10-Q

UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

 WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: NOVEMBER 30, 2008
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                             to

Commission File Number: 0-27587

ARKADOS GROUP, INC.

 (Exact name of Registrant as specified in its charter)

Delaware (State or Other Jurisdiction of Incorporation or Organization)	22-3586087 (I.R.S. Employer Identification No.)
220 Old New Brunswick Road, Piscataway, NJ 08854 (Address of principal executive offices) (Zip Code)
(732) 465-9300 (Registrant’s telephone number)
(Former Name, Former Address and Former Fiscal Year, if changed since last report)

        Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý      No  o

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

Large accelerated filer  o Accelerated filer  o Non-accelerated filer  o  (Do not check if a smaller reporting company) Smaller reporting company  ý

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

        The number of the registrant’s shares of common stock outstanding was 30,963,928 as of January 20, 2009.

Arkados Group, Inc.

Quarterly Report on Form 10-Q

Quarter Ended November 30, 2008

Table of Contents

PART I—FINANCIAL INFORMATION
	Item 1.	Financial Statements	3
		Consolidated Balance Sheets as of November 30, 2008 (Unaudited) and May 31, 2008	4
		Consolidated Statements of Operations Cumulative During the Development Stage (March 24, 2004 to November 30, 2008) and for the Three and Six Months Ended November 30, 2008 (Unaudited)	5
		Consolidated Statements of Cash Flows – Cumulative During the Development Stage (March 24, 2004 to November 30, 2008) and for the Six Months Ended November 30, 2008 (Unaudited)	6
		Notes to Consolidated Financial Statements (Unaudited)	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
	Item 4T	Controls and Procedures	33
PART II—OTHER INFORMATION
	Item 1	Legal Proceedings	35
	Item 1A.	Risk Factors	35
	Item 6.	Exhibits	36
Signatures

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INTRODUCTORY NOTE

         This Report on Form 10-Q for Arkados Group, Inc. (“Arkados” or the “Company”) may contain forward-looking statements. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate” and “continue” or similar words. Forward-looking statements include information concerning possible or assumed future business success or financial results. You should read statements that contain these words carefully because they discuss future expectations and plans, which contain projections of future results of operations or financial condition or state other forward-looking information. We believe that it is important to communicate future expectations to investors. However, there may be events in the future that we are not able to accurately predict or control. Accordingly, we do not undertake any obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

         The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties set forth under “Risk Factors” in our Annual Report on Form 10-K for the year ended May 31, 2008 and other periodic reports filed with the SEC. Accordingly, to the extent that this Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company, please be advised that Arkados’ actual financial condition, operating results and business performance may differ materially from that projected or estimated in such forward-looking statements.

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

ARKADOS GROUP, INC. & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	30-Nov-08			31-May-08
	(Unaudited)
Assets
Current assets
Cash	$	3,666		$	24,480
Accounts receivable, net		133,867			34,976
Inventory		31,138			—
Total current assets		168,671			59,456
Equipment, net		40,509			39,860
Deferred financing expenses, net		709,650			899,073
Intangible assets, net		255,392			293,883
Other assets		50,383			98,417
	$	1,224,605		$	1,390,689
Liabilities and Stockholders’ Deficiency
Current liabilities:
Accrued expenses and  other liabilities	$	3,621,217		$	2,936,012
Related Party Payable					23,717
Related Party Borrowings		187,700			177,700
Note Payable		122,015			125,000
Current portion convertible debentures		11,917,301			11,848,458
Payroll taxes and related penalties and interest payable		936,906			936,906
Total current liabilities		16,785,139			16,047,793
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 30,963,928 and 26,278,888, respectively, issued and outstanding		3,096			2,628
Additional paid-in capital		20,109,734			17,865,820
Treasury stock		(16,000	)		(16,000	)
Accumulated Deficit during Development Stage		(35,657,364	)		(32,509,556	)
Total stockholder’s deficiency		(15,560,534	)		(14,657,104	)
	$	1,224,605		$	1,390,689

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

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ARKADOS GROUP, INC. & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months Ended November 30, 2007			For the Three Months Ended November 30, 2008			For the Six Months Ended November 30, 2007			For the Six Months Ended November 30, 2008			Cumulative during the Development Stage (March 24, 2004 to November 30,2008)
Net Sales	$	330,077		$	160,443		$	380,563		$	384,425		$	2,318,513
Cost of Goods Sold		136,690			129,137			173,960			275,570			1,346,936
Gross Profit		193,387			31,306			206,603			108,855			971,577
Research and Development Expenses		496,950			343,417			1,003,150			687,729			7,240,043
General and Administrative Expenses		720,923			795,965			1,468,859			1,615,638			16,685,441
Net Loss From Operations		(1,024,486	)		(1,108,076	)		(2,265,406	)		(2,194,512	)		(22,953,907	)
Other Income (Expenses):
Interest Expense		(286,017	)		(433,492	)		(549,858	)		(953,299	)		(4,826,341	)
Net Loss Before Income Taxes		(1,310,503	)		(1,541,568	)		(2,815,264	)		(3,147,811	)		(27,780,248	)
Provision for Income Taxes														(400,149	)
Net Loss	$	(1,310,503	)	$	(1,541,568	)	$	(2,815,264	)	$	(3,147,811	)	$	(27,380,099	)
Net loss per share
- Basic and diluted	$	(0.05	)	$	(0.05	)	$	(0.11	)	$	(0.11	)
Weighted Average of Common Shares Outstanding
- Basic and diluted		26,082,221			30,963,928			26,082,221			29,193,894

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

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ARKADOS GROUP, INC. & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Six Months Ended November 30, 2007			For the Six Months Ended November 30, 2008			Cumulative During the Development Stage (March 24, 2004 to November 30, 2008
Cash Flows From Operating Activities
Net Loss	$	(2,815,264	)	$	(3,147,811	)	$	(27,380,099	)
Adjustments to reconcile net loss to net cash provided by (used) in operating activities
Depreciation and Amortization		258,275			311,111			1,355,684
Common stock and warrants issued for services		386,081			761,120			8,343,191
Warrants and beneficial conversion rights with debt		170,984			142,130			627,716
Debt and Interest penalty		—			—			1,004,701
Accounts Receivable		(45,775	)		(98,891	)		(133,867	)
Inventory		34,011			(31,138	)		(31,138	)
Deferred Expenses		108,919			189,423			248,683
Prepaid and Other assets		(47,659	)		48,034			(55,407	)
Related Party Payable		—			(23,717	)		—
Payroll Taxes and related penalties and interest payable		—			—			(22,916	)
Accounts Payable and accrued expenses		915,869			1,017,113			3,127,644
Net Cash Provided by (Used) in Operating Activities		(1,034,559	)		(832,626	)		(12,915,808	)
Cash Flows from Investing Activities
Purchases of capital expenditures and Patents		(540	)		(5,242	)		(140,671	)
Net Cash Used in Investing Activities		(540	)		(5,242	)		(140,671	)
Cash Provided by Financing Activities
Loan payable - related party		855,000			10,000			1,586,726
Note Payable		—			122,015			247,015
Contribution of capital		—			810,038			2,042,684
Debt Discount		(170,984	)		—			—
Exercise of stock options		—						1,756
Proceeds from convertible debt		—						1,066,500
Repayment of debt		—			(125,000	)		(469,256	)
Issuance (repayment) of Debentures		—						9,533,461
Repayment of related party debt		—						(949,027	)
Net Cash Provided by (Used) in Financing Activities		684,016			817,053			13,059,859
Net (Decrease) Increase in Cash		(351,083	)		(20,815	)		3,380
Cash, beginning of the period		406,457			24,480			285
Cash, end of the period	$	55,374		$	3,666		$	3,666
Supplemental cash flow information
Cash paid for interest	$	757		$	517		$
Cash paid for taxes	$	—		$	2,875		$
Conversion of accrued interest to debt	$	263,431		$	331,551		$
Conversion of debt to equity	$	—		$	409,113		$
Debt discount	$	—		$	264,111		$

