound by set prices.

Market conditions could result in wafers being in short supply and prevent us from having adequate supply to meet our customer requirements. In addition, any prolonged inability to utilize third-party foundries because of fire, natural disaster, or otherwise would have a material adverse effect on our financial condition and results of operations. If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and, consequently, our sales would likely be reduced, and we may be forced to purchase wafers from higher-cost suppliers or to pay expediting charges to obtain additional supply, if we are able to acquire wafers at all.

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We will be dependent on our subcontractors to perform some of the design and key manufacturing functions for us.

We depend on third-party subcontractors for the elements of the design, assembly, packaging, and testing of our products. International operations and sales may be subject to political and economic risks, including political instability, currency controls, exchange rate fluctuations, and changes in import/export regulations, tariff, and freight rates, as well as the risks of natural disaster. Although we will seek to reduce our dependence on a limited number of subcontractors, as demand for our products merits, the concentration of subcontractors and manufacturing operations in certain areas of the World could subject us to the risks of conducting business internationally, including political and economic conditions in such regions as Asia, India, etc. Disruption or termination of the assembly, packaging or testing of our products could occur, and such disruptions could harm our business and operating results. In addition, we are unable to predict whether events such as the epidemic of SARS will have a negative effect on the design, supply, testing, and packaging of our products.

We may be unable to protect our intellectual property rights from third-party claims and litigation.

Our success depends on our ability to obtain patents and licenses and to preserve our other intellectual property rights covering our technology, applications, products, and development and testing tools. We seek patent protection for those inventions and technologies for which we believe such protection is suitable and is likely to provide a competitive advantage to us. We also rely substantially on trade secrets, proprietary technology, non-disclosure and other contractual agreements, and technical measures to protect our technology, application, design, and manufacturing know-how, and work actively to foster continuing technological innovation to maintain and protect our competitive position. We cannot assure you that steps taken by us to protect our intellectual property will be adequate, that our competitors will not independently develop or patent substantially equivalent or superior technologies or be able to design around patents that we may receive, or that our intellectual property will not be misappropriated. Also, the laws of some foreign countries may not protect our intellectual property as much as the laws of the United States.

Potential intellectual property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.

The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. Even if we receive a patent grant we would not be able to offer any assurance that it will not be invalidated, circumvented, or challenged, that rights granted under the patent will provide competitive advantages to us, or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. As is typical in the semiconductor industry, we expect that we and our customers may have received and may receive in the future, communications from third parties asserting patents, mask work rights, or copyrights on certain of our products and technologies. In the event third parties were to make a valid intellectual property claim and a license was not available on commercially reasonable terms, our operating results could be harmed. Litigation, which could result in substantial cost to us and diversion of our resources, may also be necessary to defend us against claimed infringement of the rights of others. An unfavorable outcome in any such suit could have an adverse effect on our future operations and/or liquidity.

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If we are unable to make continued substantial investments in research and development, we may not be able to sell our products.

We plan significant expenditures in research and development activities to develop products and solutions. If we fail to make sufficient expenditures in research and development programs, new technologies and process improvements implemented by our competitors could render our current and planned products obsolete, and our business could be harmed. Substantially all of our operating expenses are related to research and development.

Pending litigation.

We have reported that former officers of Enikia, LLC, the company from which we indirectly acquired patents and other assets relating to our planned products, have filed a lawsuit against Andreas Typaldos, our Chairman, Oleg Logvinov, our CEO, Enikia, Enikia’s counsel, Arkados and us. The action is captioned Robert Dillon, et al. v. Andreas Typaldos et al., and was commenced in the Superior Court of New Jersey, Chancery Division, Somerset County (Docket No. C-12102-04). The plaintiffs claim damages and allege, among other things entitlement to a portion of the Common Shares issued as consideration for Miletos, Inc. (an affiliate of Mr. Typaldos’) merging into our Arkados subsidiary. We do not believe there is any merit to these claims. Such matters could require a significant amount of our management’s time and are detrimental to our business.

Obligation to license certain intellectual property rights.

As a member of the HomePlug Alliance and IEEE P1901, we are obligated to license certain intellectual property rights to our competitors, on a non-discriminatory basis, which may adversely affect our ability to compete.

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Item 3.   Controls and Procedures.

