Unassociated Document

CONDENSED BALANCE SHEETS

See accompanying notes to condensed financial statements

	March 31,			December 31,
	2010			2009 (1)
ASSETS
CURRENT ASSETS:
Cash	$	6,922,888		$	3,357,510
Restricted cash		1,918,606			1,565,841
Accounts receivable, net of allowance		617,843			489,464
Deferred financing costs, current		217,075			191,566
Prepaid expenses		281,027			302,291
Deferred charges, current		7,327,610			5,629,288
Total Current Assets		17,285,049			11,535,960
PROPERTY AND EQUIPMENT, net		753,251			242,927
DEFERRED FINANCING COSTS, net of current portion		25,509			47,892
DEFERRED CHARGES, net of current portion		627,058			609,904
OTHER ASSETS		109,903			67,605
Total Assets	$	18,800,770		$	12,504,288
LIABILITIES AND STOCKHOLDERS’ DEFICIT
CURRENT LIABILITIES:
Accounts payable	$	5,697,170		$	4,893,186
Accrued expenses		498,598			862,023
Deferred revenue, current		10,285,308			9,662,030
Capital lease obligations, current		56,886			9,410
Total Current Liabilities		16,537,962			15,426,649
DEFERRED RENT		147,835			65,938
DEFERRED REVENUE, less current portion		1,334,452			1,117,116
NOTES PAYABLE, net of discount		5,808,629			1,593,000
CAPITAL LEASE OBLIGATIONS, less current portion		129,047			9,708
Total Liabilities		23,957,925			18,212,411
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ DEFICIT:
Common stock, no par value; 50,000,000 shares authorized; 25,829,675 and 25,673,967 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively		16,760,914			16,595,314
Additional paid-in capital		18,754,783			16,488,488
Accumulated deficit		(40,672,852	)		(38,791,925	)
Total Stockholders’ Deficit		(5,157,155	)		(5,708,123	)
Total Liabilities and Stockholders’ Deficit	$	18,800,770		$	12,504,288

(1)	Derived from audited financial statements

CYBERDEFENDER CORPORATION

CONDENSED STATEMENTS OF OPERATIONS

(UNAUDITED)

	For the Three Months Ended
	March 31,			March 31,
	2010			2009
REVENUES:
Net sales	$	9,477,330		$	3,191,630
COST OF SALES		3,155,050			679,704
GROSS PROFIT		6,322,280			2,511,926
OPERATING EXPENSES:
Advertising		3,067,893			3,743,694
Product development		752,127			299,737
Selling, general and administrative		2,877,213			1,251,557
Investor relations and other related consulting		165,045			1,220,002
Depreciation and amortization		20,242			10,336
Total Operating Expenses		6,882,520			6,525,326
LOSS FROM OPERATIONS		(560,240	)		(4,013,400	)
OTHER INCOME/(EXPENSE):
Change in the value of derivative liabilities		-			109,058
Interest expense, net		(1,320,487	)		(912,509	)
Total Other Expense, net		(1,320,487	)		(803,451	)
LOSS BEFORE INCOME TAX EXPENSE		(1,880,727	)		(4,816,851	)
INCOME TAX EXPENSE		200			200
NET LOSS	$	(1,880,927	)	$	(4,817,051	)
Basic and fully diluted net loss per share	$	(0.07	)	$	(0.27	)
Weighted Average Shares Outstanding:
Basic and fully diluted		25,758,260			17,990,516

See accompanying notes to condensed financial statements

CONDENSED STATEMENTS OF CASH FLOWS

See accompanying notes to condensed financial statements

	For the Three Months Ended
	March 31, 2010			March 31, 2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(1,880,927	)	$	(4,817,051	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of debt discount		124,200			563,215
Provision for doubtful accounts receivables		143,805			-
Change in fair value of derivative liabilities		-			(109,058	)
Depreciation and amortization		20,242			10,336
Compensation expense from vested stock options		91,361			85,208
Amortization of deferred financing costs		47,892			236,718
Warrants issued for interest		1,101,318			35,615
Shares and warrants issued for services		165,045			1,323,038
Changes in operating assets and liabilities:
Restricted cash		(352,765	)		-
Accounts receivable		(272,184	)		55,081
Prepaid expenses		21,264			92,481
Deferred charges		(1,715,476	)		(819,688	)
Other assets		(42,298	)		(6,088	)
Accounts payable and accrued expenses		522,456			242,428
Deferred revenue		840,614			2,134,245
Cash Flows Used In Operating Activities:		(1,185,453	)		(973,520	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(358,725	)		(6,567	)
Cash Flows Used In Investing Activities		(358,725	)		(6,567	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from convertible notes payable and notes payable, net of costs		4,948,982			333,700
Principal payments on capital lease obligations		(5,026	)		(6,414	)
Proceeds from exercise of stock options		33,925			-
Proceeds from exercise of stock warrants, net of placement fees		131,675			-
Cash Flows Provided by Financing Activities		5,109,556			327,286
NET INCREASE/(DECREASE) IN CASH		3,565,378			(652,801	)
CASH, beginning of period		3,357,510			779,071
CASH, end of period	$	6,922,888		$	126,270

CONDENSED STATEMENTS OF CASH FLOWS

See accompanying notes to condensed financial statements

	For the Three Months Ended
	March 31, 2010		March 31, 2009
Supplemental disclosures of cash flow information:
Income taxes paid	$	-	$	-
Cash paid for interest	$	121,501	$	2,132
Supplemental schedule of non-cash investing and financing activities:
Discount on note payable	$	1,208,571	$	158,887
Property and equipment acquired through capital lease obligations	$	171,841	$	-
Warrants issued in connection with sale of stock	$	-	$	18,197
Conversion of notes payable to common stock	$	-	$	1,739,943
Cumulative effect of accounting change to additional paid-in capital for derivative liabilities	$	-	$	7,065,940
Cumulative effect of accounting change to retained earnings for derivative liabilities	$	-	$	723,930
Value of warrants and embedded conversion features recorded to derivative liabilities	$	-	$	906,805

NOTE 1 - INTERIM FINANCIAL STATEMENTS

These unaudited interim financial statements have been prepared by CyberDefender Corporation (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. The information furnished herein reflects all adjustments (consisting of normal recurring accruals and adjustments) that are, in the opinion of management, necessary to fairly present the operating results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such rules and regulations. These unaudited interim financial statements should be read in conjunction with the audited financial statements and footnotes for the Company for its year ended December 31, 2009 included in the Company’s Annual Report on Form 10-K. The results for the three-month interim period ended March 31, 2010 are not necessarily indicative of the results to be expected for the full year ending December 31, 2010.

NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

The Company, based in Los Angeles, California, is a provider of security software and services to the consumer and small business market. The Company develops, markets and licenses security software and related services. The Company’s goal is to be a leading provider of advanced solutions to protect consumers and small businesses against threats such as identity theft, Internet viruses and spyware and to provide remote technical resolution services to those who use our products.

The Company sells a suite of products and services that includes anti-malware software, a registry cleaner, technical support and identity protection services. The Company markets its products directly to consumers through multiple channels including internet, radio, television and retail.

The Company developed a collaborative Internet security network, which we refer to as earlyNETWORK, based on certain technology principles commonly found in a peer-to-peer network infrastructure. A peer-to-peer network does not have the notion of clients or servers, but only equal peer nodes that simultaneously function as both “clients” and “servers” to the other nodes on the network. This means that when a threat is detected from a computer that is part of the earlyNETWORK, the threat is relayed to our Early Alert Center. The Early Alert Center tests, grades and ranks the threat, automatically generates definition and signature files based on the threat, and relays this information to the Alert Server, in some cases after a human verification step. The Alert Server will relay the information it receives from the Early Alert Center to other machines in the earlyNETWORK, and each machine that receives the information will, in turn, relay it to other machines that are part of the earlyNETWORK. This protocol allows us to rapidly distribute alerts and updates regarding potentially damaging viruses, e-mails and other threats to members of the earlyNETWORK, without regard for the cost of the bandwidth involved. Because cost is not a factor, updates can be continuous, making our approach significantly faster than the client/server protocols used by traditional Internet security companies that provide manual broadcast-updated threat management systems. Computer users join the earlyNETWORK simply by downloading and installing our software.