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

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ARKADOS GROUP, INC. & SUBSIDIARIES

 NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

Six Months Ended November 30, 2008 and 2007

(Unaudited)

NOTE 1 - DESCRIPTION OF BUSINESS

Arkados Group, Inc. (the “Company”), a development stage enterprise, is a fabless semiconductor company providing integrated system-on-chip and software solutions that directly support networking, smart-grid and multimedia applications.  Arkados, “the HomePlug Applications Company,” delivers a universal platform that enables the networking of home entertainment and computer devices using standard electricity lines. We also offer licenses to some ingredient technologies for wireless multimedia solutions. The Company’s system-on-chip solutions are uniquely designed to drive a wide variety of powerline-communication solutions such as utility company applications, and powerline-enabled consumer electronics and home computing products, such as stereo components, radios, speakers, MP3 players, computers, televisions, gaming consoles, security cameras and cable and DSL modems. With Arkados’ solutions, 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™ platform. Arkados solutions leverage the benefits of standard powerline communications technologies that are used worldwide for in-building and to-the-home Broadband Powerline (“BPL”) applications.  The Company is a member of an industry alliance of over 75 companies referred to as the HomePlug Powerline Alliance, “HomePlug”, for developing the standards of such technologies and is 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, 2008, and included in its report on Form 10-K.  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 over $27 million since inception including a net loss in excess of $6 million for the year ended May 31, 2008 and $3.1 million for the six months ended November 30, 2008.  Additionally, the Company had a net working capital deficiency and shareholders’ deficiencies at November 30, 2008 and May 31, 2008 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. and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

c.   Business combinations – We account for acquired businesses using the purchase method of accounting which requires that the assets and liabilities assumed be recorded at the date of acquisition at their respective fair values. Because of the expertise required to value intangible assets and intellectual property research and development “IPR&D”, we typically engage a third party valuation firm to assist management in determining those values. Valuation of intangible assets and IPR&D entails significant estimates and assumptions including, but not limited to: determining the timing and expected costs to complete projects, estimating future cash flows from product sales, and developing appropriate discount rates and probability rates by project. We believe that the fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions. To the extent actual results differ from those estimates, our future results of operations may be affected by incurring charges to our statements of operations. Additionally, estimates for purchase price allocations may change as subsequent information becomes available

d.   Fair Value of Financial Instruments – The carrying value of cash, accounts receivable, other receivables, accounts payable and accrued expenses approximate their fair values based on the short-term maturity of these instruments. The carrying amounts of debt were also estimated to approximate fair value. The Company can not estimate the fair value of the remaining outstanding payroll taxes penalties and interest recorded in connection with the merger. 

e.   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.

f.   Revenue Recognition – The Company derives revenues from two sources – sales of products and revenues from services in the form of custom development activities.  For product sales, revenue is recognized when our products are shipped to our customers. For sales related to development, the Company has recorded revenues pursuant to a number of long term development contracts. The revenues are earned and recorded 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 its obligation to fulfill the terms of such long term contracts and compares such costs to the expected revenues to be earned to ensure that estimated losses are recorded on a timely basis.

g.   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

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and warrants have not been included since there is a net loss and the effect of including these options and warrants would be anti-dilutive.

h.   Tax Provision – No tax provision is required at this time since the company expects to be in a tax loss position at year-end May 31, 2008 and has net operating losses from previous years. The Company has established a 100% valuation allowance against the deferred tax asset.

In December 2007, the Company sold $4,967,706 of its State Net Operating Loss carry forwards under the State of New Jersey’s Technology Business Tax Certificate Transfer Program (the Program). The Program allows qualified technology and biotechnology businesses in New Jersey to sell unused amounts of net operating loss carry forwards and defined research and development tax credits for cash. The proceeds from the sale in 2007 were $400,149.  This amount has been recorded as a tax benefit in the consolidated statements of operations in 2008.

On September 9, 2008, the Company was approved for the sale of its 2007 Net Operating Losses of approximately $4,200,000 under the Program in addition to the sale of its Research and Development Tax Credits.  The proceeds from the sales in 2008 were $440,149 and were received in the first half of December. This amount has been recorded as a tax benefit in the consolidated statements of operations in 2009 The State renews the Program annually and limits the aggregate proceeds to $10,000,000. We cannot be certain if we will be able to sell any of our remaining or future carry forwards under the Program.

i.   Accounting for Uncertainty in Income Taxes (“FIN 48”) – In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. Measurement of the tax uncertainty occurs if the recognition threshold has been met. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Arkados conducts business in the U.S. and, therefore, files U.S. and New Jersey income tax returns. In the normal course of business, the Company is subject to examination by taxing authorities. At present, there are no ongoing audits or unresolved disputes with the various tax authorities with whom the Company files. Given the Company’s substantial net operating loss carryforwards (“NOLs”, which are subject to a full valuation allowance) as well as the historical operating losses, the adoption of FIN 48 on June 1, 2007 did not have any effect on our financial position, results of operations or cash flows as of  November 30, 2008.

j.   Stock Options –.  The Company adopted SFAS No. 123R, “Share Based Payments.” SFAS No. 123R requires companies to expense the value of employee stock options and similar awards and applies to all outstanding and vested stock-based awards.

In computing the impact, the fair value of each option is estimated on the date of grant based on the Black-Scholes options-pricing model utilizing certain assumptions for a risk free interest rate; volatility; and expected remaining lives of the awards. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of

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management judgment. As a result, if factors change and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. In estimating the Company’s forfeiture rate, the Company analyzed its historical forfeiture rate, the remaining lives of unvested options, and the amount of vested options as a percentage of total options outstanding. If the Company’s actual forfeiture rate is materially different from its estimate, or if the Company reevaluates the forfeiture rate in the future, the stock-based compensation expense could be significantly different from what we have recorded in the current period. The impact of applying SFAS No. 123R approximated $562,874 in additional compensation expense during the six months ended November 30, 2008.  Such amount is included general and administrative expenses on the statement of operations.

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 Six Months Ended	For Six Months Ended
	November 30, 2008	November 30, 2007
Risk free interest rate	2.19 - 2.76%	4.82%
Expected life	3-5 years	5 years
Dividend rate	0.00%	0.00%
Expected volatility	64.00 - 99.00%	65%

k.   New Accounting Pronouncements

In June 2008, the Financial Accounting Standards Board (“FASB”) issued EITF Issue No. 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5.  “EITF No. 08-4”)”. The objective of EITF No. 08-4 is to provide transition guidance for conforming changes made to EITF No. 98-5,  Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, that result from EITF No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments”, and SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”.  This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008. Early application is permitted. The Company is currently evaluating the impact of adoption of EITF No. 08-4 on the accounting for the convertible notes and related warrants transactions

In May 2008, the FASB issued FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement”).  (“FSP APB 14-1”). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, “  Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants”.   Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted. The

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Company is currently evaluating the impact of the adoption of FSP APB 14-1 on the Company’s financial condition and results of operations.