In performing its audit of our Consolidated Financial Statements for Fiscal 2006, our independent auditors, Sherb & Co., LLP “ Sherb”, notified our Board of Directors of a material weakness in internal controls under standards established by the American Institute of Certified Public Accountants. Reportable conditions and material weaknesses involve matters coming to the attention of our auditors relating to significant deficiencies in the design or operation of internal controls that, in their judgment, could adversely affect our ability to record, process, summarize, and report financial data consistent with the assertions of management in the consolidated financial statements.

Sherb designed its audit procedures to address the matter described below in order to obtain reasonable assurance that the financial statements are free of material misstatement and to issue an unqualified audit report.

A material weakness is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. As of May 31, 2006, we did not maintain effective controls related to transactional accounting and financial reporting. These deficiencies included a lack of timely and sufficient financial statement account reconciliation and analysis and lack of sufficient support resources within the accounting and finance department. Management believes that such control deficiencies represents a material weakness in internal control over financial reporting that result in a reasonable likelihood that a material misstatement in our financial statements will not be prevented or detected by our employees in the normal course of performing their assigned functions.

We continue our efforts to remediate these conditions. We have and will continue to implement enhanced procedures to accelerate improvement of our internal controls. During the third quarter of 2007, we have hired a dedicated financial resource, whose initial primary focus will to ensure that appropriate controls and procedures are in place.

Our senior management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-15 and 15d-15 under the Exchange Act) designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive officer or officers and principal financial officers, to allow timely decisions regarding required disclosure.

We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Accounting Officer, of our disclosure controls and procedures as defined in Exchange Act Rule 13(a)-15(e). In designing and evaluating our disclosure controls and procedures, we recognize that any disclosure controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objective. Due to the material weakness in internal control over financial reporting previously noted and insufficient passage of time to test the enacted changes to determine if such changes are effective as at and prior to February 28, 2007, management concluded that our disclosure controls and procedures are ineffective.

There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our fiscal quarter ended February 28, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1.   Legal Proceedings.

In December 2004, Robert Dillon, William Simons and Stephen Schuster (the “Plaintiffs”) named us, our Arkados, Inc. subsidiary, Enikia, LLC, Oleg Logvinov, our CEO, Andreas Typaldos, our Chairman, and others in a lawsuit. The action is captioned Robert Dillon, et al. v. Andreas Typaldos et al., and was commenced in the Superior Court of New Jersey, Chancery Division, Somerset County (Docket No. C-12102-04). The plaintiffs claim damages and allege, among other things entitlement to a portion of the Common Shares issued as consideration for Miletos, Inc. (an affiliate of Mr. Typaldos’) merging into our Arkados subsidiary. We do not believe there is any merit to these claims, but discussions with plaintiffs’ counsel several months ago did not result in a settlement. Whether or not any future discussions lead to a settlement, the resolution of this litigated matter could require a significant amount of our management’s time and is detrimental to our business. Plaintiff Dillon, a holder of membership interests in Enikia and the other plaintiffs that hold options to acquire Enikia interests allege, among other things, that they are entitled to various forms of equitable relief and unspecified damages. Litigation is currently pending regarding what parties and what issues should be decided in an arbitration rather than in Superior Court of New Jersey. We believe claims against the Company are wholly without merit and intend to vigorously defend against the claims against us unless the claims can be settled for nuisance value.

The outcome of any litigation is inherently uncertain and we are required under our certificate of incorporation, bylaws and employment agreements to indemnify our officers and directors for certain liabilities, including the cost of defending litigation brought against them in their capacity as such. Nevertheless, a portion of our indemnification liability is insured and shares of our common stock were escrowed at the time of the merger in which Arkados is the surviving corporation, to indemnify us against certain claims being made in the above actions.

Item 5.    Other Information.

None

Item 6.    Exhibits.

(a) Exhibits.

31.1 Certification of Chief Executive Officer of Periodic Report pursuant to Rule 13a-14a and Rule 15d-14(a).

31.2 Certification of Chief Financial Officer of Periodic Report pursuant to Rule 13a-14a and Rule 15d-14(a).

32.1 Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350

32.2 Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350

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SIGNATURES

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

	ARKADOS GROUP, INC.
Dated:     April 16, 2007	By:	/s/ Oleg Logvinov
		Oleg Logvinov
		President and Chief Executive Officer

By:	/s/ Kirk M. Warshaw
	Kirk M. Warshaw, Chief Financial Officer
	(Principal Financial and Accounting Officer)

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