Use of Estimates

The preparation of financial statements in conformity with GAAP 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. Significant estimates made by management are, among others, collectability of accounts receivable, recoverability of prepaid expenses, deferred charges and property and equipment, value of shares and options/warrants granted, valuation of deferred tax assets and recognition of revenue. Actual results could differ from those estimates and assumptions.

Property and Equipment

Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance and repairs are charged to expense as incurred. When equipment is retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided over the estimated useful lives of the related assets ranging from three to seven years, using the straight-line method. Amortization of leasehold improvements is provided over the shorter of the estimated useful lives of the improvements or the term of the lease.

NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Fair Value of Financial Instruments

The Company cannot determine the estimated fair value of its convertible notes payable as instruments similar to the convertible notes payable could not be found. Other than this item, the Company believes the carrying value of financial instruments approximates their fair value.

Equipment under Capital Lease

The Company leases certain of its equipment under agreements accounted for as capital leases. The assets and liabilities under capital lease are recorded at the lesser of the present value of aggregate future minimum lease payments, including estimated bargain purchase options, or the fair value of the assets under lease. Assets under capital lease are depreciated using the straight-line method over their estimated useful lives.

Revenue Recognition

Revenue recognition. The Company sells products, services and packages that include both.

The Company recognizes revenue from the sale of software licenses under the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 985, “Software.”

Specifically, the Company recognizes revenues from its software products when all of the following conditions for revenue recognition are met:

persuasive evidence of an arrangement exists,

ii.

the product or service has been delivered,

iii.

the fee is fixed or determinable, and

iv.

collection of the resulting receivable is reasonably assured.

As part of the sales price of some of its software licenses, the Company provides renewable product support and content updates, which are separate components of product licenses and sales. Term licenses allow customers to use the Company’s products and receive product support coverage and content updates for a specified period, generally twelve months. The Company invoices for product support, content updates and term licenses at the beginning of the term. These revenues contain multiple element arrangements where “vendor specific objective evidence” (“VSOE”) may not exist for one or more of the elements. Certain of the Company’s software licenses are in substance a subscription and therefore the sale is deferred and recognized ratably over the term of the arrangement. Revenue is recognized immediately for the sale of products that do not require product updates.

The Company recognizes revenue from the sale of its technical support services under the guidance of the FASB ASC Topic 605-20, “Revenue Recognition – Services.” Revenue is recognized immediately for our one-time technical support service as it is performed when purchased. The Company recognizes a portion of the sale of one of its annual services at the time of purchase when all of the elements necessary for revenue recognition have occurred and the remaining revenue is deferred over the annual term. Revenue is deferred and recognized over the term of the service agreements for the technical support services that are provided by third parties.

The Company recognizes revenue on the sale of bundled products based on the individual components included in the bundle. Revenue is recognized on the individual components as detailed above.

The Company also uses third parties to sell its software and therefore evaluates the criteria of FASB ASC Topic 605, “Revenue Recognition,” in determining whether it is appropriate to record the gross amount of revenue and related costs or the net amount earned as commissions. The Company is the primary obligor, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, establishes product specifications, and has the risk of loss. Accordingly, the Company's revenue is recorded on a gross basis.

The Company also offers MyIdentityDefender Toolbar free to the subscriber and still supports CyberDefender FREE 2.0, which was free to subscribers. Revenues are earned from advertising networks which pay the Company to display advertisements inside the software or through the toolbar search. The Company recognizes revenue from the advertising networks monthly based on a rate determined either by the quantity of the ads displayed or the performance of the ads based on the amount of times the ads are clicked by the user. Furthermore, advertising revenue is recognized provided that no significant Company obligations remain at the end of a period and collection of the resulting receivable is probable. The Company’s obligations do not include guarantees of a minimum number of impressions.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Deferred Charges

The Company uses a third party to provide technical support services associated with the CyberDefenderULTIMATE product. The costs associated with this service are deferred and amortized against the recognition of the related sales revenue. In addition, the Company defers a portion of its advertising costs as further discussed below.

Advertising Costs

The Company has traditionally expensed most advertising costs as incurred. As a result of the Company’s shift to direct-response advertising as its primary customer acquisition strategy in October 2009, beginning in the fourth quarter of 2009, in accordance with FASB ASC Topic 340-20, “Capitalized Advertising Costs”, the Company began capitalizing its direct-response advertising costs and amortizing them over their expected period of future benefits, generally twelve months. As of March 31, 2010 and December 31, 2009, $4.0 million and $2.3 million, respectively, of capitalized advertising costs were recorded in deferred charges on the accompanying condensed balance sheets.

Reserves for Product Returns

The Company’s policy with respect to product returns is defined in its End User License Agreement (“EULA”), which states “...products purchased that are downloadable are refundable within the first 30 days after the date of purchase.” Product returns are generally received within 30 days of the original sale and are charged against the associated sale upon receipt of the return. A chargeback occurs when a customer contacts the issuing credit card company directly to request a refund instead of contacting the Company. The Company’s third party processor is notified of any chargebacks by the issuing credit card company. The third party processor reduces the amounts due to the Company as a result of any chargeback. A majority of chargebacks occur within 30 days of the sale event and are recorded prior to closing the previous month’s accounting records. The Company may voluntarily accept returns from a customer after 30 days of purchase. The returns are charged against revenues or deferred revenues (as applicable) upon receipt. As of March 31, 2010 and December 31, 2009, the Company had $0 accrued for customer returns and chargebacks, based on historical returns.

Certain Risks and Concentrations

We derive a majority of our net revenue from our security software and services. The market in which we operate is highly competitive and rapidly changing. Significant technological changes, changes in customer requirements, or the emergence of competitive products with new capabilities or technologies could adversely affect operating results.

As of March 31, 2010, all of our cash was maintained at a major financial institution in the United States. At times, deposits held with the financial institution may exceed the amount of insurance provided on such deposits by the Federal Deposit Insurance Corporation (“FDIC”) which provides deposit coverage with limits up to $250,000 per owner through December 31, 2013. As of March 31, 2010, the Company had a balance of approximately $6.8 million in excess of the FDIC limit.

We regularly review the collectability of our accounts receivable to determine an appropriate allowance for doubtful accounts. Our uncollectible accounts could exceed our allowance. We exercise judgment when determining the adequacy of these reserves as we evaluate historical collection experience. At March 31, 2010 and December 31, 2009, our allowance for doubtful accounts was approximately $144,000 and $0, respectively.

Advertising expenses that are expensed as incurred consist primarily of various forms of media purchased from Internet-based marketers and search engines. Advertising purchased from four vendors accounted for 80% and 92% of the Company’s non direct-response advertising expense for the three months ended March 31, 2010 and 2009, respectively.

Income Taxes

The Company has adopted the liability method of accounting for income taxes pursuant to FASB ASC Topic 740, “Income Taxes.” Deferred income taxes are recorded to reflect tax consequences on future years for the differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets, including tax loss and credit carryforwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

FASB ASC Topic 740 prescribes recognition thresholds that must be met before a tax position is recognized in the financial statements and provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. An entity may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold.

The Company does not have any unrecognized tax benefits as of March 31, 2010 that, if recognized, would affect the Company’s effective income tax rate.

The Company’s policy is to recognize interest and penalties related to income tax issues as components of income tax expense. The Company did not recognize or have any accrual for interest and penalties relating to income taxes as of March 31, 2010.

Software Development Costs

The Company accounts for software development costs in accordance with FASB ASC Topic 985, “Software.” Such costs are expensed prior to achievement of technological feasibility and thereafter are capitalized. There have been very limited software development costs incurred between the time the software and its related enhancements have reached technological feasibility and its general release to customers. As a result, all software development costs have been charged to product development expense.