In March of 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” – An Amendment of FASB’s Statement No. 133, which expands the disclosure requirements in Statement 133 about an entity’s derivative instruments and hedging activities.  It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The Company is currently evaluating the impact that adopting SFAS No. 161 will have on its financial position, cash flows, and statements of operations.

In December 2007, the FASB issued FASB Statement No. 141 (revised 2007), Business Combinations. This Statement replaces FASB Statement No. 141, Business Combinations. This Statement retains the fundamental requirements in Statement 141 that the acquisition method of accounting (which Statement 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. This Statement defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. This Statement’s scope is broader than that of Statement 141, which applied only to business combinations in which control was obtained by transferring consideration. By applying the same method of accounting—the acquisition method—to all transactions and other events in which one entity obtains control over one or more other businesses, this Statement improves the comparability of the information about business combinations provided in financial reports.  This Statement requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the Statement. That replaces Statement 141’s cost-allocation process, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values.  This Statement applies to all transactions or other events in which an entity (the acquirer) obtains control of one or more businesses (the acquirer), including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. This Statement applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for some business combinations. It does not apply to: (a) The formation of a joint venture, (b) The acquisition of an asset or a group of assets that does not constitute a business, (c) A combination between entities or businesses under common control, (d) A combination between not-for-profit organizations or the acquisition of a for-profit business by a not-for-profit organization.  This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. Management believes this Statement will have no impact on the financial statements of the Company once adopted.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115, which is effective for the Company in fiscal years beginning July 1, 2008. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for

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which the fair value option has been elected will be reported in earnings. The Company is currently evaluating the potential impact of this statement on its consolidated financial position, results of operations and cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for the Company for fiscal years beginning July 1, 2008. We are evaluating the impact of the provisions of this statement on our consolidated financial position, results of operations and cash flows.

All other new accounting pronouncements have been deemed not to be relevant.

NOTE 3 – REVENUE RECOGNITION

During the three and six month periods ended November 30, 2008, the Company sold and delivered approximately $63,948 and $ 110,216, respectively of chips to customers.  In addition, during the three and six month periods ended November 30, 2008, the Company recognized revenues related to development contracts in the amounts of approximately $96,495 and $  274,209 , respectively.  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.

In October 2007, the Company entered into a strategic collaboration with MainNet Communications, Ltd. to create commercial hardware and software solutions for Smart-Grid applications.  Subject to the terms of the agreement and the completion of certain milestones, MainNet is expected to pre-pay up to $500,000 for the delivery of Arkados solutions; as of November 30, 2008 $236,000 has been paid for achievement of milestones according to this agreement.  The details of the collaboration include a financial arrangement that provides discounts to MainNet if it purchases 600,000 Arkados 200Mb/s chipsets (HomePlug AV) over the next three years.

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.

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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.

On July 6, 2007, the Company reached an agreement with more than the requisite holders of 2/3 of the outstanding $1,066,500 principal amount of 6% Convertible Subordinated Notes due July 7, 2007 to extend the due date of the Notes to June 30, 2008. In exchange for the amendment, the Company agreed to issue approximately 188,200 three year warrants to purchase shares of the Company’s common stock for $0.85 per share and lowered conversion prices in the Notes to $0.85.  In connection with the amendments, the Company retained Trident Partners, Ltd., who served as placement agent for the Notes in 2005, to solicit the consent of Note holders that were their customers.  Under the Solicitation Agreement, the Company paid Trident $25,000 and issued Trident 137,656 Warrants. A deferred expense was recorded in the amount of $56,481 for the 325,856 warrants for the extension of the debentures.  The amortization recorded was $5,416 and has been recorded as interest expense for the six months ended November 30, 2008.

On July 9, 2008, Arkados Group Inc. (the “Company”) reached an agreement with more that the requisite holders of 2/3 of the outstanding $1,066,500 principal amount of 6% Convertible Subordinated Notes (the “Notes”) due June 30, 2008 to extend the due date of the Notes to June 30, 2009.  In exchange for the amendment, the Company agreed to exchange approximately 876,100 shares of common stock, pro rata, for notes in the original principal amount of $313,214.  The debt was converted at $0.35 versus $0.85 in the original agreement.

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During the six months ended November 30, 2008, interest expense of $ 142,130 was recognized to account for the additional shares that issued at the lower conversion price.

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.  See subsequent event for conversion of the remaining balance into shares of the Company’s common stock with the holders.

During the first half of 2008, the Company borrowed $855,000 at the times set forth below, on an unsecured basis from affiliates of the Company’s Chairman and two non-employee directors, with the understanding that these advances would be exchanged for additional 6% Secured Debentures and related warrants.  On December 15, 2007, this related party debt was converted to additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.

From March 1, 2008 through November 30, 2008, the Company borrowed $187,700 from two directors.  These advances were due on demand with interest at the annual rate of 6%.

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”).

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 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 FSP EITF 00-19-2.  The Company

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granted demand registration rights to the purchasers of the 6% Secured Debentures which requires the Company to file an initial registration statement under the Securities Act 45 days following demand made by the holders of 60% of the securities eligible for registration under the agreement.  Under the registration rights agreement, the Company incurs a penalty if it fails to file such a registration statement within 45 day following such a demand 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 it can comply with a demand for registration in a timely manner and therefore no accrual for possible penalties under the registration rights agreement 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 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

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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, initially payable semi-annually on January 1 and July 1 of each year beginning January 1, 2007.  In January 2007, the 6% Secured Debentures were amended to provide that interest payable on January 1, 2007 and July 1, 2007 would be added to principal.  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 two wholly-owned operating subsidiaries.  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 the three month period ending August 31, 2008.

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.

On June 30, 2006, the Company signed a letter amendment to the consulting agreement with Andreas Typaldos dated May 21, 2004. The amendment removed 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 made 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%

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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, and thereafter. 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, the Company entered into an amendment agreement with the holders of the 6% Secured Debentures.  The Amendment agreement made additional material changes to the securities purchase agreements, warrants, registration rights agreements, security agreements and other ancillary documents we executed in connection with the 6% debentures the Company sold during the period from December 28, 2005 to January 8, 2007, including removing the negative covenant prohibiting the Company from issuing stock, warrants or convertible securities at a fixed price to finance its operations, permitting the issuance of additional secured debentures and warrants on the same terms as the outstanding such securities, and providing that interest due on the debentures on January 1, 2007 and July 1, 2007 be added to principal on those dates.  The Company converted all of the accrued interest due January 1, 2007 and July 1, 2007 to debt in the amounts of $263,431 and $230,174, respectively.

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.

During the fourth quarter of 2007, the Company issued an aggregate of $1,264,106 of additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 594,874 short term and 594,874 long term warrants to the purchasers of the 6% Secured Debentures.  The individual issuances are identified below:

March 12, 2007	$	20,000
March 28, 2007		150,000
April 15, 2007		115,000
April 30, 2007		70,000
May 10,2007		380,000
May 31, 2007		529,106
Total during the 4th quarter of 2007	$	1,264,106

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During the first half of 2008, the Company borrowed $855,000 at the times set forth below, on an unsecured basis from affiliates of the Company’s Chairman and two non-employee directors, with the understanding that these advances would be exchanged for additional 6% Secured Debentures and related warrants.  Such an exchange is subject to the consent of the holders of outstanding 6% Secured Debentures or the satisfaction of the holders’ pre-emptive rights.

July 10, 2007	$	215,000
August 3, 2007		150,000
August 22, 2007		50,000
August 27, 2007		20,000
August 31, 2007		50,000
September 28, 2007		100,000
October 16, 2007		60,000
October 30, 2007		90,000
November 7, 2007		70,000
November 19, 2007		50,000
Total during the 1st half of 2008	$	855,000

On December 15, 2007, this related party debt was converted to additional principal of the 6% Secured Debentures on substantially the same terms as the 6% Secured Debentures previously issued by the Company.  The Company issued 402,353 short-term and 402,353 long-term warrants to the purchasers of the 6% Secured Debentures.  Based on the issuance date of the debentures, debt discounts were recorded in the third quarter of 2008 in the amount of $118,723, respectively for 402,353 short and 402,353 long term warrants issued with these 6% Secured Debentures.

The amortization recorded attributed to all the debt discounts amounted to $268,973 and has been recorded as interest expense for the six months ended November 30, 2008.

On December 6, 2007, the Company entered into an Amendment Agreement with the holders of the outstanding 6%  Secured Debentures which made material changes to the 6% Secured Debentures and other ancillary documents we executed in connection to an aggregate of $8,428,461 of 6% Secured Debentures sold to investors during the period from December 28, 2005 to May 31, 2007.  The material changes were made, at the Company’s request, to facilitate the possible private placement of equity securities included:

·   waiver of defaults which could have occurred as a result of the Company failing to make an interest payment of approximately $230,000 on January 1, 2008 until the earlier of an equity financing or March 3, 2008;

·   deferral of any request on the part of the holders of the 6% Secured Debentures, to require the filing of a registration statement under the Securities Act within 45 days of the request until April 15, 2008;

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·   waiver of pre-emptive rights with respect to the equity financing; and

·   extending the maturity date of the 6% Secured Debentures twelve months to December 28, 2009 and converting all interest payments into additional principal (as of the date such payment is due) if the Company completes equity financing of $2.0 million on or before March 3, 2008.

The Company also agreed to amend the 10,065,210 warrants outstanding and issued with the then outstanding 6% Secured Debentures to be consistent with the 804,706 new warrants issued December 15, 2007 by extending the expiration date from an outside date of December 28, 2010 to December 28, 2012 and removing any restriction on exercising the warrants on a cashless basis or any provision which accelerates the expiration date if the shares issuable on exercise of the warrants are registered for resale under the Securities Act.

During the 3rd quarter of 2008, a deferred expense was recorded in the amount of $774,789 for the extension of the expiration date of the warrants to December 28, 2012.  The amortization recorded was $51,653 and has been recorded as interest expense for the quarter ended August 31, 2008.

On April 2, 2008, the Company entered into a Waiver and Amendment Agreement with the holders of $9,283,461 issued principal amount of 6% secured convertible debentures due December 28, 2008.  Pursuant to the Waiver and Amendment, the Holders agreed to waive all potential defaults caused by our not making a scheduled interest payment of approximately $255,000 which became due under the terms of the Debentures, as previously amended on March 3, 2008.  The Holders agreed to add the interest due to principal and make such a waiver in exchange for the Company issuing additional Debentures equal to 10% of the principal amount of the Debenturesheld by the Holders (after adding the past due interest to principal).

As of November 30, 2008, there was a total of $11,917,301 in principal amount, including interest on the 6% Secured Debentures converted to debt totaling $1,095,099, an interest penalty of $1,004,701 and 9,328,494 warrants outstanding.

Other Obligations - As a consequence of the Company raising an aggregate of $3 million of financing since June 2004, 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. While the deferred salary of $91,875 has been paid, the bonus of $65,333 remains outstanding. The Company’s chief executive officer temporarily waived the right to receive immediate payment of the $65,333 until May 31, 2007.  The Company’s failure to pay this bonus and other amounts due under the employment agreement gives the chief executive the right to terminate the agreement and continue to receive salary at the annual rate of $300,000 for twelve months following the date of such termination.

Included in accrued expenses and other liabilities as of November 30, 2008 is unpaid accrued payroll of $ 1,650,353 (which includes approximately 5 months of payroll for non-executive employees in the amount of $ 762,548 and approximately fifteen months of unpaid executive payroll in the amount of $ 887,805, an unpaid bonus of $65,333 due to the Company’s CEO since December 2005 and unpaid expense reimbursements of $67,998 due

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to executive officers.  As of November 30, 2008, the Company had accrued and unpaid aggregate payroll of $ 1,650,353.

Related Party Activities - As of November 30, 2008, the Company has reported a related party payable in the amount of $ 187,770 which represents funds that were advance to the Company by one of the Officers of the Company.

In aggregate, $4,287,700 of the $11,383,260 of 6% Secured Debentures is held by related parties.

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 $937,000 still recorded on the Company’s books as due and outstanding for the federal and state tax authorities for penalties and interest under such agreement.  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 or the statute of limitation has expired, 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 as extension fees 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.

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, 2008		14,972,381	$	0.51
Granted		4,786,238		0.22-27
Exercised		—		—
Expired or cancelled		—		—
Outstanding at November 30, 2008		19,758,619	$	0.44

Information, at date of issuance, regarding stock option grants during the six month period ended November 30, 2008 is summarized as follows:

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	Shares		Weighted- Average Exercise Price		Weighted- Average Fair Value
Period ended November 30, 2008
Exercise price exceeds market price		—	$	—	$	—
Exercise price equals market price		4,786,238	$	0.22 -.027	$	0.15 -0.21
Exercise price is less than market price		—	$	—	$	—

The compensation expense attributed to the issuance of the options and warrants is recognized as they vest or are otherwise earned.  The Company has recorded $562,874 of compensation for options vested / earned in the six month period ended November 30, 2008 for employees.  In addition, 500,000 options were awarded to two service providers; an expense in the amount of $90,246 was recognized in the six months ended November 30, 2008 for these options.  These stock options and warrants are exercisable for three to ten years from the grant date.

Also, 360,000 shares of stock were granted to a service provider during the six month period ending November 30, 2008; $108,000 of consulting expense for this transaction was recorded during this period.

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.

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

	Shares		Weighted Average Exercise Price
Outstanding at May 31, 2008		10,044,916	$	0.84
Granted		4,022,225		0.25
Exercised		—		—
Expired or cancelled		2,332,137		0.85
Outstanding at November 30, 2008		11,735,004	$	0.72

Information, at date of issuance, regarding warrant grants during the period ended November 30, 2008.

	Shares		Weighted- Average Exercise Price		Weighted- Average Fair Value
Period ended November 30, 2008
Exercise price exceeds market price		—		—		—
Exercise price equals market price		4,022,219	$	0.25	$	0.11
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 “NOTE 4 – CONVERTIBLE DEBENTURES AND RELATED PARTY PAYABLES,” above.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the Company’s financial condition and results of operations. The MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes thereto. In addition, reference is made to our annual report on Form 10-K which provides disclosures regarding material risks that are not repeated in this Report which may have an impact on future financial condition and results of  operations.