Derivative Instruments

Effective January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815, “Derivatives and Hedging,” that applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. As a result, as of January 1, 2009, 7,134,036 of the Company’s issued and outstanding common stock purchase warrants previously treated as equity pursuant to the derivative treatment exemption were no longer afforded equity treatment. In addition, amounts related to the embedded conversion feature of convertible notes issued previous to January 1, 2009 and treated as equity pursuant to the derivative treatment exemption were also no longer afforded equity treatment. As such, effective January 1, 2009, the Company reclassified the fair value of these common stock purchase warrants and the fair value of the embedded conversion features, which both have exercise price reset features, from equity to liability status as if these warrants and embedded conversion features were treated as a derivative liability since the earliest date of issue in September 2006. On January 1, 2009, the Company reclassified from additional paid-in capital, as a cumulative effect adjustment, $7,065,940 to beginning additional paid-in capital, $723,930 to opening retained earnings and $6,342,010 to a long-term derivative liability to recognize the fair value of such warrants and embedded conversion features on such date.

During the three months ended March 31, 2009, the Company issued 1,192,000 common stock purchase warrants that contained features that required the Company to record their fair value as a derivative liability. In addition, the value related to the embedded conversion feature of convertible notes issued during the three months ended March 31, 2009 was also recorded as a derivative liability. The fair value of these common stock purchase warrants and the embedded conversion feature on their respective value date for the three months ended March 31, 2009 was $906,805. We recognized income of $109,058 from the change in fair value of the outstanding warrants and embedded conversion feature for the three months ended March 31, 2009.

The Company obtained waivers from the warrant and note holders, pursuant to which the warrant and note holders forever waived, as of and after April 1, 2009, any and all conversion or exercise price adjustments that would otherwise occur, or would have otherwise occurred on or after April 1, 2009, as a result of the price reset provisions included in the warrants and notes. As a result of obtaining the waivers, the warrants and notes are now afforded equity treatment resulting in the elimination of the derivative liabilities of $7,139,757 and a corresponding increase in additional paid-in capital.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Fair Value Measurements

FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The fair value hierarchy distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

Level one — Quoted market prices in active markets for identical assets or liabilities;

Level two — Inputs other than level one inputs that are either directly or indirectly observable; and

Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter. The Company has no assets or liabilities that are measured at fair value on either a recurring or non-recurring basis.

Loss Per Share

In accordance with FASB ASC Topic 260, “Earnings Per Share,” the basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding. Diluted loss per common share is computed similar to basic loss per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. As of March 31, 2010 and 2009, there were 17,627,439 and 15,329,433 shares of potentially dilutive securities outstanding, respectively. As the Company reported a net loss, none of the potentially dilutive securities were included in the calculation of diluted earnings per share since their effect would be anti-dilutive for that reporting period.

Stock Based Compensation

The Company applies FASB ASC Topic 718, “Compensation – Stock Compensation,” which requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. For non-employee stock based compensation, the Company recognizes an expense in accordance with FASB ASC Topic 505, “Equity,” and values the equity securities based on the fair value of the security on the date of grant. For stock-based awards the value is based on the market value of the stock on the date of grant or the value of services, whichever is more readily available. Stock option awards are valued using the Black-Scholes option-pricing model.

The Company accounts for equity instruments issued to consultants and vendors in exchange for goods and services in accordance with the provisions of FASB ASC Topic 505, “Equity.” The measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement. An asset acquired in exchange for the issuance of fully vested, non-forfeitable equity instruments should not be presented or classified for accounting purposes as an offset to equity on the grantor’s balance sheet once the equity instrument is granted. Accordingly, the Company records the fair value of the fully vested, non-forfeitable common stock issued for future consulting services as prepaid expense in its balance sheet.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Segment Disclosures

The Company operates in one segment and its chief operating decision maker is its chief executive officer.

Subsequent Events

The Company has evaluated subsequent events through the filing date of this Form 10-Q, and determined that no subsequent events have occurred that would require recognition in the condensed financial statements or disclosure in the notes thereto other than as discussed in the accompanying notes (see Note 8).

Recently Issued Accounting Pronouncements

The Company has adopted all accounting pronouncements effective before March 31, 2010 which are applicable to the Company.

In September 2009, the FASB issued an update to its accounting guidance regarding multiple-deliverable revenue arrangements. The guidance addresses how to measure and allocate consideration to one or more units of accounting. Specifically, the guidance requires that consideration be allocated among multiple deliverables based on relative selling prices. The guidance establishes a selling price hierarchy of (1) vendor-specific objective evidence, (2) third-party evidence and (3) estimated selling price. This guidance is effective for annual periods beginning on or after June 15, 2010 but may be early adopted as of the beginning of an annual period. The Company expects to adopt this guidance on January 1, 2011 and does not expect this guidance to have a material impact on its financial statements.

In October 2009, the FASB issued an update to its accounting guidance regarding software revenue recognition. The guidance changes the accounting model for revenue arrangements that include both tangible products and software elements. Under this guidance, tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are excluded from the software revenue guidance in FASB ASC Topic 985, “Software.” In addition, hardware components of a tangible product containing software components are always excluded from the software revenue guidance. This guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 but may be early adopted. The Company expects to adopt this guidance on January 1, 2011 and does not expect this guidance to have a material impact on its financial statements.

In January 2010, the FASB issued an update to its accounting guidance regarding fair value measurement and disclosure. The guidance affects the disclosures made about recurring and non-recurring fair value measurements. This guidance is effective for annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010. Early adoption is permitted. The Company is currently evaluating the impact that this guidance will have on its financial statements.

NOTE 3 – RESTRICTED CASH

Under a credit card processing agreement with a financial institution, the Company is required to maintain a security reserve deposit as collateral. The amount of the deposit is at the discretion of the financial institution and as of March 31, 2010 and December 31, 2009 was $10,000. Under a separate credit card processing agreement with a different financial institution, the Company is also required to maintain a security reserve deposit as collateral. The amount of the deposit is currently based on 10% of the six-month rolling sales volume and was approximately $1.7 million and $1.3 million as of March 31, 2010 and December 31, 2009, respectively. The security reserve deposit is funded by the institution withholding a portion of daily cash receipts from Visa and MasterCard transactions.

On September 30, 2009, the Company entered into a second amendment to its lease as more fully described in Note 6 below. As part of the amendment the Company was required to issue a $250,000 letter of credit as a security deposit. The letter of credit is collateralized by cash held in an account at the Company’s bank. The account is interest bearing and the Company receives the interest that is earned.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 4 - STOCKHOLDERS’ DEFICIT

Common Stock

During February 2009, the Company issued 94,628 shares of restricted common stock valued at $1.10 per share to a vendor as settlement for past services rendered.

See “stock warrants” below for additional shares issued related to the exercise of stock warrants.

See “stock options” below for additional shares issued related to the exercise of stock options.

See Note 5 for additional shares issued related to the convertible notes payable.

Stock warrants

During August 2008, the Company closed an offering of units. Each unit consisted of 25,000 shares of common stock and a warrant to purchase 18,750 shares of common stock at an exercise price of $1.25 per share. The purchase price was $25,000 per unit. The warrants have a term of five years. Pursuant to the warrant agreements, from and after the warrant issue date, in the event the Company sells common stock for less than the exercise price or issues securities convertible into or exercisable for common stock at a conversion price or exercise price less than the exercise price (a “Dilutive Issuance”), then the exercise price shall be multiplied by a fraction, the numerator of which is the number of shares of common stock sold and issued at the closing of such Dilutive Issuance plus the number of shares which the aggregate offering price of the total number of shares of common stock sold and issued at the closing of such Dilutive Issuance would purchase at the exercise price, and the denominator of which is the number of shares of common stock issued and outstanding on the date of such Dilutive Issuance plus the number of additional shares of common stock sold and issued at the closing of such Dilutive Issuance. As of April 1, 2009, the holders of the warrants have waived their rights to any adjustments to the exercise price as a result of a Dilutive Issuance (see Note 2).

On November 11, 2008, the Company entered into a consulting agreement with Newview Consulting L.L.C. (“Newview”) Pursuant to this agreement, Newview provided investor relations services for a period of 6 months in exchange for warrants to purchase 2,250,000 shares of common stock at a price of $1.25 per share. 900,000 warrants vested immediately and 270,000 warrants were to vest on the 1st of each month beginning December 1, 2008 and ending April 1, 2009. At January 1, 2009, the Company amended the vesting schedule in the Newview warrant to vest the remaining 1,080,000 warrants on the first of each month from January 1, 2009 to June 1, 2009 at the rate of 180,000 warrants per month. 540,000 warrants, valued at $502,891 using the Black Scholes pricing model, vested during the three months ended March 31, 2009 and were expensed to investor relations and other consulting expense.

On January 17, 2009, the Company entered into a two-month consulting agreement with a consultant for services relating to financial management and reporting. As part of the agreement, the consultant was granted a warrant to purchase 2,500 shares of common stock with a term of five years at an exercise price of $1.25 per share, for each month of the term of the agreement. The fair value of these warrants was $3,753, using a Black Scholes pricing model, and was expensed to investor relations and other consulting expense.

On October 30, 2008, the Company executed a letter of intent with GRM to create, market and distribute direct response advertisements to sell the Company’s products. Pursuant to the letter of intent, GRM was responsible for creating, financing, producing, testing and evaluating a radio commercial to market the Company’s products in exchange for $50,000 and a fully vested, non-forfeitable warrant to purchase 1,000,000 shares of common stock at a price of $1.25 per share with an estimated fair value of $951,495 using the Black-Scholes pricing model. The fair value of the warrant was capitalized to prepaid expenses at the time of issuance and was expensed over the five-month term of service. The Company expensed $570,897 to investor relations and other consulting expense for the three months ended March 31, 2009. The warrant included an anti-dilutive provision that reduced the exercise price of the warrant if the Company at any time while this warrant is outstanding sells and issues any common stock at a price per share less than the then exercise price. During August 2009, the Company received a waiver whereby GRM permanently waived, as of and after April 1, 2009, any and all exercise price adjustments that would otherwise occur, or would have occurred on or after April 1, 2009, as a result of this provision.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 4 - STOCKHOLDERS’ DEFICIT (Continued)

On March 24, 2009, the Company entered into a Media and Marketing Services Agreement with GRM. Pursuant to the agreement, GRM will provide direct response media campaigns, including radio and television direct response commercials, to promote the Company’s products and services and will purchase media time on the Company’s behalf. During the term of the agreement, which is to continue until June 1, 2011, as amended, subject to certain rights of termination, GRM will be the exclusive provider of all media purchasing and direct response production services. On June 23, 2009, per the agreement, the Company appointed a representative of GRM to the Company’s board of directors. A GRM representative will continue to serve throughout the term of the agreement and for so long as GRM owns shares of the Company’s common stock or the right to purchase shares of the Company’s common stock which constitute at least 5% of the Company’s issued and outstanding common stock.

As compensation for GRM’s services, the Company agreed to amend the warrant described above so that the terms were consistent with the warrants described below. None of the amended terms resulted in an accounting change to the warrant. In conjunction with the execution of the Media and Marketing Services Agreement and for creating, financing, producing, testing and evaluating a television commercial to market the Company’s products, the Company issued to GRM a second five-year warrant for the purchase of 1,000,000 shares of the Company’s common stock at a price of $1.25 per share valued at $712,303 using the Black-Scholes pricing model. The fair value of the warrant was capitalized at the time of issuance and was expensed over the five-month expected term of service. During the three months ended March 31, 2009, $142,461 was expensed to investor relations and other consulting. This warrant may be exercised only for cash. Finally, the Company agreed to issue to GRM a five-year warrant (“Media Services Warrant”) for the purchase of 8,000,000 shares of the Company’s common stock at an exercise price of $1.25 per share. The Media Services Warrant may be exercised only with cash and is subject to vesting as follows: for each $2 of media placement costs advanced by GRM on the Company’s behalf, the right to purchase one share of the Company’s common stock will vest. As of March 31, 2010, the right to purchase 3,383,470 of the 8,000,000 Media Services Warrant shares has vested and was valued at $2,459,408 using the Black-Scholes pricing model. During the three months ended March 31, 2010 and 2009, 1,546,138 and 50,000 warrants vested, and $1,101,318 and $35,615 was expensed to interest expense. The fair value of these vested shares has been expensed to interest expense as the shares represent compensation to GRM for the advancement of media costs on the Company’s behalf. The remaining 4,616,530 shares from the Media Services Warrant are not guaranteed to vest as they are contingent upon GRM advancing media placement costs, therefore, these unvested warrants have not been included or accounted for as outstanding dilutive securities at March 31, 2010. These warrants included an anti-dilutive provision that reduced the exercise price of the warrants if the Company at any time while the warrants are outstanding sells and issues any common stock at a price per share less than the then exercise price. During August 2009, the Company received a waiver whereby GRM permanently waived, as of and after April 1, 2009, any and all exercise price adjustments that would otherwise occur, or would have occurred on or after April 1, 2009, as a result of this provision.

If GRM terminates the agreement due to a breach by the Company in the Company’s performance or as a result of the Company’s discontinuance, dissolution, liquidation, winding up or insolvency, or if the Company terminates the agreement for any reason, any unexpired and unvested rights of GRM to purchase shares of the Company’s common stock pursuant to the agreement will immediately vest. If the Company breaches its payment obligations under the agreement and fails to cure the breach within 15 days after receiving notice from GRM, then the number of warrant shares which would otherwise vest during the month of the delinquent payment will automatically double.

In November 2009, the Company amended the Media and Marketing Services Agreement with GRM. Pursuant to this amendment, if any of the warrants that have been issued to GRM are outstanding and the Company sells and issues common stock at a price per share less than the exercise price set forth in the applicable warrant, as adjusted thereunder (such issuances collectively, a “Lower Priced Issuance”), without the prior written consent of GRM, then 37.5% of any unexpired and unvested rights of GRM to purchase shares of the Company’s common stock pursuant to the Media Services Warrant shall immediately and automatically vest in full without any notice or action of GRM. As of March 31, 2010, no common stock has been issued at a price less than the exercise price of the GRM warrants.

On April 1, 2009, the Company entered into an agreement with a consultant for management consulting and business advisory services on an as needed basis. The consultant was granted a warrant to purchase 850,000 shares of the Company’s common stock for a period of five years at an exercise price of $1.25. These warrants vest as follows: 300,000 immediately and 50,000 per month on the 1st day of each month commencing May 1, 2009 and ending March 1, 2010. As of March 31, 2010, all of the warrant shares have vested. During the three months ended March 31, 2010, $139,112 was expensed to investor relations and other consulting expense.

On August 1, 2009, the Company entered into an agreement with a consultant for business development services related to the signing of the Wiley licensing contract. The consultant was granted a warrant to purchase 55,000 shares of the Company’s common stock for a period of three years at an exercise price of $2.18. The warrant was to vest 15,000 shares at the signing of the Wiley contract, 15,000 shares at the Wiley launch and 25,000 shares at the earlier of the first anniversary date of the agreement or when sales of the Wiley branded products exceed 100,000 units. The second 15,000 warrant shares vested during the three months ended March 31, 2010 and $25,933 was expensed to investor relations and other consulting expense.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 4 - STOCKHOLDERS’ DEFICIT (Continued)

See Note 5 for additional warrants issued during the three months ended March 31, 2009 related to the convertible notes payable.