Arkados Products

Our highly integrated semiconductors facilitate internet or network connections over existing electric lines for new consumer electronic products (such as stereo systems, television sets, intercoms and personal iPods®). Our solutions can also be used for bridging legacy products with newer home networking and broadband communications technologies.

Arkados’ solutions offer a completely different approach than that of our competitors.  Our solutions incorporate a processor and multiple interfaces into the same chip that houses HomePlug communication technology, as well as provide application-level software that runs on the chip. We believe this “system-on-a-chip” approach provides a more cost-effective and more flexible strategy to bring products to market for our customers.

In October 2008, Arkados announced an agreement with STMicroelectronics to develop and manufacture a 200 Mbit per second, HomePlug AV wideband powerline modem System-on-Chip (SoC). Planned for availability mid-next year, the world’s first HomePlug AV SoC is designed to power applications ranging from simple Ethernet-to-powerline bridges to full-featured products as wide ranging as HDTV distribution, digital set-top boxes, IPTV, whole-house audio, networked digital picture frames, surveillance systems, and also industrial and commercial applications, especially targeting the Smart Grid and Green Energy segments. STMicro is largest semiconductor manufacturer to announce plans to bring a HomePlug AV chip to market, and, based on announced product plans of other HomePlug members, we believe this chip will be the only chip available in the near term that will be interoperable with three established powerline standards: TIA-1113/HomePlug 1.0, HomePlug AV, and the recently confirmed IEEE 1901 Baseline Standard.

In January 2009, Arkados announced teaming with Freescale Semiconductor, Inc. to bring a versatile “Whole-House Audio In a Box” platform to market. The platform uses Arkados’ HomePlug® based multimedia streaming technology, and Freescale’s Synkro wireless communications technology, enabling untethered devices to control and monitor the system and display live data. This platform was announced at CES 2009.

Last year, Arkados received a major award from G4 Television for its HomePlug system-on-chip and software solution. Arkados won the award on the strength of its embedded solution powering the IOGEAR Powerline Stereo Audio System which creates whole-house music at a fraction of the cost of dedicated installed systems. In 2009, Arkados continued to be recognized through the products of our customers: Checkolite International received a “CES Best of the Best” award from G4

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Television for a system that combines whole-house audio with lighting control, and Russound’s Collage and NuVo’s Renovia systems were each recognized as Honorees in the 2009 CES Innovations awards. Each system is built around the Arkados chip and software platform.

Sales & Customers

Our solutions have been shown in a number of public venues, including the 2008 and 2009 International Consumer Electronics Show, CEDIA Expo 2009, Microsoft’s WinHEC 2008, and other conferences. Our prototypes or products have been publicly announced and/or demonstrated by Analog Devices, Channel Vision, Checkolite, Corporate Systems Engineering, devolo AG, Freescale, GigaFast, GoodWay, IOGEAR, NuVo, Meiloon, PAC Electronics, Russound, Tatung, Zinwell, and Zylux. Many of these companies are suppliers to top tier brands in the market place. Several of these relationships, among others, have progressed into sales of chips, software development services, and related revenue.

We have also been involved with our customers in projects related to Smart Grid applications.

We have experienced the beginning of semiconductor sales.  While most of our revenue has come from design and development agreements, we expect that such agreements will lead to volume orders, but we cannot assure you that they will. We are targeting the sale of our powerline connectivity products to a broad range of communications, computing and consumer electronics ODMs/OEMs, but we have not yet derived significant product revenue from these ODMs/OEMs due to lengthy development cycle to develop and produce finished products.

We believe that products that use our are easy-to-install and easy-to-use since they create connectivity through the existing electrical outlets and electrical wires. For the end user, products that use Arkados solutions connect to each other by simply plugging in, while also being reliable and secure.

Technology

Arkados is committed to building standards based solutions.  Currently, Arkados’ SoCs are based on the specifications developed by the HomePlug Powerline Alliance and TIA-1113 standards. We have announced that that our upcoming HomePlug® AV based AI-2100 SoC will likely be the only chip available that will be interoperable with three established powerline standards: TIA-1113/HomePlug 1.0, HomePlug AV, and the recently confirmed IEEE 1901 Baseline Standard. The upcoming chip will also offer support for the Inter PHY Communication Protocol (IPP) as defined by the IEEE P1901 Working Group, and which is scheduled to be included in the upcoming ITU-T G.hn standard.

System-on-Chip Semiconductors

Arkados has a number of design wins that employ our first SoC, the Arkados AI-1100, which we started marketing in Fiscal 2007.  The device supports applications such as whole-house music streaming, whole-house internet access, and can be used in IPTV set-top boxes designed to decode and display standard definition video content -- from sources as varied as surveillance cameras and YouTube -- on regular TVs throughout the home.

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Our next generation SoC, the AI-2100, will be backwards compatible with our current chip and it will feature an enhanced embedded Quality of Service (QoS) engine which supports video flows for low jitter, lip synch and low latency delivery. The chip is being developed and manufactured under an agreement with STMicroelectronics.

Software

Today’s digital products are incomplete without an array of software components that enable both device-to-device communications and robust product features. Arkados services our customers by providing a host of software components that run directly on our chips, further eliminating development time for our customers. These software components include application-level features (such as our Direct-to-Speaker™ multi-channel audio synchronization, networking and internet, online gaming, etc.) embedded application support software (audio compression/decompression, internet radio support, GUI support, video drivers, etc.), Quality of Service engine, traffic management, and TCP/IP components.

Market Opportunities

Arkados solutions contribute to several large markets each of which is global, broad, and deep. The retail consumer electronics market, the whole-home custom installation market, the smart grid market, and the subscription services market combine to form a very broad potential base for Arkados solutions.

The following is a brief compendium of publicly available quotes that echo our beliefs in the strength of Arkados’ target markets1:

·     Retail Consumer Electronics for the Digital Home Market

o     iSuppli: “The next networking frontier is the home – and the ubiquitous power line is its Holy Grail,” says Steve Rago, Principal analyst and author for iSuppli’s new report ‘Home Networking Technology’s Killer Connection’. “Both the IEEE and the ITU are driving emerging power line standards. It currently appears that the IEEE, which includes HomePlug AV technology, may have the advantage due to the timing, available silicon, and its announced supporters, including STMicroelectronics and Arkados. In its report, iSuppli forecasts 210 million power line devices will ship during 2013, a CAGR of 76% over the next five years.” (1/6/2009)

o     ABI Research: “Total network-enabled consumer electronics and media devices shipments are expected to grow from 92 million in 2007 to nearly 460 million by 2012, exceeding the 368 million network-enabled home gateways, routers, network adapters and home network storage products shipped the same year.” (10/18/2007)

o     ABI Research: “Networked Home Audio Market to Hit $7.2 Billion by 2012” (4/17/2007)

o     Multimedia Intelligence as quoted by EETimes magazine: “By 2012, as consumer electronics manufacturers and operators gradually add IP connectivity across a broad array of equipment,” the analyst forecasts “the market for the resulting network

1 The statements and conclusions are those of the respective quoted authors, based upon their research and understanding of the market for semiconductors, consumer produces and the powerline industry.  We do not adopt or confirm such statements and are not responsible such statements’ accuracy.  In addition many of these statements are foreward looked and we have not verified any of the assumptions upon which such statements are made.