The following represents a summary of the warrants outstanding at March 31, 2010 and 2009 and changes during the three months then ended:

	Three Months Ended
	March 31, 2010							March 31, 2009
				Weighted						Weighted
	Number			Average		Aggregate		Number		Average		Aggregate
	of			Exercise		Intrinsic		Of		Exercise		Intrinsic
	Warrants			Price		Value		Warrants		Prices		Value
Outstanding, beginning of period		13,026,657		$	1.20				11,029,890	$	1.14
Issued		1,546,138		$	1.25				1,218,300	$	1.25
Exercised		(126,750	)	$	1.11				-		-
Outstanding, end of period		14,446,045		$	1.20	$	41,829,743		12,248,190	$	1.16	$	1,158,715
Exercisable, end of period		14,421,045		$	1.20	$	41,781,743		11,708,190	$	1.15	$	1,158,715

The following table summarizes information about warrants outstanding at March 31, 2010:

		Weighted
		Average
	Number of	Remaining
	Warrant	Contractual
Exercise Price	Shares	Life (Years)
$ 1.00	2,704,840	1.61
$ 1.01	700,306	5.66
$ 1.20	324,875	2.76
$ 1.25	10,441,034	3.31
$ 1.80	2,500	4.07
$ 1.83	125,000	4.14
$ 2.05	77,490	4.48
$ 2.18	55,000	2.48
$ 2.25	15,000	4.39
	14,446,045

The weighted average grant date fair value of warrants granted during the three months ended March 31, 2010 and 2009 was $0.71 and $0.73 per share, respectively. As of March 31, 2010, 25,000 shares of common stock covered by a warrant, with an estimated remaining value of $43,222, remain unvested and will vest once a milestone has occurred per the underlying contract. The weighted average remaining life of the vested warrants is 3.10 years.

NOTE 4 - STOCKHOLDERS’ DEFICIT (Continued)

Stock options

In January 2005, the Company adopted the CyberDefender Corporation 2005 Stock Option Plan (sometimes called the CyberDefender Corporation 2005 Equity Incentive Plan and referred to herein as the “2005 Plan”), which consists of equity programs that provide for the granting of Incentive Stock Options or Nonstatutory Stock Options, the issuance of stock appreciation rights, stock purchase rights and awards of stock. Under the terms of the 2005 Plan, the exercise price of options granted may be equal to, greater than or less than the fair market value on the date of grant, the options may have a maximum term of ten years and generally vest over a period of service or attainment of specified performance objectives. The maximum aggregate amount of options that may be granted from the 2005 Plan is 931,734 shares, of which 753,233 have been granted, 178,125 have been exercised and 376 are available to grant at March 31, 2010.

On October 30, 2006, the Company adopted the Amended and Restated 2006 Equity Incentive Plan (“2006 Plan”) that provides for the granting of Incentive Stock Options or Nonstatutory Stock Options, the issuance of stock appreciation rights, stock purchase rights and awards of stock. Under the terms of the 2006 Plan, the exercise price of options granted may be equal to, greater than or less than the fair market value on the date of grant, the options may have a maximum term of ten years and generally vest over a period of service or attainment of specified performance objectives. The Company amended the 2006 Plan in June 2009 to increase the maximum number of shares available to be granted by 1,500,000 shares. The maximum aggregate amount of stock based awards that may be granted from the 2006 Plan is 2,875,000, shares of which 1,356,166 have been granted, 302,449 have been exercised and 1,216,385 are available to grant at March 31, 2010.

In January 2009, the Company granted Kevin Harris, the Company’s Chief Financial Officer, an option to purchase 200,000 shares of common stock at an exercise price of $1.00 per share, vesting as follows: 25,000 of the option shares will vest upon grant; 25,000 of the option shares will vest three months after the grant date; and the balance of 150,000 option shares will vest in equal monthly increments over the term of his employment agreement. In addition, per the terms of the employment agreement, on March 31, 2010 and 2009 the Company granted an option to purchase 25,000 shares of common stock at an exercise price of $1.00 per shares, vesting evenly over 24 months, as bonus compensation.

On January 1, 2009, the Company entered into a three month consulting agreement with Unionway International, LLC, an entity controlled by Mr. Bing Liu, for consulting services. As part of the agreement, Mr. Liu has been granted 10-year options to purchase a total of 18,000 shares of common stock at an exercise price of $1.00 per share vesting over the term of the agreement as compensation for 2008 achievements. In addition, Mr. Liu has been granted 10-year options to purchase 5,000 shares of common stock at an exercise price of $1.00 per share vesting 2,500 on January 1, 2009, 1,250 on February 1, 2009 and 1,250 on March 1, 2009.

On January 17, 2009, the Company entered into a two month consulting agreement with a consultant for services relating to financial management and reporting. As part of the agreement, the consultant was granted options to purchase 2,500 shares of common stock at an exercise price of $1.25 per share, per month for the term of the agreement.

During the three months ended March 31, 2010 and 2009, the Company granted to employees options to purchase a total of 94,813 and 38,000 shares of common stock, respectively, at prices ranging from $1.25 to $4.27 per share.

NOTE 4 - STOCKHOLDERS’ DEFICIT (Continued)

A summary of stock option activity for the 2005 Plan and 2006 Plan is as follows:

	Three Months
	March 31, 2010									March 31, 2009
						Weighted									Weighted
	Weighted					Average							Weighted		Average
	Number			Average		Remaining		Aggregate		Number			Average		Remaining		Aggregate
	Of			Exercise		Contractual		Intrinsic		of			Exercise		Contractual		Intrinsic
	Options			Price		Term		Value		Options			Prices		Term		Value
Outstanding, beginning of year		1,856,293		$	1.09						1,444,084		$	0.83
Granted		119,813		$	2.96						291,000		$	1.04
Exercised		(28,958	)	$	1.17						-		$	-
Forfeited		(37,749	)	$	1.85						(30,083	)	$	1.22
Outstanding, end of year		1,909,399		$	1.19		7.44	$	5,555,241		1,705,001		$	0.86		7.78	$	680,045
Vested, exercisable and expected to vest in the future		1,719,162		$	1.09		7.25	$	5,182,381		1,582,494		$	0.84		7.67	$	660,661
Exercisable, end of year		1,206,171		$	0.84		6.55	$	3,932,303		1,139,016		$	0.75		7.12	$	572,525

The weighted-average grant date fair value of options granted during the three months ended March 31, 2010 and 2009 was $3.03 and $0.79 per option, respectively.

As of March 31, 2010 and 2009, 703,228 and 550,985 of the options granted are not vested with an estimated remaining value of $892,165 and $364,408, respectively. At March 31, 2010 and 2009, the remaining value of non vested options granted is expected to be recognized over the weighted average vesting period of 2.43 and 2.55 years, respectively.

The Company recorded compensation expense associated with the issuance and vesting of stock options of $91,361 and $85,208 in selling, general and administrative expense for the three months ended March 31, 2010 and 2009, respectively.

During the three months ended March 31, 2010 and 2009, 28,958 and 0 employee stock options were exercised for total proceeds to the Company of $33,925 and $0, respectively. The aggregate intrinsic value of the exercised options was $90,532 and $0 for the three months ended March 31, 2010 and 2009, respectively.

The Company recognizes the fair value of options issued to employees and consultants as stock-based compensation expense over the vesting period of the awards. The estimated fair value of options is based on the Black-Scholes pricing model.

CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 - CONVERTIBLE NOTES PAYABLE

On September 12, 2006, the Company entered into a Securities Purchase Agreement with 13 accredited investors pursuant to which it sold 10% secured convertible debentures (the “2006 Debentures”) in the aggregate principal amount of $3,243,378 and common stock purchase warrants to purchase an aggregate of 3,243,378 shares of the Company’s common stock at $1.00 per share. The 2006 Debentures are convertible at $1.00 (the “Base Conversion Price”) into shares of common stock. The 2006 Debentures mature on September 12, 2009 and bear interest at the rate of 10% per year, payable quarterly. If, during the time that the 2006 Debentures were outstanding, the Company sells or grants any option to purchase (other than options issued pursuant to a plan approved by our board of directors), or sells or grants any right to reprice its securities, or otherwise disposes of or issues any common stock or common stock equivalents entitling any person to acquire shares of the Company’s common stock at a price per share that is lower than the conversion price of the debentures or that is higher than the Base Conversion Price but lower than the daily volume weighted average price of the common stock, then the conversion price of the 2006 Debentures will be reduced. During August 2009, the Company received a waiver whereby the holders of the 2006 Debentures permanently waived, as of and after April 1, 2009, any and all conversion or exercise price adjustments that would otherwise occur, or would have occurred on or after April 1, 2009, as a result of this provision.