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interface semiconductors growing to nearly $2.5 billion.” They continue, “With more than 60 million IP-enabled consumer electronics devices shipped into the market in 2007, the semiconductors underlying that connectivity already represent more than $560 million in annual revenues. The total includes the media-access control (MAC), physical interface (PHY) and related support chips.” (7/2007)

o     iSuppli: “the worldwide home networking silicon total available market is expected to grow from $1.1 billion in 2007 to $3.1 billion in 2011, representing a compounded annual growth rate of approximately 29%.” (7/2007)

·     Smart-Grid and Utility Applications Market

Another large potential market for Arkados’ solutions relates to energy conservation, the “green” applications that help utility companies and their customers save both money and energy.  For example, “Smart Grid” applications (Green Energy, demand response, energy efficiency and grid modernization – i.e., reduction of carbon emissions) and home/building automation (such as controlling air conditioner thermostats remotely) represent large and attractive opportunities given today’s surging energy costs.

o     From CNNMoney.com: “The Brattle Group, a think tank, estimates the nation will need to spend up to $1.5 trillion on its electricity system over the next 20 years - and that’s just enough to keep the lights on. An investment in cleaner energy could put the figure at $2 trillion, and would include building new power plants, transmission lines, and focus on conservation. On the grid alone - the lines, towers, meters and substations - Brattle estimates the first steps towards a smart grid could cost about $900 billion over the next two decades. That includes money for computers, meters and software to digitize the grid. (1/8/2009)

o     From EDN Magazine: “in the electric industry alone, 500 million meters worldwide could be replaced over the next 10 years, resulting in semiconductor sales of at least $7.5 billion, according to Mark Buccini, director of strategic marketing for Texas Instruments’ microcontroller products.” And continues to say “a large number of those will be connected to a home area network, and that home network will have at least one device that can talk to the meter,” and that “the communications piece is as much as three times as big [as the $7.5B market for meters].” (6/24/2008)

o     Techno Systems Research predicts a 106.4% CAGR for SmartGrid/Broadband Powerline markets from 2005-2011. (12/2007)

·     Subscription and “over the top” Services

Many services currently available, from remotely-monitored security, to piped-in music, to health monitoring systems, require costly professional installation for communication and distribution.  With the addition of a broadband pipe to the house, and the use of an in-home distribution method such as Arkados solutions provide, over-the-top (OTT) this type of solution allows the content owners to deliver the content directly to consumers.

o     The Diffusion Group: “By 2012, approximately 190 million households will use a next-generation game console; 80% of these households – 148 million – will have this console connected to the Internet; and 75% of connected-console households – more than 110 million – will use console-based video services at least a couple times each week.” (12/1/2008)

o     The Diffusion Group: “TDG found that 40% of broadband users are watching at least an hour of video per week on the Internet. More surprising is that 30% of those are watching 25% or more of their TV online. Imagine what will happen when tens of

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millions of households are capable of watching broadband video on their big-screen, high-dollar, high-definition TVs and home theater systems.” (5/2008)

o     Harbor Research: “The ability to monitor, repair and control equipment remotely over the Internet….. has changed the concept of service for manufacturers in key industries around the world…..These new services represent a multi-billion dollar opportunity. Market growth is also extremely strong.”(3/2006)

·     Services

An additional immediate potential market for the Arkados platform is for subscription music services. Its software and chips enable the distribution of Internet music services (e.g., Rhapsody, Yahoo! Music, AOL Music, Shoutcast services).  The Company is actively working on reference designs and business strategies to address this rapidly developing market.

Corporate Background

On May 24, 2004, we filed a merger certificate completing the acquisition of Miletos, Inc., a previously unaffiliated Delaware corporation (the “Merger”). The merger was completed according to the terms of an Agreement and Plan of Merger dated as of May 7, 2004. Miletos merged into a wholly owned subsidiary we formed for the merger which then changed its name to “Arkados, Inc.”.

On March 3, 2007 we completed the merger of Arkados Wireless Technologies, Inc., our wholly owned subsidiary (“Merger Sub”) with Aster Wireless, Inc. a Delaware corporation (“Aster”). In this merger, we acquired synergistic talent and technology which has helped improve the reliability and quality of audio streaming in our current generation chipset and we believe will help deliver our next-generation chips to market more quickly, with richer capabilities.

Dependence on Financing

We have not had significant revenue from operations since inception and, as of November 30, 2008, we are still a development stage company. Furthermore, 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 December 31, 2007, we sold an aggregate $9,283,461 of 6% secured convertible debentures due December 28, 2008 of which $6,145,884 was purchased by institutional investors, $3,092,577 by our directors and their relatives and $45,000 was issued to settle an equivalent amount of legal fees.. During the fiscal year 2006, we paid down a substantial portion of outstanding short term debt and other liabilities and have issued approximately 600,000 shares of our common stock in satisfaction of approximately $406,000 of short term liabilities. During the period from June 1, 2007 to November 30, 2008, we raised $855,000 in cash from advances that were satisfied by issuing 6% secured convertible debentures.  Despite these milestones in improving our financial position, our business plan to aggressively market our chips remains constrained by our limited capital resources.  The due date on these convertible debentures was amended from December 28, 2008 to June 28, 2009 in an agreement dated August 7, 2008.

We require additional funding to finance inventory, support operations for the expansion of our research and development efforts, and the expansion of our management team and sales and marketing organization. In March, 2007, we acquired the assets of Aster Wireless, Inc., retained four of their

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engineering staff as employees and one person as a consultant, which significantly added to our engineering capability and skill sets.  The acquisition has added approximately $45,000 of monthly operating expenses and no material revenue.

If we are unable to raise funds to finance our working capital needs, we will not have the capital necessary for ongoing operations and we could lose professional staff necessary to develop our products and the value of our technology could be impaired. As of November 30, 2008, we owed $1,650,353 in payroll of which $887,805 was due to officers, including Oleg Logvinov, our CEO.  Our failure to satisfy these obligations creates a morale problem, increases the risk of our losing personnel at every level and minimizes our chance to retain additional or replacement staff.  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.

Industry Background

Music, movies, and a wide range of communication services are experiencing a fundamental shift. The distribution of content to a product, and in some cases the product itself, is transitioning from traditional methods. Digital content requires a new digital distribution model. Arkados’ solutions directly address this opportunity by enabling electrical power sockets to be turned into high-speed network ports, thereby providing a high-speed pathway through which digital information can travel both inside a home, and to the home.

Standards

Arkados is a Contributing Member of the HomePlug Powerline Alliance. Members of the Arkados team hold leadership positions in the Alliance and in several HomePlug working groups.

Market analyst In-Stat forecasted2 that by 2010, the technology based on HomePlug specifications will hold 85% of the worldwide market for powerline communications. Membership in the Alliance has grown to include over 75 industry-leading companies. HomePlug Sponsor companies include Cisco; Comcast; GE Energy., part of General Electric Co.; Intel Corporation; LG Electronics; Motorola; Sharp Laboratories of America; and Texas Instruments Incorporated (TI). Besides Arkados, contributor members include Corporate Systems Engineering; Gigle Semiconductor; Intellon Corporation; Renesas; SPiDCOM Technologies; and YiTran Communications.

Strategic Relationships

In October 2008, Arkados and STMicroelectronics announced that they reached an agreement to develop and manufacture a 200 Mbit per second, HomePlug AV wideband powerline modem System-on-Chip (SoC). The introduction of this device is timed to take place to meet the market’s needs for communications solutions that help to implement Smart Grid and Green Energy applications. The agreement specifies that both ST and Arkados will market a version of the device specifically targeted at “bridging” applications such as Ethernet-to-Powerline adapters, or other applications where only a MAC/PHY implementation is needed. Arkados will continue to focus on marketing the chip for

2 See Note 1 appearing on page 24.

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more full-featured connected media applications such as whole-house audio, IPTV, and segments of the smart-grid market. This agreement allows Arkados to complete the design and manufacturing of the state-of-the-art chip without making the costly investment of taping out a new chip. ST is contributing to the investment for the development and manufacturing for the Arkados-designed chip. In return, ST receives the rights to market the chip through its worldwide distribution network.

In January 2009, Freescale Semiconductor and Arkados debuted a “whole-house audio in a box” platform. The platform uses Arkados’ HomePlug-based multimedia streaming technology, which has been adopted by audio market leaders for custom home installations, and Freescale’s Synkro wireless communications technology, enabling untethered devices to control and monitor the system and display live data.

In July 2004, Arkados entered into a five-year Silicon Product Development and Product Collaboration Agreement with GDA Technologies, Inc., under which GDA assists Arkados in translating Arkados chip designs into a mask that can be used by a semiconductor foundry to manufacture Arkados designed integrated circuits in a cost effective manner.

We have also entered into go-to-market strategies with a number of ODMs and other technology companies, which offer even greater turnkey value to our customers. We have announced relationships and strategies with several companies, including GigaFast and Tatung Corporation, a multi-billion dollar product design and manufacturing company. In these collaborations, we are developing whole-house digital media solutions that can distribute music and video from a multitude of sources such as an iPod® , music and video stored on computers, any internet radio station, and music and video download services to existing stereo systems, televisions, and speakers throughout the house.

Manufacturing

We currently 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 to 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. Our efforts to develop multiple sources of supply have been hindered by our lack of adequate working capital

In connection with the development of our next generation chip, we have entered into a development agreement with STMicroelectronics.  The agreement allows Arkados to complete the design and manufacturing of without making the costly investment of taping out a new chip. ST is contributing to the investment for the development and manufacturing for the Arkados-designed chip.

Research and Development

We have focused on R&D since our inception. Our company has placed extraordinary value on the work done by our engineering staff, and we continue to create new software solutions, technology implementations, system-on-chip semiconductors, and the creation and development of intellectual

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property, that focus on helping our customers to get full-featured connected products to market quickly and at a lower cost.

Intellectual Property Portfolio

Examples of our IP portfolio include methods for increasing resistance to noise, allowing more robust transmissions, maximizing throughput, and several product-level applications such as adaptors and connectivity devices. We believe our patent portfolio will provide a competitive edge in the areas of the technology based on such new standards such as IEEE1901 and upcoming ITU G.hn standards.

Consistent with Arkados’ vision of seamless networking, in August 2008, Arkados was recently granted a patent that covers the use of an inexpensive PHY/MAC and adapter to communicate over diverse wire media such as power, copper phone and coax cable, while offering advanced Quality of Service features. Entitled “Integrated Universal Network Adapter” (Patent 7,440,443). The concept has been echoed and formalized by industry groups as they seek to standardize on methods for implementation of these concepts. For example, the HomePlug Powerline Alliance recently began collaborating with alliances based on other physical mediums, and ITU-T sponsored G.hn effort is focused on one MAC protocol and one PHY communications connection, regardless of whether the physical medium is power line, coax cable, phone line, or Ethernet cable.

Our patent portfolio reflects our innovative development efforts and our forecasts of how we envision the market will evolve. We have been awarded 12 U.S. Patents, which we believe is an indicator that we have developed a good understanding regarding key industry developments. In addition to our issued U.S. patents, we have over 32 pending U.S. patent applications, and various corresponding international patents and applications.

We rely on trade secret, patent, copyright, and trademark laws to protect our intellectual property in our products and technology. We intend to continue this practice in the future. In addition to our issued U.S. patents, we have over 30 pending U.S. patent applications, and various corresponding international patents and applications.

To complement our own research and development efforts, we have also licensed, and expect to continue to license, from third parties a variety of intellectual property and technologies important to our business.

Although we have not received any notification from third parties that we are infringing any of their intellectual property, there may be third party patents or other intellectual property that we are infringing. If that were the case, third parties could assert infringement claims against us or seek an injunction on the sale of any of our products in the future. If such infringement were found to exist, we may attempt to acquire the requisite licenses or rights to use such technology or intellectual property. However, we cannot assure you that such licenses or rights could be obtained on favorable terms or at all.

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Competition

Arkados faces intense competition as a solution provider, a technology developer of standards-based powerline technologies, as well as from other technologies also focused on our target markets.  Our overarching value remains in our ability to develop SoC/software solutions that help our customers to create full-featured products that are cost-effective and can be brought to market quickly.

Our competitive strategy has been to provide cost-effective integrated products bundled with software that is designed to support a turnkey approach for a variety of applications. We believe this approach, coupled with the benefits of powerline communications technology, allows us to effectively compete due the following aspects:

·     Due to embedded HomePlug standard technology, we believe our product performance includes unique features such as whole-house connectivity, high throughput, ease of setup, and Quality-of-service mechanisms that preserve a positive end-user experience

·     Due to the integration of our system-on-chip and firmware solutions, we believe our potential customers will benefit from quicker time-to-market, a competitive bill-of-materials cost, an enhanced feature set, and lower development costs

·     Due to our reliance on international technology standards, we believe our solutions are able comply with regulatory requirements on a global basis

We anticipate growth of product revenues, much of which will be recognized in the later half of calendar year 2009 into the beginning of 2010 in line with the product introductions as described above.

Results of Operations

For The Three Months Ended November 30, 2008

During the three month period ended November 30, 2008, we had total revenue of $160.443 compared to $330,077 for the same period in fiscal 2008.  About $63,948 of the revenue recognized in the second quarter of 2009 was for chip sales into the audio market.  Another $96,495 of revenue was related to development agreements with three customers.  As of November 30, 2008, there was approximately $175,000 in backlog.  Total operating expenses for the three month period ended November 30, 2008 were $1,139,382 compared to total operating expenses for the same period in fiscal 2008 of $1,217,873.  In both periods, the most significant expenses were personnel, professional fees and research related expenses.  As a result of the increase in outstanding debt and charges related to beneficial conversions related out debentures, our interest expense increased during the three month period from $286,017 in fiscal 2008 to $433,492 in fiscal 2009.

For the Six Months Ended November 30, 2008

During the six month period ended November 30, 2008, we had total revenue of $ 384,425 compared to $380,563 for the same period in fiscal 2008.  About $ 110,216 of the revenue recognized in the first six months of fiscal 2009 was for chip sales into the audio market.  Another $274,209 of revenue was related to development agreements with five customers.  As of November 30, 2008, there was approximately $175,000 in backlog.  Total operating expenses for the six month period ended

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November 30, 2008 were $2,303,367 compared to total operating expenses for the same period in 2007 of $2,472,009. In both periods, the most significant expenses were personnel, professional fees and research related expenses.  As a result of the increase in outstanding debt and charges related to beneficial conversions related out debentures, our interest expense increased during the six month period from $549,858 in fiscal 2008 to $ 953,299 in fiscal 2009.