Under the terms of the Registration Rights Agreement executed in conjunction with the offering, the Company is obligated to register for resale at least 130% of the shares of its common stock issuable upon the conversion of the 2006 Debentures and the exercise of the common stock purchase warrants. However, the agreement also prohibits the Company from registering shares of common stock on a registration statement that total more than one-half of the issued and outstanding shares of common stock, reduced by 10,000 shares.

If a registration statement was not filed within 30 days of the sale of the 2006 Debentures, or was not effective 120 days from the date of the sale of the 2006 Debentures, which was January 10, 2007, or if the Company did not respond to an SEC request for information during the registration period within 10 days of notice, the Company was required to pay to each holder of its 2006 Debentures an amount in cash, as partial liquidated damages and not as a penalty, equal to 1.5% of the aggregate subscription amount paid by each holder. The Company, (1) was not liable for liquidated damages with respect to any warrants or warrant shares, (2) was not liable for liquidated damages in excess of 1.5% of the aggregate subscription amount of the holders in any 30-day period, and (3) the maximum aggregate liquidated damages payable to a holder was 18% of the aggregate subscription amount paid by such holder up to a maximum aggregate liquidated damages of 18% of the total amount of the 2006 Debentures, or $583,808. If the Company failed to pay any partial liquidated damages in full within seven days after the date payable, the Company would pay interest at a rate of 18% per annum to the holder, accruing daily from the date such partial liquidated damages were due until such amounts, plus all such interest, were paid in full. The partial liquidated damages applied on a daily pro-rata basis for any portion of a month.

Pursuant to Amendment No. 1 to the Registration Rights Agreement, the holders of the Company’s 2006 Debentures agreed to extend the filing date of the registration statement to October 31, 2006, and pursuant to Amendment No. 2 to the Registration Rights Agreement, the holders of the Company’s 2006 Debentures agreed to extend the filing date of the registration statement to November 3, 2006. The Company did not meet the 10 day response period for responding to an SEC request for additional information nor did the Company meet the target registration statement effectiveness date of January 10, 2007. The holders did not agree to waive the liquidated damages that accrued due to the Company’s failure to meet the 10 day period for responding to an SEC request for additional information nor did the holders agree to waive the liquidated damages that accrued due to the Company’s failure to have the registration statement declared effective by January 10, 2007.

The Company believed, at the time the 2006 Debentures were issued, that it was probable that it would be in violation of certain filing provisions within the Registration Rights Agreement and recorded $111,897 as a discount to the 2006 Debentures. On March 23, 2007 the Company entered into a Consent and Waiver agreement as more fully described below that determined the actual liquidated damages to be $169,917 calculated through March 23, 2007 and covering the period through April 30, 2007.

The Company was also required to make an interest payment to the 2006 Debenture holders on April 1, 2007. The Consent and Waiver allowed the Company to make the April 1 interest payment and pay the liquidated damages in one of two ways to be chosen by each holder. For payment of the 2006 Debenture holder’s pro rata portion of the April 1 interest payment, the 2006 Debenture holder could choose to increase the principal amount of his 2006 Debenture by his pro-rata share of the accrued interest amount or accept shares of the Company’s common stock valued at $0.85 per share for this purpose. For payment of the 2006 Debenture holders pro rata portion of the liquidated damages, each 2006 Debenture holder had the same choice, that is, either to increase his 2006 Debenture by the pro rata liquidated damages amount or accept shares of the Company’s common stock valued at $0.85 per share for this purpose. If all the 2006 Debenture holders were to choose to accept shares of the Company’s common stock in payment of the April 1 interest payment and the liquidated damages, the Company would be required to issue up to a total of 566,336 shares of the Company’s common stock. The Consent and Waiver allowed the Company to issue these shares without triggering the anti-dilution rights included in the original offering documents. The Company issued 195,594 shares during 2007 as partial payment for these liquidated damages valued at $166,259. At March 31, 2010 and December 31, 2009, $3,658 of these damages remained in accrued expenses on the accompanying condensed balance sheets. The Company issued 190,090 shares in November and December 2007 as a partial payment in the amount of $161,580 for the April 1 interest. The Company issued 15,669 shares in January and February 2008 as a partial payment in the amount of $13,319 for the April 1 interest.

The Company did not meet the April 30, 2007 date for its registration statement to be declared effective by the SEC. The registration statement became effective on July 19, 2007. As a result, the Company incurred additional liquidated damages for the period May 1 through July 19, 2007 of $132,726. On September 21, 2007 the Company received from the holders of the 2006 Debentures a second Consent and Waiver. The holders of the 2006 Debentures agreed to accept shares of the Company’s common stock at $0.85 per share instead of cash as payment for the interest due on July 1, 2007 and October 1, 2007 and for damages incurred under the Registration Rights Agreement. The Company issued 135,063 shares in February 2008 as partial payment for these liquidated damages valued at $106,513. The Company issued 931 shares in April 2009 as partial payment for these liquidated damages valued at $791. At March 31, 2010 and December 31, 2009, $25,422 of these damages remained in accrued expenses on the accompanying condensed balance sheets. The Company issued 94,952 shares in February 2008 as a partial payment in the amount of $110,147 for the July 1 and October 1, 2007 interest payments.

The Company did not meet the August 18, 2007 date to file a second registration statement. As a result, the Company incurred additional liquidated damages for the period August 18 through December 19, 2007 of $194,603. The Company received from the holders of the 2006 Debentures a third Consent and Waiver, dated February 13, 2008 and amended on August 19, 2008. The third Consent and Waiver waived the requirement included in the 2006 Debentures and the Registration Rights Agreement that the Company file a second registration statement, waived the liquidated damages that accrued from and after December 19, 2007 and waived the payment of any interest that would have accrued on the liquidated damages. The holders of the 2006 Debentures agreed to accept either additional debentures or shares of the Company’s common stock at $0.85 per share instead of cash as payment for the interest due on January 1, 2008 and as payment of the liquidated damages accrued prior to December 19, 2007 under the Registration Rights Agreement. In September 2008, the Company issued $64,422 in additional unsecured convertible 10% debentures (“2006 Unsecured Debentures”) as payment of liquidated damages, which included $4,422 of penalty interest, and $26,868 in 2006 Unsecured Debentures as payment for quarterly interest due on January 1, 2008, which included $1,868 of penalty interest. The 2006 Unsecured Debentures had a term of 18 months and are convertible at $0.85 per share. During October and December 2008, the Company issued $349,494 in 2006 Unsecured Debentures as payment of liquidated damages, quarterly interest, and penalty interest. The Company issued 3,750 shares in December 2008 as partial payment for these liquidated damages valued at $3,750. The Company issued 5,567 shares in April 2009 as final payment for $4,732 in liquidated damages.

According to the terms of the 2006 Debentures, the Company is to make interest payments quarterly on January 1, April 1, July 1 and October 1 until September 2009, when the principal amount and all accrued but unpaid interest will be due. On September 22, 2008 the Company received from the holders of the 2006 Debentures a fourth Consent and Waiver of defaults of the 2006 Debentures. The holders of the 2006 Debentures agreed to accept either additional debentures or shares of the Company’s common stock at $0.85 per share instead of cash as payment for the interest due on April 1, July 1, and October 1, 2008, totaling $205,207. In August 2008, certain holders of the 2006 Debentures converted $8,694 of accrued interest into 8,694 shares of common stock as more fully described below. The Company issued 6,250 shares in December 2008 as partial payment for $6,250 in interest. The Company failed to make the interest payments that were due on January 1, April 1, and July 1 2009, totaling $126,614. The Company issued 9,281 shares in April 2009 as partial payment for $7,886 in interest. In May 2009, the Company paid $56,575 for quarterly interest, which included $3,810 of penalty interest. In September 2009, the Company paid $47,614 for quarterly interest. At March 31, 2010 and December 31, 2009, $69,982 remained in accrued interest on the 2006 Debentures and is included in accrued expenses on the accompanying condensed balance sheets.

The holders of certain shares and warrants for the purchase of common stock issued in conjunction with the sale of the Company’s Secured Convertible Promissory Notes during the period from November 2005 through March 2006, which were converted on September 12, 2006, also have certain registration rights. These holders agreed to defer their rights to require registration of their securities on the registration statement the Company filed; however, they have maintained the rights to piggyback on future registration statements filed by the Company.