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.  If we are not able to raise capital in the near term we will have to curtail our operations and our business and potential value could be substantially impaired.

There can be no assurance that our efforts to raise additional capital will be successful, or even if successful will fund our planned operations or capital commitments.

At November 30, 2008, we had $3,666 in cash and negative working capital of $(16,616,468), compared to $24,480 in cash and negative working capital of $(15,988,337) at May 31, 2008. Funds received from an equity raise were used to fund operating activities. Working capital reflects the short-term maturities of all of the secured 6% convertible debentures.

Our present material commitments are the compensation of our employees, including our executive officers (of which $1,550,363. remains past due at November 30, 2008) payment of $1,066,550 of convertible debt due June 30, 2009, payment of convertible debt due, with interest at the annual rate of 6%, on June 28, 2009, and professional and administrative fees and expenses associated with the preparation of our filings with the Securities and Exchange Commission and other regulatory requirements.  Our lack of working capital has constrained and can be expected to continue to constrain all aspects of our operations.  As design solutions are completed for existing customers, our need to finance the purchase of chip inventory will increase.  If we are unable to finance the purchase of chip inventory, we will not be able to fulfill sale commitments and will not be able to recognize revenue on firm orders; such failures will have an adverse impact on our important technical relationships and future marketing efforts.  In additional to general efforts to raise capital to support our operations, we will explore arrangements specifically relating to inventory that may be costly (in the case of a factoring arrangement), require the consent of holders of secured debt and may involve the licensing of technology in exchange for manufacturing services.

We continue to seek financing to meet the commitments either in the form of the sale of equity, additional secured or unsecured debt and any combination of the foregoing.  There is no assurance sufficient financing to meet these commitments will be available, and, if they are not met, our business could be suspended or, upon a material default in our obligations to the holders of our convertible secured debt, face the acceleration of our obligations and the seizure of our assets to satisfy the debt.

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Commitments

We do not have any commitments which are required to be disclosed in tabular form as of November 30, 2008.

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) collectability 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

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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.

Item 3.    Quantitative And Qualitative Disclosures About Market Risk

Not Applicable

Item 4T.  Controls and Procedures.

The Company’s management evaluated, with the participation of the Company’s principal executive and principal financial officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of  November 30, 2008. Based on this evaluation, the Company’s principal executive and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of  November 30, 2008.

There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s fiscal quarter and six months periods ended November 30, 2008 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

In connection with the preparation of our annual financial statements, our management performed an assessment of the effectiveness of internal control over financial reporting as of May 31, 2008. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this evaluation, management determined that, as of May 31, 2008, there were material weaknesses in our internal control over financial reporting. The material weaknesses identified during management’s assessment were (i) a lack of sufficient internal accounting expertise to provide reasonable assurance that our financial statements and notes thereto, are prepared in accordance with generally accepted accounting principles (GAAP) and (ii) a lack of segregation of duties to ensure adequate review of financial statement preparation. In light of these material weaknesses, management concluded that, as of May 31, 2008, we did not maintain effective internal control over financial reporting. As defined by the Public Company Accounting Oversight Board Auditing Standard No. 5, a material weakness is a deficiency or a combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the relationship between the benefit of desired controls and procedures and the cost of implementing new controls and procedures.

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 The consolidated financial statements as of and for the period ended November 30, 2008 include all adjustments identified as a result of the evaluation performed.

Changes In Internal Control Over Financial Reporting

None

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PART II - OTHER INFORMATION

Item 1.  Legal Proceedings.

On December 4, 2008, we received an arbitration award (In the Matter of the Arbitration Between: Robert Dillon, William Simons and Stephen Schuster, Petitioners and Andreas Typaldos, Renee Typaldos,. OIeg Logvinov, Enikia, LLC, Miletos, LLC, Plitra Holdings, LLC, The Andreas Typaldos Family Ltd. Partnership and The Renee Typaldos Farnily Ltd. :Partnership, Respondents, American Arbitration Association, Case No: 13 117 Y 00150 08) denying the relief sought by Robert Dillon, William Simons and Stephen Schuster (the “Plaintiffs”) initially sought in the action action we previously disclosed which they commenced in the Superior Court of New Jersey, Chancery Division, Somerset County (Docket No. C-12102-04). The arbitration panel denied all relief sought by the Plaintiffs  and awarded Andreas Typaldos fees in the approximate amount of $55,000.After hearings in October 2008 with the, the arbitrators ruled against Dillon.

In August, 2008 a $58, 691.87 judgment was entered against the company in the matter of Porter Levay & Rose, Inc. v. Arkados Group, Inc.   The case is pending in the Superior Court of New Jersey, Law Division, Middlesex County (Docket No. MID-L-008649-07) and involved non-payment of fees for investor relations services and expenses.  Approximately $41,000 of the amount had already been accrued as of May 31, 2008 and we do not anticipate that the amount of the judgment exceeds the total amount accrued for such services as of November 30, 2008 by a material amount.

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 1A.    Risk Factors

        In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended May 31, 2008 which could materially affect our business, financial condition or future results. There have been no other material changes during the quarter ended November 30, 2008 to the risk factors discussed in the periodic reports noted above:

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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.

Dated: January 20, 2009	ARKADOS GROUP, INC
	By:      /s/ Oleg Logvinov Oleg Logvinov President and Chief Executive Officer
	By:     /s/ Larry L. Crawford Chief Financial Officer , EVP, CFO (Principal Financial and Accounting Officer)

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EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Oleg Logvinov, certify that:

1. I have reviewed this Form 10-Q of Arkados Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)                Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)                Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)                Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)                Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)                All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)                Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: January 20, 2009	/s/ Oleg Logvinov
	Oleg Logvinov, CEO

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Larry L. Crawford, certify that:

1. I have reviewed this Form 10-Q of Arkados Group, Inc.;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

(a)                Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)                Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)                Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)                Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)                All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)                Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: January 20, 2009	/s/ Larry L.  Crawford
	Larry L.  Crawford, CFO

EX-32.1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

   I am the Chief Executive Officer of Arkados Group, Inc., a Delaware corporation (the "Company"). I am delivering this certificate in connection with the Form 10-Q of the Company for the quarter ended November 30, 2008 and filed with the Securities and Exchange Commission ("Form 10-Q").

        Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, I hereby certify that, to the best of my knowledge, the Form 10-Q fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Oleg Logvinov                                                                    

Oleg Logvinov

Chief Executive Officer

January 20, 2009

A signed original of this certification has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

EXHIBIT 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

   I am the Chief Financial Officer of Arkados Group, Inc., a Delaware corporation (the "Company"). I am delivering this certificate in connection with the Form 10-Q of the Company for the quarter ended November 30, 2008 and filed with the Securities and Exchange Commission ("Form 10-Q").

        Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, I hereby certify that, to the best of my knowledge, the Form 10-Q fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Larry L. Crawford                                                                    

Larry L.  Crawford

Chief Financial Officer

January 20, 2009

A signed original of this certification has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.