The Company has accounted for the 2006 Debentures according to FASB ASC Topic 470, “Debt.” The value of the 2006 Debentures was allocated between the 2006 Debentures, the registration rights arrangement and the warrants, including the discount, which amounted to $63,689, $111,897 and $3,067,792, respectively. The discount of $3,179,689 related to the registration rights arrangement and the warrants, including the discount, is being amortized over the term of the 2006 Debentures. The Company amortized $0 and $398,391 to interest expense for the three months ended March 31, 2010 and 2009, respectively, including the acceleration of amortization due to conversions discussed below.

In addition, as part of the transaction, the Company paid $217,000, issued 1,000,515 shares of common stock in November 2006 valued at $1,000,515 and issued 217,000 unit purchase options with each unit consisting of 1 share of common stock and a warrant to purchase 1 share of common stock for $1.00 per share in November 2006. The unit purchase options were valued at $374,531 using the Black-Scholes option pricing model. These costs, totaling $1,592,046, are being amortized over the term of the 2006 Debentures. The Company recorded amortization of $0 and $199,165 to interest expense, including the acceleration of amortization due to conversions discussed below, related to the 2006 Debentures during the three months ended March 31, 2010 and 2009, respectively.

During the first quarter of 2009, certain holders of the 2006 Debentures converted $1,505,602 of principal into 1,505,602 shares of common stock at $1.00 per share. The unamortized discount and the unamortized debt issuance costs on the converted notes were recorded as interest expense at the time of the conversion.

During the first quarter of 2009, certain holders of the 2006 Unsecured Debentures converted $234,341 of principal into 275,695 shares of common stock at $0.85 per share.

As of December 31, 2009, all of the holders of the 2006 Debentures and 2006 Unsecured Debentures had converted the outstanding principal amount to shares of common stock and all of the related note discount and debt issuance costs have been amortized to interest expense.

On November 21, 2008, the Company entered into a fifth Consent and Waiver agreement whereby the holders of the 2006 Debentures agreed to allow the Company to sell up to $1,200,000 in aggregate principal amount of the Company’s 10% Convertible Promissory Notes (“2008 Convertible Notes”), due eleven months from the date of issuance and convertible into shares of Common Stock at a conversion price of $1.25 per share. In consideration of the waiver and the consent provided by the holders, the Company agreed to accelerate the maturity date of the 2006 Unsecured Debentures to September 12, 2009 and the Company agreed and acknowledged that the 2006 warrant shares and the shares of common stock underlying the 2006 Unsecured Debentures issued or issuable to each of the holders in payment of interest and liquidated damages pursuant to prior consent and waiver agreements shall carry “piggyback” registration rights.

Per the Consent and Waiver discussed above, in November and December 2008, the Company entered into a Securities Purchase Agreement, that also included registration rights, with certain accredited investors to which it sold 2008 Convertible Notes in the aggregate principal amount of $845,000, which may be converted at the price of $1.25 per share (subject to adjustment as discussed below) into an aggregate of 676,000 shares of common stock. In conjunction with the sale of the 2008 Convertible Notes, the Company issued common stock purchase warrants to purchase an aggregate of 338,000 shares of common stock at $1.25 per share and paid its placement agent a total of $50,700 in commissions and issued to its placement agent a five-year warrant to purchase an additional 50,700 shares of the Company’s common stock, at an exercise price of $1.25 per share, valued at $47,498 using the Black-Scholes option pricing model. In January 2009, the Company completed the sale and issuance of the Company’s 2008 Convertible Notes. Accordingly, the Company received additional gross proceeds of $355,000, which may be converted at the price of $1.25 per share (subject to adjustment as discussed below) into an aggregate of 284,000 shares of common stock. In conjunction with the sale of the 2008 Convertible Notes, the Company issued common stock purchase warrants to purchase an aggregate of 142,000 shares of common stock at $1.25 per share and paid its placement agent a total of $21,300 in commissions and issued to its placement agent a five-year warrant to purchase an additional 21,300 shares of the Company’s common stock, at an exercise price of $1.25 per share, valued at $18,197 using the Black-Scholes option pricing model.

If, during the time that the 2008 Convertible Notes are outstanding, the Company sells or grants any option to purchase (other than options issued to its employees, officers, directors or consultants), or sells or grants any right to re-price its securities, or otherwise dispose of or issue any common stock or common stock equivalents entitling any person to acquire shares of our common stock at a price per share that is lower than the conversion price of these notes, then the conversion price of the 2008 Convertible Notes will be reduced according to the following weighted average formula: the conversion price will be multiplied by a fraction the denominator of which will be the number of shares of common stock outstanding on the date of the issuance plus the number of additional shares of common stock offered for purchase and the numerator of which will be the number of shares of common stock outstanding on the date of such issuance plus the number of shares which the aggregate offering price of the total number of shares so offered would purchase at the conversion price. A reduction in the conversion price resulting from the foregoing would allow holders of the Company’s 2008 Convertible Notes to receive more than 960,000 shares of its common stock upon conversion of the outstanding principal amount. In that case, an investment in the Company’s common stock would be diluted to a greater extent than it would be if no adjustment to the conversion price were required to be made. During August 2009, the Company received a waiver from the holders of the 2008 Convertible Notes pursuant to which they forever waived, as of and after April 1, 2009, any and all conversion or exercise price adjustments that would otherwise occur, or would have otherwise occurred on or after April 1, 2009, as a result of this provision.

Under the terms of the Registration Rights Agreement executed in conjunction with the offering, the Company was obligated to file a registration statement with the SEC covering the resale of the shares issuable upon conversion of the 2008 Convertible Notes and the exercise of the common stock purchase warrants The Company was required to file the registration statement no later than 60 days following the final closing date of the sale and issuance of the 2008 Convertible Notes and warrants, and must use its best efforts to cause the registration statement to become effective no later than 120 days thereafter. If the Company was delinquent in the filing deadline or the effectiveness deadline of the registration statement, it would have been obligated to pay the holders of the 2008 Convertible Notes liquidated damages equal to 1% of the outstanding principal amount of the 2008 Convertible Notes for every 30-day period of delinquency, up to a maximum of 10%. The Company would have been required to pay any such liquidated damages in cash or its common stock valued at the average volume weighted average price (“VWAP”) for the five trading days preceding the applicable due date, provided such average VWAP exceeds $1.00 per share. On May 1, 2009, the Company received a Consent and Waiver from the holders of the 2008 Convertible Notes waiving all liquidated damages under the Registration Rights Agreement.

The warrants are redeemable at a price of $0.01 per share in the event (i) the average VWAP of the Company’s common stock for 10 consecutive trading days equals or exceeds 2.5 times the then current exercise price, (ii) the average daily trading volume of the common stock during such 10-trading day period is at least 50,000 shares and (iii) there is an effective registration statement covering the resale of the shares issuable upon exercise of the warrants.

The total value of the 2008 Convertible Notes was allocated between the 2008 Convertible Notes and the warrants, including the discount, which amounted to $595,646 and $604,354, respectively. The discount of $604,354 ($158,886 was recorded in the first quarter of 2009) related to the warrants, including the discount, is being amortized over the term of the 2008 Convertible Notes. The Company amortized $0 and $164,824 to interest expense related to the 2008 Convertible Notes for the three months ended March 31, 2010 and 2009, respectively. At March 31, 2010 and December 31, 2009, $0 and $109,001 of accrued interest on these notes is included in accrued expenses on the accompanying condensed balance sheets.

In addition, as part of the transaction, the Company paid to the placement agent $72,000 and issued common stock purchase warrants to purchase an aggregate of 72,000 shares of common stock at $1.25 per share. The warrants were valued at $65,695 using the Black-Scholes option pricing model. These costs, totaling $137,695 ($39,497 was recorded in 2009), are being amortized over the term of the 2008 Convertible Notes. The Company recorded amortization of $0 and $37,553 to interest expense during the three months ended March 31, 2010 and 2009, respectively.

On September 30, 2009, all of the holders of the 2008 Convertible Notes converted $1,200,000 of principal into 960,000 shares of common stock at $1.25 per share and all of the related note discount and debt issuance costs have been amortized to interest expense.

During May 2009, the Company entered into a ninth Consent and Waiver agreement whereby the holders of the 2006 Debentures agreed to allow the Company to sell up to $300,000 in aggregate principal amount of the Company’s 10% Convertible Promissory Notes (“2009 10% Convertible Notes”), due five months from the date of issuance and convertible into shares of Common Stock at a conversion price of $1.75 per share. Subsequent to the execution of the Consent and Waiver, in May 2009, the Company entered into a Securities Purchase Agreement with certain accredited investors to which it sold 2009 10% Convertible Notes in the aggregate principal amount of $300,000, which may be converted into an aggregate of 171,429 shares of common stock. In conjunction with the sale of the 2009 10% Convertible Notes, the Company paid its placement agent a total of $12,000 in commissions, which was amortized in full during 2009.

The total value of the 2009 10% Convertible Notes was allocated between the 2009 10% Convertible Notes and the discount, which amounted to $19,715. The discount was amortized over the term of the 2009 10% Convertible Notes. At March 31, 2010 and December 31, 2009, $0 and $12,500 of accrued interest on these notes is included in accrued expense on the accompanying condensed balance sheets.

On September 30 2009, all of the holders of the 2009 10% Convertible Notes converted $300,000 of principal into 171,429 shares of common stock at $1.75 per share and all of the related note discount and debt issuance costs have been amortized to interest expense.

On November 4, 2009, the Company closed the sale and issuance of $2.2 million in aggregate principal amount of its 8% Secured Convertible Promissory Notes (the “2009 8% Convertible Notes”), convertible into common stock of the Company at a conversion price of $2.05 per share. The Company has the right, up to and including the trading day immediately prior to the payment due date, to force the holders to convert all or part of the then outstanding principal amount of the 2009 8% Convertible Notes, plus accrued but unpaid interest, into shares of the Company’s common stock if the 10-day volume weighted average price (sometimes referred to as “VWAP”) exceeds 250% of the conversion price. All outstanding principal and interest of the 2009 8% Convertible Notes is due April 1, 2011. Out of the total gross proceeds of the offering, the Company paid its placement agent $154,980 in commissions, equal to 7% of the gross proceeds of the offering, and issued to its placement agent a three year warrant to purchase 77,490 shares of common stock, equal to 3.5% of the number of shares of common stock into which the 2009 8% Convertible Notes initially may be converted, at an exercise price of $2.05 per share. The warrants were valued at $132,369 using the Black-Scholes option pricing model. These costs, totaling $287,349, are being amortized over the term of the 2009 8% Convertible Notes. The Company recorded amortization of $47,892 to interest expense during the three months ended March 31, 2010. In conjunction with the sale of the 2009 8% Convertible Notes, the Company executed a Security Agreement pursuant to which it granted to the note holders a first lien security interest, subject only to certain Permitted Liens which are defined in the Security Agreement, in certain collateral to secure payment of the 2009 8% Convertible Notes.

The total value of the 2009 8% Convertible Notes was allocated between the 2009 8% Convertible Notes and the discount, which amounted to $745,200. The discount is being amortized over the term of the 2009 8% Convertible Notes. The Company amortized $124,200 to interest expense related to the 2009 8% Convertible Notes for the three months ended March 31, 2010. At March 31, 2010 and December 31, 2009, $76,999 and $32,719 of accrued interest on these notes is included in accrued expenses on the accompanying condensed balance sheets.

On March 31, 2010, the Company sold and issued in a private placement to GRM a 9% Secured Convertible Promissory Note in the aggregate principal amount of $5,300,000 (the “GR Note”), due March 31, 2012. The Company received net proceeds of $5,000,000 after payment of an issuance fee of $300,000 to GRM. The Company has recorded the $300,000 as a discount to the GR Note as if the amount were an original issue discount. The GR Note will accrue simple interest at the rate of 9% per annum, payable on the first day of each calendar quarter in cash; provided, however, that GRM may elect to cause the accrued unpaid interest for any applicable quarter to be added to the then outstanding principal amount of the GR Note in lieu of a cash payment of interest by delivering written notice of such election to the Company no later than 15 days prior to the applicable interest payment date. The Company may elect to make the first interest payment due July 1, 2010 either in cash or by adding it to the aggregate principal amount of the GR Note.

Commencing 180 days after March 31, 2010, the outstanding principal amount of the GR Note and accrued unpaid interest due thereon may be converted, at GRM’s election, into the Company’s common stock at a conversion price of $3.50 per share (the “Conversion Price”), subject to adjustment only in the event of stock splits, dividends, combinations, reclassifications and the like. If at any time after 180 days from the later of March 31, 2010 or such date when a registration statement filed with the SEC covering the resale of the shares issuable upon conversion of the GR Note becomes effective, the volume weighted average price of the Company’s common stock for each of any 30 consecutive trading days, which period shall have commenced after the effective date of such registration statement, exceeds 250% of the then applicable Conversion Price, and the daily trading volume for the common stock is at least 100,000 shares (subject to adjustment for stock splits, combinations, recapitalizations, dividends and the like) during such 30 trading day period, then the Company may force GRM to convert all or part of the then outstanding principal amount of the GR Note. GRM has piggyback and demand registration rights with respect to the shares issuable upon conversion of the GR Note.

The Company has the right to prepay the GR Note at any time without penalty upon 30 days written notice to GRM. GRM’s right to convert the GR Note (commencing 180 days after its issuance date), remains active during the prepayment notice period. Therefore, if the Company notifies GRM of its election to prepay the GR Note sooner than 150 days from the issuance date of the GR Note, then GRM would be obligated to accept repayment in cash.

The Company granted GRM a first lien priority security interest in all of the Company’s assets securing the Company’s obligations under the GR Note, subject to certain permitted indebtedness and liens permitted in connection with the same.

The Company agreed that on or before 90 days following March 31, 2010, the Company shall: (i) cause each holder (each, a “Senior Debt Holder”) of the Company’s outstanding 2009 8% Convertible Notes, dated on or about November 5, 2009, in the aggregate principal amount of $2,214,000, to (A) be entirely converted, along with accrued unpaid interest thereon, into shares of the Company’s common stock in accordance with the terms thereof; or (B) expressly subordinate any lien which the Senior Debt Holder holds in the Company's assets to the GR Note and the security interest granted to GRM pursuant to a written subordination agreement with GRM acceptable to GRM in its sole discretion; or (C) prepay the entire outstanding principal balance of each 2009 8% Convertible Note, and any accrued unpaid interest thereon and cause each of the 2009 8% Convertible Notes to be cancelled.

The total value of the GR Note was allocated between the GR Note and the discount, which amounted to $1,208,571 including the $300,000 issuance fee. The discount will be amortized over the term of GR Note. The Company amortized $0 to interest expense related to the GR Note for the three months ended March 31, 2010.

As part of the transaction, the Company incurred costs of approximately $51,000. These costs are being amortized over the term of the GR Note. The Company recorded amortization of $0 to interest expense during the three months ended March 31, 2010 and 2009, respectively.

Convertible notes payable consist of the following:

	March 31, 2010			December 31, 2009
GR Note		5,300,000			-
2009 8% Convertible Notes		2,214,000			2,214,000
Unamortized discount		(1,705,371	)		(621,000	)
Convertible notes payable, net	$	5,808,629		$	1,593,000

NOTE 6 - COMMITMENTS AND CONTINGENCIES

Royalty Agreement

On July 24, 2009, the Company entered into a licensing agreement with Wiley Publishing, Inc., owner of the For Dummies® trademark, for use of the For Dummies® trademark in connection with the manufacture, development, operation, sale, distribution and promotion of the Company’s products. The term of the agreement is five years with an option for the Company to renew for an additional five years provided that the Company has paid to Wiley a minimum royalty of $2,000,000 during the initial term of the agreement. The Company paid a $100,000 non-refundable royalty advance that is recorded in prepaid expenses on the accompanying balance sheet. There was no royalty expense for the three months ended March 31, 2010.